REG - Personal Flashcards
Susan inherits her father's house upon his death. At the time of the inheritance, the father's basis in the property was $100,000. The fair market value of the house at the time of the inheritance was $90,000. The alternative valuation method was not elected in regard to the father's estate. Susan does not use the house as her principal residence and subsequently sells the house for $95,000. Susan will include a capital gain/loss of what amount on her individual tax return in the year she sells the house $5,000 gain $5,000 loss $0 gain $95,000 gain
$5,000 gain
The basis of inherited property is generally the value of the property (as determined for estate tax purposes) at the decedent’s date of death. The estate tax value is generally the fair market value of the property as of the date of death. In certain limited circumstances, the executor or personal representative is permitted to elect an alternate valuation date. In such a case, the basis will be the fair market value six months after the date of death or upon sale within six months.
In this question, Susan’s basis in the property is $90,000 (the fair market value at the time of the inheritance). Thus, when she sold the property for $95,000, she incurred a $5,000 gain.
IRC Section 1014(a)
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4420 Basis and Holding Periods of Assets
4450 Amount and Character of Gains and Losses, and Netting …
Which of the following is not considered a primary authoritative source when conducting tax research Internal Revenue Code Tax Court cases IRS publications Treasury Regulations
IRS publications
The Internal Revenue Code, or IRC, is the most authoritative source when conducting tax research. Treasury Regulations and U.S. Tax Court cases are also primary sources. IRS publications are not considered a primary authoritative source when conducting tax research.
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4381 Authoritative Hierarchy
Under Treasury Circular 230, which of the following actions of a CPA tax advisor is characteristic of a best practice in rendering tax advice
Requesting written evidence from a client that the fee proposal for tax advice has been approved by the board of directors
Recommending to the client that the advisor’s tax advice be made orally instead of in a written memorandum
Establishing relevant facts, evaluating the reasonableness of assumptions and representations, and arriving at a conclusion supported by the law and facts in a tax memorandum
Requiring the client to supply a written representation, signed under penalties of perjury, concerning the facts and statements provided to the CPA for preparing a tax memorandum
Establishing relevant facts, evaluating the reasonableness of assumptions and representations, and arriving at a conclusion supported by the law and facts in a tax memorandum
Generally, a CPA can rely on information furnished by a client in the preparation of a tax memorandum. If the information seems to be incorrect, inconsistent, or incomplete, the CPA must make reasonable inquiries. When the facts are established, then relevant tax law must be applied accurately to the known facts.
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4111 Treasury Department Circular 230
A tax preparer has advised a company to take a position on its tax return. The tax preparer believes that there is a 75% possibility that the position will be sustained if audited by the IRS. If the position is not sustained, an accuracy-related penalty and a late-payment penalty would apply. What is the tax preparer’s responsibility regarding disclosure of the penalty to the company
The tax preparer is responsible for disclosing both penalties to the company
The tax preparer is responsible for disclosing only the accuracy-related penalty to the company.
The tax preparer is responsible for disclosing only the late-payment penalty to the company.
The tax preparer has no responsibility for disclosing any potential penalties to the company, because the position will probably be sustained on audit.
The tax preparer is responsible for disclosing both penalties to the company
A practitioner must inform a client of any and all penalties that are likely to apply to the client with respect to a position taken on a tax return.
Circular 230, Section 10.34(c)(1)
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4111 Treasury Department Circular 230
Which of the following facts will result in an offering of securities being exempt from registration under the Securities Act of 1933
The securities are nonvoting preferred stock.
The issuing corporation was closely held prior to the offering.
The sale or offer to sell the securities is made by a person other than an issuer, underwriter, or dealer.
The securities are AAA-rated debentures that are collateralized by first mortgages on property that has a market value of 200% of the offering price.
The sale or offer to sell the securities is made by a person other than an issuer, underwriter, or dealer.
Under the Securities Act of 1933, most issuances of securities must first be registered with the SEC. However, this requirement is only applicable to issuers, underwriters, and dealers. An “issuer” is the individual or business entity that is offering the securities for sale to the public. It may also include a “control person,” meaning someone having substantial power to influence the policies of management (such as the president of the company).
Thus, a sale or offer to sell the securities is made by a person other than an issuer, underwriter, or dealer (e.g., a stockbroker) is exempt from registration under the Securities Act of 1933.
No exemption from registration applies just because the securities are nonvoting preferred stock or the issuing corporation was closely held prior to the offering or even if the securities are AAA-rated debentures that are collateralized by first mortgages on property that has a market value of 200% of the offering price.
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4251 Federal Securities Regulation
In preparing Watt’s individual income tax return, Stark, CPA, took a deduction contrary to a Tax Court decision that had disallowed a similar deduction. Stark’s position was adopted in good faith and with a reasonable belief that the Tax Court decision failed to conform to the Internal Revenue Code. Under the circumstances, Stark will:
be liable for the preparer’s negligence penalty.
not be liable for a preparer penalty unless the understatement of taxes is at least 25% of Watt’s tax liability.
be liable for the preparer’s penalty because of Stark’s intentional disregard of the Tax Court decision.
not be liable for a preparer penalty if Stark exercised due diligence.
not be liable for a preparer penalty if Stark exercised due diligence.
IRC Section 6501 contains a penalty for the omission of at least 25% of gross income, not tax liability.
Under IRC Section 6694(a)(3), no penalty will be imposed if there is reasonable cause for the action and the preparer acted in good faith. The penalty under this section applies if there is an intentional disregard of rules or regulations—not court cases. IRC Section 6662(c) defines negligence as the failure to make a reasonable attempt to comply with tax law. A position taken in good faith would not be negligence.
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4113 Internal Revenue Code of 1986, as Amended, and …
Dowd, Elgar, Frost, and Grant formed a general partnership. Their written partnership agreement provided that the profits would be divided so that Dowd would receive 40%; Elgar, 30%; Frost, 20%; and Grant, 10%. There was no provision for allocating losses. At the end of its first year, the partnership had losses of $200,000. Before allocating losses, the partners’ capital account balances were: Dowd, $120,000; Elgar, $100,000; Frost, $75,000; and Grant, $11,000. Grant refuses to make any further contributions to the partnership. Ignore the effects of federal partnership tax law.
What would be Grant's share of the partnership losses $9,000 $20,000 $39,000 $50,000
$20,000
Grant’s share of the partnership losses is $20,000. The computation is based on the legal principle that if there is no provision for allocating losses, the method used to allocate profits will be used.
- Grant 10% of profits
- 0.10 × $200,000 (losses) = $20,000
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4264 Rights, Duties, Legal Obligations, and Authority of …
Which of the following entities may adopt any tax year-end C corporation S corporation Limited liability company Trust
C corporation
A C corporation may adopt any tax year-end. An S corporation is generally required to adopt a calendar year-end. An LLC with two or more members is taxed as a partnership in the absence of an election otherwise. The partnership’s taxable year must correspond to the partner’s taxable year and they are, therefore, generally calendar years. A trust may only adopt a calendar year.
IRC Sections 444(e), 706(b), and 644; Regulation Section 301.7701-2(c)(1)
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4662 Income and Deductions
What is the initial maximum annual gross receipts test amount beneath which a small business corporation qualifies for relief from the AMT $5 million $6 million $7 million $7.5 million
$5 million
A small corporation is exempt from AMT tax. In general, to be considered a small corporation for this purpose, the corporation must have average annual gross receipts under $7.5 million for the preceding 3-year period.
A special rule applies for the first two years a corporation is in existence. All corporations are exempt from AMT for their first tax year. The second tax year of a new corporation is its initial test year. The gross receipts test for a corporation’s initial test year is $5 million to qualify as a small corporation exempt from AMT. For all later years, the gross receipts test is $7.5 million.
For example, New Corp. starts January 2, 2012, and has gross receipts of $4 million in 2012 and $7 million in 2013. New Corp. is not subject to AMT in 2012 since that is its first tax year. For 2013, it is not subject to the AMT since the gross receipts in its preceding tax year of $4 million is less than the $5 million initial test year threshold. For 2014, it is not subject to AMT because the average annual receipts in the preceding tax years of $5.5 million is less than the $7.5 million general test threshold.
IRC Section 55(e)
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4632 Tax Computations and Credits, Including Alternative …
For Year 2, Quest Corp., an accrual-basis calendar-year C corporation, had an $8,000 unexpired charitable contribution carryover from Year 1. Quest’s Year 2 taxable income before the deduction for charitable contributions was $200,000. On December 12, Year 2, Quest’s board of directors authorized a $15,000 cash contribution to a qualified charity, which was made on January 6, Year 3.
What is the maximum allowable deduction that Quest may take as a charitable contribution on its Year 2 income tax return
$23,000
$20,000
$15,000
$8,000
$20,000
For an accrual-basis corporation, any charitable contribution authorized by the board of directors prior to year-end and paid within 2-1/2 months from year-end may be deducted on the prior-year tax return.
The maximum allowable deduction that Quest Corp. may take as a charitable contribution is 10% of $200,000 (its taxable income), which is $20,000.
The current-year charitable contribution is used first before any carryover. In Year 2, Quest will use all of the current-year contribution of $15,000 plus $5,000 of the carryover contribution from Year 1. The remaining carryover of $3,000 from Year 1’s contribution will be carried over to Year 4.
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4631 Determination of Taxable Income/Loss
Wren purchased a factory from First Federal Realty. Wren paid 20% at the closing and gave a note for the balance secured by a 20-year mortgage. Five years later, Wren found it increasingly difficult to make payments on the note and defaulted. First Federal threatened to accelerate the loan and foreclose if Wren continued in default. First Federal told Wren to make payment or obtain an acceptable third party to assume the obligation. Wren offered the land to Moss, Inc., for $10,000 less than the equity Wren had in the property. This was acceptable to First Federal and at the closing Moss paid the arrearage, assumed the mortgage and note, and had title transferred to its name. First Federal released Wren. The transaction in question is:
an assignment and delegation.
a third-party beneficiary contract.
a novation.
a purchase of land subject to a mortgage.
a novation.
A novation occurs (generally with regard to a mortgage) when a third party assumes a liability and the original lender releases the original debtor from the liability.
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4224 Discharge, Breach, and Remedies
During an audit of Trent Realty Corp.’s financial statements, Clark, CPA, reviewed the following instrument:
FRONT OF INSTRUMENT BACK OF INSTRUMENT
To: Pure Bank M. West
Upton, VT
Pay to C. Larr
April 5, 20X1 T. Keetin
Pay to the order of M. West $1,500.00
One Thousand Five Hundred and 00/100 Dollars C. Larr
on May 1, 20X1. Without recourse
(SIGNED) W. Fields
order paper.
Keetin made a special indorsement on the back of the instrument because his signature was combined with a directive as to whom the instrument would next be payable (in this case, C. Larr). As a result of this special indorsement the instrument becomes order paper, meaning that the named party’s indorsement (Larr, in this case) is now necessary to further negotiate the instrument.
(The instrument was and continues to be negotiable because all requirements for negotiability appear on the face/front of the instrument; the special indorsement has no effect on the negotiability of the instrument.)
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4232 Negotiable Instruments
Dart Corp. engaged Jay Associates, CPAs, to assist in a public stock offering. Jay audited Dart’s financial statements and gave an unqualified opinion, despite knowing that the financial statements contained misstatements. Jay’s opinion was included in Dart’s registration statement. Larson purchased shares in the offering and suffered a loss when the stock declined in value after the misstatements became known.
If Larson succeeds in the Section 11 suit against Dart, Larson would be entitled to:
damages of three times the original public offering price.
rescind the transaction.
monetary damages only.
damages, but only if the shares were resold before the suit was started.
monetary damages only.
If Larson succeeds in the Section 11 suit against Dart (issuer), the investor would be entitled to monetary damages only.
Section 11 of the Securities Act of 1933 does not provide for treble damages or for rescission. There is also no requirement that the shares be resold before the suit is started.
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4132 Federal Statutory Liability
In the current year, Brown, a C corporation, has gross income (before dividends) of $900,000 and deductions of $1,100,000 (excluding the dividends-received deduction). Brown received dividends of $100,000 from a Fortune 500 corporation during the current year. What is Brown's net operating loss $100,000 $130,000 $170,000 $200,000
$170,000
Since a Fortune 500 corporation’s stock is generally widely held, this indicates that Brown owns less than 20% of its stock and qualifies for the 70% dividends-received deduction. The taxable income limitation for the dividends-received deduction does not apply since Brown has a net operating loss. Brown’s net operating loss is calculated as follows:
Income before dividends $ 900,000
Dividends 100,000
———–
Gross income 1,000,000
Deductions (1,100,000)
———–
Net operating loss before special deductions (100,000)
Dividend-received deduction ($100,000 x 70%) (70,000)
———–
Net operating loss $ (170,000)
===========
IRC Sections 243(a)(1) and 246(b)(1)–(2)
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4631 Determination of Taxable Income/Loss
Among which of the following related parties are losses from sales and exchanges not recognized for tax purposes
Father-in-law and son-in-law
Grandfather and granddaughter
Ancestors, lineal descendants, and all in-laws
Brother-in-law and sister-in-law
Grandfather and granddaughter
Losses from sales and exchanges between certain related parties are not recognized for tax purposes. Related parties are considered brother and sisters, half-brothers and half-sisters, spouses, ancestors (parents and grandparents), and lineal descendants. Relatives by marriage, or in-laws, are not considered related parties for tax purposes.
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4460 Related Party Transactions
After an S corporation elects to revoke its status as an S corporation, it must:
always wait five years before making a new election.
wait five years, but can apply to the IRS for an earlier reelection.
never reapply for S corporation status again.
wait until at least 50% of stock is owned by new shareholders.
wait five years, but can apply to the IRS for an earlier reelection.
When S corporation status is revoked (either voluntarily or through failing to meet the requirements), a corporation can apply to the IRS National Office for an early reelection. The IRS will usually grant the early reelection if ownership has changed by more than 50% or when the termination was not within their control, such as death of a shareholder and inheritance of the stock by someone who is not a U.S. citizen or resident.
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4641 Eligibility and Election
The generation-skipping transfer tax is imposed:
instead of the gift tax.
instead of the estate tax.
as a separate tax in addition to the gift and estate taxes.
on transfers of future interest to beneficiaries who are more than one generation above the donor’s generation.
as a separate tax in addition to the gift and estate taxes.
In order to keep families from avoiding the federal gift and estate tax (called the unified transfer tax) by passing wealth to younger generations (for example, the father would pass wealth directly to his great-grandchild), the Internal Revenue Code imposes an additional generation-skipping transfer tax (GSTT).
The GSTT applies to lifetime transfers by gifts made after September 25, 1985, and to transfers by death occurring after October 22, 1986. The GSTT applies to gifts made to descendants two or more generations below the donor’s generation.
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4473 Determination of Taxable Estate
According to the standards of the profession, which of the following activities would most likely not impair a CPA’s independence if otherwise allowed under Sarbanes-Oxley
Providing extensive advisory services for a non audit client
Contracting with a client to supervise the client’s office personnel
Signing a client’s checks in emergency situations
Accepting a luxurious gift from a client
Providing extensive advisory services for a non audit client
A member in public practice must be independent in the performance of professional services. Providing advisory services does not have an effect on independence if the client is not an audit client. However, supervising a client’s office personnel, signing a client’s checks, and accepting luxurious gifts from a client all impair independence.
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4121 Liability Generally
During an audit of Trent Realty Corp.’s financial statements, Clark, CPA, reviewed the following instrument:
FRONT OF INSTRUMENT BACK OF INSTRUMENT
To: Pure Bank M. West
Upton, VT
Pay to C. Larr
April 5, 20X1 T. Keetin
Pay to the order of M. West $1,500.00
One Thousand Five Hundred and 00/100 Dollars C. Larr
on May 1, 20X1. Without recourse
(SIGNED) W. Fields
Larr's indorsement makes the instrument: bearer paper. order paper. negotiable. nonnegotiable.
bearer paper.
Larr made a blank indorsement since he did not indicate the next person to whom the instrument would be payable. Pursuant to a blank indorsement, the instrument is bearer paper. The fact that Larr added “without recourse” to the indorsement does not affect whether or not the instrument is bearer paper or negotiable.
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4232 Negotiable Instruments
Wilk bought an apartment building from Dix Corp. There was a mortgage on the building securing Dix’s promissory note to Xeon Finance Co. Wilk took title subject to Xeon’s mortgage. Wilk did not make the payments on the note due Xeon, and the building was sold at a foreclosure sale. If the proceeds of the foreclosure sale are less than the balance due on the note, which of the following
statements is correct regarding the deficiency
Xeon must attempt to collect the deficiency from Wilk before suing Dix.
Dix will not be liable for any of the deficiency because Wilk assumed the note and mortgage.
Xeon may collect the deficiency from either Dix or Will.
Dix will be liable for the entire deficiency.
Dix will be liable for the entire deficiency.
If the proceeds of the foreclosure sale are less than the balance due on the note, Dix will be liable for the entire deficiency. This question tests your understanding of the liabilities involved in assuming a mortgage obligation.
The mortgage was taken out by Dix Corp. from Xeon Finance Co. When Wilk took title subject to Xeon’s mortgage, Dix was not relieved of its financial obligation under the original mortgage. The only way for Dix to be released from its financial obligation to Xeon Finance is to have the finance company release it from its obligation. When new buyers assume a mortgage, they agree to make payments on that mortgage, but that agreement does not mean that the mortgage company has released the original debtor from the obligation.
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4222 Performance
Which of the following statements related to a traditional IRA is not correct for 2014
The maximum deduction is generally $5,500 per individual.
An individual at least age 50 may deduct up to $6,500.
A 10% penalty tax applies to any withdrawal made prior to age 59-1/2.
The $5,500 maximum deduction is phased out for taxpayers with adjusted gross income over certain amounts.
A 10% penalty tax applies to any withdrawal made prior to age 59-1/2.
The 10% penalty does not apply to all withdrawals made prior to age 59-1/2. Withdrawals may be made for qualified education expenses and by first-time homebuyers with no penalty.
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4560 Taxation of Retirement Plan Benefits
White, who owned a small business that operated as a sole proprietorship, filed for bankruptcy on October 1, 20X1. Among his creditors was his sole employee, who was owed $3,000 for wages earned within the previous two months ($1,500 each month). In this case, the employee is:
a priority creditor in the amount of $1,500.
a priority creditor in the amount of $2,000.
a priority creditor in the amount of $3,000.
not a priority creditor.
a priority creditor in the amount of $3,000.
Under the Bankruptcy Reform Act of 2005 as adjusted by the indexing provisions, employees have priority status for wages earned within the prior 180 days, up to a maximum of $12,475 (indexed for inflation). In this case, the employee is given priority status for the full amount of wages earned ($3,000).
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4242 Bankruptcy and Insolvency
In 2014, Starke Corp., an accrual-basis calendar-year corporation, reported book income of $380,000. Included in that amount was $50,000 municipal bond interest income, $170,000 for federal income tax expense, and $2,000 interest expense on the debt incurred to carry the municipal bonds. What amount should Starke's taxable income be as reconciled on Starke's Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return $330,000 $500,000 $502,000 $550,000
$502,000
Book income $380,000
Less:
1. Municipal bond interest income - 50,000
——–
$330,000
Add:
2. Federal income tax expense + 170,000
3. Interest expense on the debt
incurred to carry tax-exempt bonds 2,000
——–
Taxable income $502,000
========
A corporation’s Schedule M-1 (Form 1120) reconciles book income to taxable income.
- Municipal bond interest is not taxable income.
- Federal income taxes are not deductible in determining taxable income.
- No deduction is allowed for interest paid on a debt incurred or continued in order to purchase or carry tax-exempt bonds.
Corporations with over $10,000,000 in assets must use Schedule M-3.
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4621 Reconciliation of Book Income to Taxable Income
Under a contract governed by the U.C.C. Sales Article, which of the following statements is correct
Unless both the seller and the buyer are merchants, neither party is obligated to perform the contract in good faith.
The contract will not be enforceable if it fails to expressly specify a time and a place for delivery of the goods.
The seller may be excused from performance if the goods are accidentally destroyed before the risk of loss passes to the buyer.
If the price of the goods is less than $500, the goods need not be identified to the contract for title to pass to the buyer.
The seller may be excused from performance if the goods are accidentally destroyed before the risk of loss passes to the buyer.
The seller may be excused from performance if the goods are accidentally destroyed before the risk of loss passes to the buyer.
The other statements are false:
- “Unless both the buyer and seller are merchants, neither party is obligated to perform the contract in good faith.” The good faith obligation is applied to both parties.
- “The contract will not be enforceable if it fails to expressly specify a time and a place for delivery of goods.” The U.C.C. states that if delivery is not specified, then delivery is at the seller’s place of business or where the parties both know the goods are (such as a warehouse).
- “If the price of the goods is less than $500, the goods need not be identified to the contract for title to pass to the buyer.” This is an attempt to confuse you with the Statutes of Fraud provision in the U.C.C. which states that the sale of goods of $500 or more must be evidenced by a writing to be enforceable.
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4231 Sales Contracts
Lane, Inc., an S corporation, pays single coverage health insurance premiums of $4,800 per year and family coverage premiums of $7,200 per year for each eligible employee. Mill is a 10% shareholder-employee in Lane. On Mill's behalf, Lane pays Mill's family coverage under the health insurance plan. What amount of insurance premium is includible in Mill's gross income $0 $720 $4,800 $7,200
$7,200
If Mill owned less than 2% of the company, the correct answer would be zero.
Since Mill owns more than 2% of the company, the insurance premiums paid by the S corporation are fully taxable.
Mill received family benefits of $7,200, which are taxable.
Revenue Ruling 91-26
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4511 Inclusions and Exclusions
Under Section 12 of the Securities Exchange Act of 1934, in addition to companies whose securities are traded on a national exchange, what class of companies is subject to the SEC’s continuous disclosure system
Companies with annual revenues in excess of $5 million and 300 or more shareholders
Companies with annual revenues in excess of $10 million and 500 or more shareholders
Companies with assets in excess of $5 million and 300 or more shareholders
Companies with assets in excess of $10 million and 500 or more shareholders
Companies with assets in excess of $10 million and 500 or more shareholders
Companies whose securities are traded over-the-counter, whose assets exceed $10 million, who have 500 or more shareholders, and whose securities are traded in interstate commerce are subject to the SEC’s continuous disclosure system.
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4251 Federal Securities Regulation
Under the uniform capitalization rules applicable to property acquired for resale, which of the following costs should be capitalized with respect to inventory if no exceptions are met
Marketing costs
Off-site storage costs
Both marketing costs and off-site storage costs
Neither marketing costs nor off-site storage costs
Off-site storage costs
Under the uniform capitalization rules, the following costs must be included in inventory:
-All direct cost of the property (IRC Section 263A(a)(2)(A))
-Indirect costs (such as off-site storage costs) (IRC Section 263A(a)(2)(B))
The following costs are never capitalized to inventory: selling, marketing, advertising, and distribution expenses.
Regulation Section 1.263A-1
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4342 Inventory Valuation Methods, Including Uniform …
Which Senate committee considers new tax legislation Budget Finance Appropriations Rules and Administration
Finance
The Senate Committee on Finance reviews all tax bills that are approved by the U.S. House of Representatives and forwarded to the Senate for action.
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4310 Federal Tax Legislative Process
4381 Authoritative Hierarchy
During 2014, Hall, an unmarried taxpayer, made a $10,000 cash gift to his son in May and a further $14,000 cash gift to him in August. The cash transfers: are a gift of present interest. are a gift of a future interest. are not a completed gift. are not subject to the gift tax.
are a gift of present interest.
The cash transfer is a gift of a present interest because the recipient has full enjoyment immediately of the gift.
Therefore, the transfer is subject to the gift tax and is eligible for the $14,000 annual exclusion. In this case, $10,000 would be subject to gift tax. The taxpayer can apply any unused applicable (unified) credit against the gift tax.
IRC Sections 2503(b) and 2505(a)
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4471 Transfers Subject to the Gift Tax
Dart, Inc., a closely held corporation, was petitioned involuntarily into bankruptcy under the liquidation provisions of Chapter 7 of the Federal Bankruptcy Code. Dart contested the petition.
Dart has not been paying its business debts as they became due, has defaulted on its mortgage loan payments, and owes back taxes to the IRS. The total cash value of Dart’s bankruptcy estate after the sale of all assets and payment of administration expenses is $100,000.
Dart has the following creditors:
- Fracon Bank is owed $75,000 principal and accrued interest on a mortgage loan secured by Dart’s real property. The property was valued at and sold, in bankruptcy, for $70,000.
- The IRS has a $12,000 recorded judgment for unpaid corporate income tax.
- JOG Office Supplies has an unsecured claim of $3,000, which was timely filed.
- Nanstar Electric Co. has an unsecured claim of $1,200, which was not timely filed.
- Decoy Publications has a claim of $18,000, of which $2,000 is secured by Dart’s inventory, which was valued and sold, in bankruptcy, for $2,000. The claim was timely filed.
Which of the following events will follow the filing of the Chapter 7 involuntary petition
I. A trustee will be appointed.
II. A stay against creditor collection proceedings will go into effect.
Both I and II
I only
II only
Neither I nor II
Both I and II
After a bankruptcy petition is filed, a trustee will be appointed by the bankruptcy judge. The trustee will represent the creditors and will seek to seize and sell the debtor’s assets so as to pay the listed creditors as much as possible out of the bankrupt’s estate. The bankruptcy judge will order a stay preventing individual creditors from initiating their own collection proceedings; all such actions must be taken by the trustee.
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4242 Bankruptcy and Insolvency
On February 15, Mazur Corp. contracted to sell 1,000 bushels of wheat to Good Bread, Inc., at $6 per bushel with delivery to be made on June 23. On June 1, Good advised Mazur that it would not accept or pay for the wheat. On June 2, Mazur sold the wheat to another customer at the market price of $5 per bushel. Mazur had advised Good that it intended to resell the wheat. Which of the following statements is correct?
Mazur can successfully sue Good for the difference between the resale price and the contract price.
Good can successfully sue Mazur for specific performance.
Mazur can resell the wheat only after June 23.
Good can retract its anticipatory breach at any time before June 23.
Mazur can successfully sue Good for the difference between the resale price and the contract price.
Under a sales contract, neither party can sue unless they offer to perform their part of the contract. It is the buyer’s obligation to accept conforming goods. When a buyer wrongfully revokes acceptance of the goods, the seller can resell the goods and recover damages.
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4231 Sales Contracts
The AB Trust had DNI of $30,000, fiduciary accounting income of $50,000, and distributed $40,000 to beneficiaries during 2014. What amount should the sole beneficiary of the AB Trust report as taxable income from the trust $0 $30,000 $40,000 $50,000
$30,000
Beneficiaries are taxed on their share of the trusts income distributed to them, but not more than their share of DNI of the trust.
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4663 Determination of Beneficiary’s Share of Taxable Income
Which of the following statements best describes the ethical standard of the profession pertaining to advertising and solicitation
All forms of advertising and solicitation are prohibited.
There are no prohibitions regarding the manner in which CPAs may solicit new business.
A CPA may advertise in any manner that is not false, misleading, or deceptive.
A CPA may only solicit new clients through mass mailings.
A CPA may advertise in any manner that is not false, misleading, or deceptive.
A quick review of the answers shows key characteristics of questions that often are wrong, “all,”“no” prohibitions, and “may only.” Whenever you see these types of answers, be very careful.
Under AICPA Ethics Rule ET 502.01: “Advertising and other forms of solicitation. A member in public practice shall not seek to obtain clients by advertising or other forms of solicitation in a manner that is false, misleading, or deceptive. Solicitation by the use of coercion, over-reaching, or harassing conduct is prohibited.”
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4111 Treasury Department Circular 230
The prospectus for the sale of securities of a not-for-profit corporation contained material misrepresentations due to the negligence of the person who prepared the financial statements. As a result of the misrepresentations, purchasers of the shares lost their investment. Do the anti-fraud provisions of the Securities Act of 1933 apply in this situation
Yes, because the securities are required to be registered
Yes, because the misrepresentations were material
No, because the securities are exempt from registration
No, because only the issuer was negligent
Yes, because the misrepresentations were material
Under the Act, it matters not whether the omission was intentional or not, negligence is sufficient. Further, the fact the materials were for a nonprofit entity are of no importance, nor is the question as to whether the securities were required to be registered or not. The recovery action would be brought by the aggrieved party in federal court and the issuer will have to prove that the error was not material to avoid liability.
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4251 Federal Securities Regulation
A tax communication should include all of the following except:
one complete conclusion for all of the issues.
a brief summary of the facts.
a reasoning for the tax conclusion reached.
each tax issue listed.
one complete conclusion for all of the issues.
A tax communication should include:
- a brief statement of the facts,
- each tax issue listed,
- a separate conclusion for each tax issue, and
- where the conclusions came from, e.g., the authority.
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4382 Communications with or on Behalf of Clients
Which of the following items must be separately stated on Schedule K-1 of Form 1120S, U.S. Income Tax Return for an S Corporation
Mark-to-market income
Unearned revenue
Section 1245 gain
Gain or loss from the sale of collectibles
Gain or loss from the sale of collectibles
The primary purpose of the Schedule K-1 for an S corporation is to list any income, losses, deductions, or credits that might affect the tax liability of a shareholder in a different manner depending on any other factors in their particular tax situation. Gains or losses on collectibles are generally taxed at a different rate than other items of income.
Any ordinary income items are not separately stated on the Schedule K-1 of an S corporation. Unearned revenue is the same as prepaid revenue, is taxable when received, and is generally considered ordinary income. IRC Section 1245 gain is taxed as ordinary income.
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4642 Determination of Ordinary Income/Loss and Separately …
Permanent differences between taxable income and pre-tax accounting income affect:
both interperiod and intraperiod income tax allocation.
interperiod income tax allocation.
neither interperiod nor intraperiod income tax allocation.
intraperiod income tax allocation.
neither interperiod nor intraperiod income tax allocation.
FASB ASC 740-10-10, “Income Taxes,” notes: “Certain revenues are exempt from taxation and certain expenses are not deductible.”
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4362 Projections of Tax Consequences
*VIDEO EXPLANATION 12/09
Under the liability provisions of Section 11 of the Securities Act of 1933, a CPA may be liable to any purchaser of a security for certifying materially misstated financial statements that are included in the security’s registration statement.
Under Section 11, which of the following must be proven by a purchaser of the security
Reliance on the financial statements
Fraud by the CPA
Both reliance on the financial statements and fraud by the CPA
Neither reliance on the financial statements nor fraud by the CPA
Neither reliance on the financial statements nor fraud by the CPA
Under Section 11 of the Securities Act of 1933, the purchaser of a security may have a cause of action against the CPA if the associated financial statements are materially misleading. The purchaser need not prove reliance on the financial statements nor must the purchaser prove fraud (or even negligence) by the CPA.
Section 11 shifts the burden of proof from the plaintiff to the defendant—the CPA must prove innocence by establishing one of the permitted defenses.
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4132 Federal Statutory Liability
*VIDEO EXPLANATION
Sam's Year 2 taxable income was $175,000 with a corresponding tax liability of $30,000. For Year 3, Sam expects taxable income of $250,000 and a tax liability of $50,000. In order to avoid a penalty for underpayment of estimated tax, what is the minimum amount of Year 3 estimated tax payments that Sam can make $30,000 $33,000 $45,000 $50,000
$33,000
General Safe Harbor Rule: To avoid any penalty for underpayment of estimated taxes, the taxpayer must pay in 100% of the prior-year tax paid or 90% of the current-year tax due.
Special Safe Harbor Rule: If the taxpayer had taxable income in the previous year in excess of $150,000, then the safe harbor for avoiding underpayment penalties is 110% of the prior-year tax.
For Year 3, the safe harbor for Sam is to pay in $30,000 × 1.10 = $33,000. Since Sam had taxable income of $175,000 for Year 2, this exceeds the $150,000 rule, so he would have to use the special safe harbor rule.
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4362 Projections of Tax Consequences
4365 Impact of Estimated Tax Payment Rules on Planning
In April, A and B formed X Corp. A contributed $50,000 cash and B contributed land worth $70,000 (with an adjusted basis of $40,000). B also received $20,000 cash from the corporation. A and B each received 50% of the corporation's stock. What is the tax basis of the land to X Corp. $40,000 $50,000 $60,000 $70,000
$60,000
X Corp. received land with an adjusted basis of $40,000 from shareholder B. X Corp. paid B an additional $20,000 in cash. The tax basis of the land for X Corp. is $60,000, made up of the $40,000 in basis from B and the $20,000 paid to B.
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4634 Entity/Owner Transactions, Including Contributions and …
A husband and wife agree to split monetary gifts to their relatives. The husband gives his daughter $20,500, and the wife gives her niece $17,000. The annual exclusion is $12,000. What amount is the taxable gift for the husband and wife? $17,000 $0 $13,500 $37,500
$0
Married taxpayers are allowed to split gifts which will maximize the annual gift exclusion for each gift recipient. In this example, the first gift of $20,500 will be considered a gift of $10,250 by each spouse. The gift will then fall under the annual exclusion specified of $12,000. The second gift of $17,000 will be considered a gift of $8,500 by each spouse. Once again, this falls under the annual exclusion of $12,000 specified above. For both of the gifts, there was not a taxable portion. The correct answer is A.
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4472 Annual Exclusion and Gift Tax Deductions
When Jim and Nina became engaged in April of Year 1, Jim gave Nina a ring that had a fair market value of $50,000. After their wedding in July of Year 2, Jim gave Nina $75,000 in cash so that Nina could have her own bank account. Both Jim and Nina are U.S. citizens. What was the amount of Jim’s marital deduction $75,000 $115,000 $125,000 $0
$75,000
Any transfer of assets after the marriage of Jim and Nina is considered a marital deduction. The gift of a ring for the engagement happened prior to the marriage and thus does not qualify.
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4474 Marital Deduction
A CPA is permitted to disclose confidential client information without the consent of the client to:
I. another CPA who has purchased the CPA’s tax practice.
II. another CPA firm if the information concerns suspected tax return irregularities.
III. a state CPA society voluntary quality control review board.
I and III only
II and III only
II only
III only
III only
A CPA is permitted to disclose confidential client information to a state CPA society voluntary control review board. A CPA is not permitted to disclose confidential client information to another CPA who had purchased the CPA’s tax practice without the consent of the client. The CPA must obtain the client’s permission before consulting another CPA firm with respect to a client’s tax return.
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4133 Privileged Communications, Confidentiality, and …
What is the highest rate of tax on long-term capital gains from the sale of stock in 2014 5% 10% 15% 20%
20%
For long-term capital gains from sales prior to May 6, 2003, the maximum long-term capital gain rate is 20% (8% or 10% for gains that would otherwise be taxed in the 15% bracket, depending on whether the holding period is over five years or not).
Long-term capital gains are generally taxed at a maximum of 15% for sales after May 5, 2003. For taxable years after 2007, for long-term capital gains that would otherwise be taxed in the 10% or 15% bracket, the maximum rate is 0%. For taxable years after 2012, for long-term capital gains that would be taxed in the 39.6% bracket, the maximum rate is 20%.
IRC Section 1(h)
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4550 Loss Limitations
Rules limiting passive activity losses apply to: S corporations. partnerships. widely held C corporations. personal service corporations.
personal service corporations.
Passive loss rules apply to individuals, estates, trusts, personal service corporations, and certain closely held corporations. Limitations on passive activity losses apply to individuals as a result of a flow through from S corporations and partnerships, but do not apply at the S corporation or partnership level.
IRC Section 469(a)(2), 752(a), 1367, and 7773(a)(3)
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4540 Passive Activity Losses
Mackenzie is the grantor of a trust over which Mackenzie has retained a discretionary power to receive income. Kelly, Mackenzie’s child, receives all taxable income from the trust unless Mackenzie exercises the discretionary power. To whom is the income earned by the trust taxable
To the trust to the extent it remains in the trust
To Mackenzie because he has retained a discretionary power
To Kelly as the beneficiary of the trust
To Kelly and Mackenzie in proportion to the distributions paid to them from the trust
To Mackenzie because he has retained a discretionary power
The general rule is that whoever receives the income from the trust is taxed on the income. However, there is an exception for the grantor who retains a discretionary power. Then, the income from the trust is taxed to the grantor whether or not the grantor receives the income.
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4662 Income and Deductions
Grove is seeking to avoid performing a promise to pay Brook $1,500. Grove is relying on lack of consideration on Brook’s part. Grove will prevail if he can establish that:
prior to Grove’s promise, Brook had already performed the requested act.
Brook’s only claim of consideration was the relinquishment of a legal right.
Brook’s asserted consideration is only worth $400.
the consideration to be performed by Brook will be performed by a third party.
prior to Grove’s promise, Brook had already performed the requested act.
“Consideration” is a required element of almost every contract. It involves a mutual exchange of legal obligations between parties. In this case, Grove promised to pay Brook $1,500, which satisfies the consideration requirements on his part. Brook’s satisfaction on the consideration requirement would have to consist of a promise or act on Brook’s part that was legally bargained for between the parties. If Brook had already performed the requested act at the time Grove made the promise to pay $1,500, then the performance of the act could not have been bargained for and would not constitute consideration. This doctrine is sometimes described as “past consideration is no consideration.”
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4222 Performance
When Susan Jones graduated from college, she received a gold bracelet from her favorite aunt. Aunt Bess had spent $350 on the bracelet. When Susan died, her daughter Grace received the bracelet as provided in her will. At that time the gold price had risen and the value of the bracelet was $2,200. If Grace sells the bracelet for $2,350, what is her recognized gain $2,350 $2,200 $2,000 $150
$150
When it comes to items received by bequest from a deceased person, all capital gains are forgiven at the time of death. Grace receives the bracelet at the current value of $2,200. Only an increase above $2,200 would be taxable to Grace; in this case, $150.
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4420 Basis and Holding Periods of Assets
In which of the following circumstances would a tax return preparer be prohibited from disclosing a client’s tax return information?
The information will be provided to a section 501(c)(3) charity.
The information will be used to prepare state or local tax returns.
The information will be provided in response to a court order.
The information will be needed for a peer review.
The information will be provided to a section 501(c)(3) charity.
A tax return preparer may disclose tax return information for:
- A peer review
- A response to a court order
- To prepare state or local returns
Tax return information may not be disclosed to other third parties – including a 501(c)(3) charity.
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4111 Treasury Department Circular 230
Dart, Inc., a closely held corporation, was petitioned involuntarily into bankruptcy under the liquidation provisions of Chapter 7 of the Federal Bankruptcy Code. Dart contested the petition.
Dart has not been paying its business debts as they became due, has defaulted on its mortgage loan payments, and owes back taxes to the IRS. The total cash value of Dart’s bankruptcy estate after the sale of all assets and payment of administration expenses is $100,000.
Dart has the following creditors:
- Fracon Bank is owed $75,000 principal and accrued interest on a mortgage loan secured by Dart’s real property. The property was valued at and sold, in bankruptcy, for $70,000.
- The IRS has a $12,000 recorded judgment for unpaid corporate income tax.
- JOG Office Supplies has an unsecured claim of $3,000, which was timely filed.
- Nanstar Electric Co. has an unsecured claim of $1,200, which was not timely filed.
- Decoy Publications has a claim of $18,000, of which $2,000 is secured by Dart’s inventory, which was valued and sold, in bankruptcy, for $2,000. The claim was timely filed.
What total dollar amount would Fracon Bank receive on its secured and unsecured claims $70,000 $72,000 $73,335 $75,000
$73,335
Fracon Bank is a secured creditor who is owed $75,000 by the debtor. Fracon Bank has first claim on all funds generated from the sale of the collateral. Unfortunately for Fracon, the sale of the collateral generated only $70,000. Fracon Bank becomes a general unsecured creditor for the remaining $5,000. As such, Fracon’s $5,000 claim will be subservient to the claims of priority creditors. The total amount available to pay general unsecured creditors is calculated as follows:
Total value of estate after sale of assets
and payment of administrative expenses: $100,000
Less: payment of Fracon Bank as secured creditor: (70,000)
payment to Decoy Publications as secured creditor: (2,000)
payment to IRS as priority creditor (12,000)
———
Total available for general unsecured creditors: $ 16,000
The total amount of general unsecured claims is calculated as follows:
Fracon: $ 5,000
JOG Office Supp.: 3,000
Decoy Pub.: 16,000
-------
Total unsecured: $24,000
With $16,000 available to pay $24,000 of general unsecured claims, all general unsecured creditors will be paid 16,000 ÷ 24,000, or 66.7%, of the balance due. Thus, Fracon Bank will receive $4,000 on the unsecured portion of its claim ($5,000 × 66.7% = $3,335). The total payout to Fracon Bank will be $70,000 + $3,335 = $73,335.
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4242 Bankruptcy and Insolvency
Curator contracted to sell Train’s painting. Train issued a $10,000 note to Curator that was payable within 10 days after Curator sold Train’s painting. Curator sold the painting on May 1. Train, alleging that the note was not a negotiable instrument, refused to pay the note. Under the Negotiable Instruments Article of the U.C.C., which of the following statements is correct regarding the status of the note
The note was not a negotiable instrument because it was not payable at a definite time.
The note was not negotiable because it was subject to another writing.
The note was negotiable because it was for a sum certain.
The note was negotiable because it was conditioned on an event that took place.
The note was not a negotiable instrument because it was not payable at a definite time.
In order to answer this question, you must know what makes an instrument negotiable. An instrument is negotiable if it is:
- in writing,
- signed by the maker or the drawer,
- payable to order or to the bearer,
- an unconditional promise or -order to pay a fixed amount of money, and
- payable on demand or at a definite time.
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4232 Negotiable Instruments
At the beginning of the year, Data, a C corporation, had a $45,000 deficit in accumulated earnings and profits. For the current year, Data reported earnings and profits of $15,000. Data distributed $18,000 to its shareholders during the current year. What amount of the distribution is treated as a taxable dividend? $3,000 $18,000 $15,000 $0
$15,000
When a corporation makes a distribution it is first distributed from earnings and profits. Any distribution in excess of earnings and profits is considered a return of capital. A return of capital is not considered to be taxable, so only the $15,000 that is from earnings and profits is considered a taxable distribution.
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4635 Earnings and Profits
The “executive pay over $1 million cap” applies to: all C corporations. all S corporations. only publicly held C corporations. all corporations.
only publicly held C corporations.
For purposes of the regular income tax and the alternative minimum tax, the deduction for compensation paid or accrued with respect to a covered employee of a publicly held corporation is limited to no more than $1 million per year.
The “executive pay over $1 million cap” does not apply to compensation paid or accrued to covered employees of all C or S corporations.
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4631 Determination of Taxable Income/Loss
Blink Corp., an accrual-basis, calendar-year corporation, carried back a net operating loss from the tax year ended December 31, 2013. Blink’s gross revenues have been under $500,000 since inception. Blink expects to have profits for the tax year ending December 31, 2014. Which methods of estimated tax payment can Blink use for its quarterly payments during the 2014 tax year to avoid underpayment of federal estimated taxes
I. 100% of the preceding tax year method
II. Annualized income method
I only
Both I and II
II only
Neither I nor II
II only
Generally, a corporation must make installment payments equal to the lesser of (1) 100% of the tax shown on its return for the current year, or (2) 100% of the tax shown on its return for the preceding year.
IRC Section 6655(d)(1)(B)
However, a corporation cannot base its estimated tax payments for the tax year on the prior tax year if (1) it filed a return for the prior year showing zero tax (due to a net operating loss (NOL)), (2) the prior year was less than 12 months, or (3) it is a large corporation (taxable income of $1,000,000 or more for any of the three immediately preceding tax years).
IRC Section 6655(d)(1) and (d)(2)(A)
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4326 Penalties
An accountant will be liable for damages under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 only if the plaintiff proves that:
the accountant was negligent.
the security involved was registered.
the security was part of an original issuance.
there was a material omission.
there was a material omission.
Rule 10b-5 specifically makes it unlawful to make an untrue statement or omit a material fact. It covers any instrumentality of interstate commerce, so it would not matter whether the security was registered or part of an original issuance. In the Supreme Court case Hochfelder, the court held that simple negligence is not enough to hold a CPA responsible. Scienter, the intent to deceive, manipulate, or defraud, must be proved to hold the CPA responsible.
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4132 Federal Statutory Liability
Thorp was a purchasing agent for Ogden, a sole proprietor, and had the express authority to place purchase orders with Ogden’s suppliers. Thorp placed an order with Datz, Inc., on Ogden’s behalf after Ogden was declared incompetent in a judicial proceeding. Thorp was aware of Ogden’s incapacity.
Which of the following statements is correct concerning Ogden’s liability to Datz
Ogden will be liable because Datz was not informed of Ogden’s incapacity.
Ogden will be liable because Thorp acted with express authority.
Ogden will not be liable because Thorp’s agency ended when Ogden was declared incompetent.
Ogden will not be liable because Ogden was a nondisclosed principal.
Ogden will not be liable because Thorp’s agency ended when Ogden was declared incompetent.
The mental incapacity of the principal automatically terminates the agency as a matter of law. In this case, agent Thorp’s authority terminated as soon as principal Ogden was declared incompetent, and any contract made thereafter by Thorp is not binding upon Ogden. This is true even if the agent is unaware of the principal’s incompetence.
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4212 Authority of Agents and Principals
When computing alternative minimum tax, the individual taxpayer may take a deduction for which of the following items?
Personal and dependency exemptions
State income taxes
Casualty losses
Miscellaneous itemized deductions in excess of 2%-of-adjusted-gross-income floor
Casualty losses
Personal and dependency exemptions, and most itemized deductions such as state income taxes and miscellaneous itemized deductions in excess of 2% of AGI floor are not deductible in calculating the alternative minimum tax.
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4590 Alternative Minimum Tax
Thorp, CPA, was engaged to audit Ivor Co.’s financial statements. During the audit, Thorp discovered that Ivor’s inventory contained stolen goods. Ivor was indicted and Thorp was subpoenaed to testify at the criminal trial. Ivor claimed accountant-client privilege to prevent Thorp from testifying.
Which of the following statements is correct regarding Ivor’s claim
Ivor can claim an accountant-client privilege only in states that have enacted a statute creating such a privilege.
Ivor can claim an accountant-client privilege only in federal courts.
The accountant-client privilege can be claimed only in civil suits.
The accountant-client privilege can be claimed only to limit testimony to audit subject matter.
Ivor can claim an accountant-client privilege only in states that have enacted a statute creating such a privilege.
The “accountant-client” privilege does not generally exist, although some states have adopted statutes providing for such a privilege. The accountant in this case could successfully claim the accountant-client privilege only in those states that have adopted a statute creating such a privilege. The privilege does not apply in federal court or federal administrative agencies. While a limited privilege exists in a noncriminal tax matter, this fact situation does not allow a consideration of that very limited privilege.
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4133 Privileged Communications, Confidentiality, and …
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 Simple Grantor Complex Pre-need funeral
Grantor
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.
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4661 Types of Trusts
When a partner’s share of partnership liabilities increases, that partner’s basis in the partnership:
increases by the partner’s share of the increase.
decreases by the partner’s share of the increase.
decreases, but not to less than zero.
is not affected.
increases by the partner’s share of the increase.
When a partner’s share of partnership liabilities increases, that partner’s basis in the partnership increases by the partner’s share of the increase.
Example
AB Partnership borrows $12,000. Able is a 40% partner. Bob is a 60% partner.
Able’s partner’s basis increases by ($12,000 x 40%) = $4,800
Bob’s partner’s basis increases by ($12,000 x 60%) = $7,200
Caution
If the partners have a different profit ratio than loss ratio and the liability is a recourse liability, the partners share the liability based on the loss ratio, but…
If the partners have a different profit ratio than loss ratio and the liability is a nonrecourse liability, the partners share the liability based on the profit ratio.
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4652 Basis of Partner’s/Member’s Interest and Basis of …
Which of the following actions requires an agent for a corporation to have a written agency agreement
Purchasing office supplies for the principal’s business
Purchasing an interest in undeveloped land for the principal
Hiring an independent general contractor to renovate the principal’s office building
Retaining an attorney to collect a business debt owed the principal
Purchasing an interest in undeveloped land for the principal
In most situations, the agreement which creates an agency may be oral or written. However, if the agent is given the authority to purchase land, the authorization must be in written form (known as a “power of attorney”). All transactions related to the purchase or sale of land must be in writing under the statute of frauds.
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4211 Formation and Termination
4222 Performance
One of the criteria for a valid assignment of a sales contract to a third party is that the assignment must:
be supported by adequate consideration from the assignee.
be in writing and signed by the assignor.
not materially increase the other party’s risk or duty.
not be revocable by the assignor.
not materially increase the other party’s risk or duty.
A party to a sales contract has the right, in most cases, to assign the contract to a third party with or without the consent of the other party to the contract. One exception to this general concept is the doctrine that an assignment is not permitted if it would materially increase the other party’s risk or duty.
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4222 Performance
Patty Cake owned real estate that was condemned by the state. Patty had purchased the property for $30,000 and received $50,000 from the state as a result of the condemnation. Patty purchased replacement real estate for $52,000. Patty's basis in the new real estate is: $30,000. $32,000. $50,000. $52,000.
$32,000.
Patty’s basis is the cost of the replacement property less the deferred gain ($52,000 - $20,000 = $32,000).
IRC Section 1033
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4550 Loss Limitations
For tax year 2014, Oaktree Corporation’s books and records reflect the following:
Net income per books (after tax) $52,800
Tax-exempt interest 500
Excess book depreciation 7,222
Capital losses 3,000
Federal income tax 8,478
Excess contributions 1,710
Premiums on officer life insurance (payable to corp.) 1,500
Meals in excess of 50% limitation 400
What is the amount of Oaktree's taxable income as it would be shown on Schedule M-1 of its corporate income tax return $74,610 $77,110 $76,610 $75,110
$74,610
Net income per books $52,800
Add back:
Federal income tax + 8,478
Capital losses + 3,000
Depreciation + 7,222
Officer life insurance + 1,500
Meals in excess of 50% limitation + 400
Excess contributions + 1,710
——–
Total $75,110
Deduct: Nontaxable interest 500
——–
Taxable income $74,610
========
Corporations are not allowed a deduction for capital losses. Corporate capital losses are only deductible against capital gains.
Contributions are limited to 10% of taxable income.
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4621 Reconciliation of Book Income to Taxable Income
Tom Lewis, a single taxpayer, had the following income and expense items for 2015:
Wages $ 55,000
Long-Term Capital Loss (4,000)
Deductible IRA Contribution (Tom is not
covered by a retirement plan at work) 2,000
Mortgage Interest on personal residence 5,000
Medical expenses not covered by insurance 4,000
Tom’s personal exemption amount for 2014 3,950
Tom’s standard deduction amount for 2014 6,200
What is Tom's adjusted gross income for the year? $55,000 $51,000 $52,000 $50,000
$50,000
The key points here are:
-all long-term capital losses may be offset against capital gains. If the loss exceeds the gains, a maximum of $3,000 may be included on the tax return, so only $3,000 of the $4,000 capital loss is deductible in the current year, and
-the IRA contribution is an adjustment in determining adjusted gross income.
Thus, Tom’s adjusted gross income is calculated as follows:
Wages $55,000
Capital loss (3,000)
IRA contribution (2,000)
——–
Adjusted gross income $50,000
Tom’s remaining unused loss of $1,000 is carried forward to be used the following year.
The mortgage interest on personal residence and unreimbursed medical expenses are from AGI deductions taken as itemized deductions, or the taxpayer may elect to take the standard deduction if it is greater than all of their itemized deductions.
IRC Section 1211(b)
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4530 Adjustments and Deductions to Arrive at Taxable Income
Which of the following items should be included on Schedule M-1, Reconciliation of Income (Loss) per Books With Income per Return, of Form 1120, U.S. Corporation Income Tax Return, to reconcile book income to taxable income
Cash distributions to shareholders
Premiums paid on key-person life insurance policy
Corporate bond interest
Ending balance of retained earnings
Premiums paid on key-person life insurance policy
Premiums paid on life insurance are not deductible by any person that is directly or indirectly a beneficiary under the policy. Key-person life insurance is life insurance purchased by a business payable to the business in the event of the death of the covered key employees to enable the business to survive the death of such key employees. Since the business, or in this case the corporation, is the beneficiary, it would not be deductible for income tax purposes and would be a reconciling item for Schedule M-1 (or Schedule M-3 required for corporations with assets over $10 million).
Corporate bond interest is part of corporate taxable income and so is not part of the Schedule M-1 reconciliation of taxable income to book income.
Cash distributions to shareholders and ending balance of retained earnings do not affect taxable income or book income and are part of Schedule M-2, reconciliation of retained earnings.
IRC Section 264
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4621 Reconciliation of Book Income to Taxable Income
Carter incurred the following expenses in the current year: $500 for the preparation of a personal income tax return, $100 for custodial fees on an IRA, $150 for professional publications, and $2,000 for union dues. Carter's current-year adjusted gross income is $75,000. Carter, who is not self-employed, itemizes deductions. What will Carter's deduction be for miscellaneous itemized deductions after any limitations in the current year $0 $750 $1,250 $2,750
$1,250
Miscellaneous itemized deductions are only deductible to the point that they exceed 2% of AGI. Two percent of the $75,000 AGI is $1,500. The total of these expenses ($500 + $100 + $150 + $2,000) is $2,750; $2,750 - $1,500 = $1,250.
Carter’s income is below the phaseout level, so this limitation would not apply in this example.
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4530 Adjustments and Deductions to Arrive at Taxable Income
Which of the following statements represent(s) a principal’s duty to an agent who works on a commission basis
I. The principal is required to maintain pertinent records, account to the agent, and pay the agent according to the terms of their agreement.
II. The principal is required to reimburse the agent for all authorized expenses incurred unless the agreement calls for the agent to pay expenses out of the commission.
I only
II only
Both I and II
Neither I nor II
Both I and II
While the agent must account to the principal for his activities, the principal has a contractual obligation to pay the agent as shown in the contract. For a commission agreement, the principal must also keep adequate records in order to calculate the commission amount.
The principal must also reimburse the agent for expenses incurred in carrying out the agency activities.
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4213 Duties and Liabilities of Agents and Principals
In 2014, Wein Corporation had a net loss from operations of $50,000, which included a deduction for charitable contributions of $2,000. In addition, Wein received dividend income of $10,000 from a 15%-owned domestic corporation. What is the amount of Wein's net operating loss for 2014 $45,000 $49,000 $55,000 $59,000
$45,000
Wein’s charitable contribution is not deductible for tax purposes since a net loss was incurred. A dividends-received deduction (DRD) is allowed.
A dividends-received deduction reduces taxable income. In addition, there is no limit in deducting 70% of dividends received if a net operating loss is either created or increased.
According to the instructions for Form 1120, U.S. Corporation Income Tax Return,“in a year in which an NOL occurs, this 70% limitation does not apply even if the loss is created by the dividends-received deduction.” (IRC Sections 172(d) and 246(b))
Loss from operations $(50,000)
Dividends 10,000
———
Total income (loss) $(40,000)
Add back charitable contributions 2,000 A charitable contribution
is not deductible for tax
purposes since a loss
occurs. According to the
scenario, the $2,000 was
already included in the
$50,000 net loss from
operations.
———
Loss before $(38,000)
Less: DRD deduction
(70% x $10,000) ( 7,000)
———
Net operating loss $(45,000)
=========
The dividends from a less-than-20%-owned domestic corporation are allowed a 70% special deduction. The $10,000 in dividend income Wein Corporation received from a 15%-owned domestic corporation would be reported on line 1 in Schedule C of Form 1120. The totals of line 1 through 8 in Schedule C are then subject to a taxable income limitation. A corporation’s percentage dividends-received-deduction (DRD) for any tax year cannot exceed a certain applicable percentage of its taxable income. There is a worksheet for Schedule C, line 9, in the Form 1120 instructions that helps a taxpayer determine the amount of the taxable income limitation. A corporation’s DRD is generally limited to 70% of its taxable income. This income limitation does not apply for any tax year for which the shareholder has an NOL.
This is not saying that the corporation gets a 100% DRD when there is an NOL in that tax year. Instead this taxable income limitation is determining what amount of the 70% DRD is going to be allowed based upon the corporation’s income. Due to the NOL, Wein Corporation is allowed to deduct 100% of its 70% special dividend deduction, or $7,000.
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4631 Determination of Taxable Income/Loss
U Co. had cash purchases and payments on account during the current year totaling $455,000. U's beginning and ending accounts payable balances for the year were $64,000 and $50,000, respectively. What amount represents U's accrual-basis purchases for the year $441,000 $469,000 $505,000 $519,000
$441,000
A total of $455,000 in cash was paid by U Co. during the year. Of that total, $14,000 was paid to reduce the balance in accounts payable ($64,000 - $50,000). Purchases for the year on the accrual basis were $441,000 ($455,000 - $14,000).
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4341 Recognition of Revenues and Expenses Under Cash, …
Lane, a single taxpayer, received $160,000 in salary, $15,000 in income from an S corporation in which Lane does not materially participate, and a $35,000 passive loss from a real estate rental activity in which Lane materially participated. Lane's modified adjusted gross income was $165,000. What amount of the real estate rental activity loss was deductible $0 $15,000 $25,000 $35,000
$15,000
Individuals may offset up to $25,000 ($50,000 if married filing jointly) of ordinary income with rental real estate activities. This exemption is reduced (but not below zero) by 50% of the amount by which the adjusted gross income of the taxpayer for the year exceeds $100,000.
- First, the passive activities were netted $15,000 from the S corporation - $35,000 from the rental = $(20,000).
- Second, the salary of $160,000 is decreased by the net $20,000 passive activity loss for a modified AGI before limitation of $140,000.
- Third, the amount of $140,000 that exceeds $100,000 is multiplied by 50%, equaling $20,000.
- Fourth, the rental loss of $35,000 is decreased by the $20,000 limitation, leaving an allowable deduction of $15,000.
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4540 Passive Activity Losses
Gulde's tax basis in Chyme Partnership was $26,000 at the time Gulde received a liquidating distribution of $12,000 cash and land with an adjusted basis to Chyme of $10,000 and a fair market value of $30,000. Chyme did not have unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. What was the amount of Gulde's basis in the land $0 $10,000 $14,000 $30,000
$14,000
Gulde’s basis in the land was $14,000, calculated as follows:
Gulde’s adjusted basis in partnership interest $26,000
Less: Cash received (12,000)
——–
Remaining basis allocated to land $14,000
========
When a liquidating distribution is received by a partner, the adjusted basis of the partnership interest is first reduced by any cash received, then reduced by any “hot” assets (unrealized receivables and/or inventory) received, and finally the remaining basis is allocated to any other property received.
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4657 Ownership Changes, and Liquidation and Termination of …
Able hired Carr to restore Able’s antique car for $800. The terms of their oral agreement provided that Carr was to complete the work within 18 months. Actually, the work could be completed within one year. The agreement is:
enforceable, because personal service contracts are exempt from the statute of frauds.
unenforceable, because it covers a time period in excess of one year.
unenforceable, because it covers services with a value in excess of $500.
enforceable, because the work could be completed within one year.
enforceable, because the work could be completed within one year.
If it is possible to complete a contract within one year, the contract is enforceable.
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4222 Performance
The at-risk limitation provisions of the Internal Revenue Code (IRC) may limit:
I. a partner’s deduction for his or her distributive share of partnership losses.
II. a partnership’s net operating loss carryover.
I only
II only
Both I and II
Neither I nor II
I only
The at-risk rules apply to all taxpayers (including partners) and encompass all business and investment activities, with a limited exception for certain types of real estate financing. The at-risk restrictions on deducting partnership losses provide that a partner may deduct his share of a loss from a partnership activity only to the extent to which he is at risk.
A partnership is not allowed a deduction for net operating losses (NOLs). A net operating loss (and any related carryback or carryforward) is determined at the partner level, taking into account all of the partner’s applicable items of income and expense.
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4652 Basis of Partner’s/Member’s Interest and Basis of …
Clark, a professional tax return preparer, prepared and signed a client’s 20X1 federal income tax return that resulted in a $600 refund. Which of the following statements is correct with regard to an Internal Revenue Code penalty Clark may be subject to for indorsing and cashing the client’s refund check
Clark will be subject to the penalty if Clark indorses and cashes the check.
Clark may indorse and cash the check, without penalty, if Clark is enrolled to practice before the Internal Revenue Service.
Clark may not indorse and cash the check, without penalty, because the check is for more than $500.
Clark may indorse and cash the check, without penalty, if the amount does not exceed Clark’s fee for preparation of the return.
Clark will be subject to the penalty if Clark indorses and cashes the check.
Clark is not permitted to indorse and cash (i.e., convert) a client’s federal income tax refund check regardless of the check’s amount, Clark’s status as an enrolled agent, or the preparation fee owed to Clark.
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4113 Internal Revenue Code of 1986, as Amended, and …
When a common stock offering requires registration under the Securities Act of 1933:
the registration statement is automatically effective when filed with the SEC.
the issuer would act unlawfully if it were to sell the common stock without a prospectus.
the SEC will determine the investment value of the common stock before approving the offering.
the issuer may make sales 10 days after filing the registration statement.
the issuer would act unlawfully if it were to sell the common stock without a prospectus.
When a common stock offering requires registration under the Securities Act of 1933, the issuer would act unlawfully if it were to sell the common stock without a prospectus. The whole purpose of the Securities Act of 1933 is to ensure that investors have adequate and truthful disclosure when making investments. The prospectus provides investors with information that should be relevant and useful (i.e., “material” to their investment decisions). When a registration statement is filed with the SEC, the SEC reviews the document for completeness (but not for veracity or “fairness” or “suitability” as an investment). If the SEC does not send a “comment” letter, the company may begin to sell its shares to the public 20 days after filing its registration.
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4251 Federal Securities Regulation
In 2013, Stewart Corp. properly accrued $5,000 for an income item on the basis of a reasonable estimate. In 2014, after filing its 2013 federal income tax return, Stewart determined that the exact amount was $6,000. Which of the following statements is correct
No further inclusion of income is required as the difference is less than 25% of the original amount reported and the estimate had been made in good faith.
The $1,000 difference is includible in Stewart’s 2014 income tax return.
Stewart is required to notify the IRS within 30 days of the determination of the exact amount of the item.
Stewart is required to file an amended return to report the additional $1,000 of income.
The $1,000 difference is includible in Stewart’s 2014 income tax return.
In 2013, Stewart Corp. properly accrued $5,000 for an income item on the basis of a reasonable estimate. In 2014, after filing its 2013 federal income tax return, Stewart determined that the exact amount was $6,000. The $1,000 difference is includible in Stewart’s 2014 income tax return. When an accrual-basis taxpayer estimates its income, if the income is underestimated, the difference is added to the income of the following year.
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4511 Inclusions and Exclusions
Par Corp. acquired the assets of its wholly owned subsidiary, Sub Corp., under a plan that qualified as a tax-free complete liquidation of Sub. Which of the following of Sub’s unused carryovers may be transferred to Par
Excess charitable contributions
Net operating loss
Both excess charitable contributions and net operating loss
Neither excess charitable contributions nor net operating loss
Both excess charitable contributions and net operating loss
If a parent corporation liquidates a subsidiary corporation, no gain or loss is recognized to the parent. (This provision is not elective. It is mandatory.)
Because the property received by the parent corporation from the subsidiary corporation has the same basis in the hands of the parent as the subsidiary had, all the carryover rules of IRC Section 381 apply. This means the parent will acquire the subsidiary’s Net Operating Loss carryover, any Business Credit carryovers, any Capital Loss carryover, any Charitable Contribution carryover, and any Earnings and Profits carryover.
In this question, only the charitable contributions and the net operating loss were addressed. All of Sub Corp.’s carryovers will be transferred to Par Corp.
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4634 Entity/Owner Transactions, Including Contributions and …
Under the Sales Article of the U.C.C., which of the following statements is correct regarding the creation of express warranties
Express warranties must contain formal words such as warranty or guarantee.
Express warranties must be part of the basis of the bargain between buyer and seller.
Express warranties are not enforceable if made orally.
Express warranties cannot be based on statements made in the seller’s promotional materials.
Express warranties must be part of the basis of the bargain between buyer and seller.
A warranty is an assurance or guarantee that goods will conform to certain standards and therefore is part of the basis of the bargain. An express warranty can be created by affirmation, promise, description, sample, or model. An express warranty is usually created by written or oral communication and becomes part of the sales contract.
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4231 Sales Contracts
Which of the following is correct concerning payments received on an inherited installment obligation
It is taxable to the beneficiary at the same gross profit percentage used by the decedent.
It is taxable only to the estate.
It is taxable to the beneficiary and the estate upon receipt of the inherited obligation.
It is taxable to the beneficiary at the same gross profit percentage used by the decedent.
The same gross profit percentage used by the decedent to calculate profit from each payment is used to determine the income that is taxable to the beneficiary.
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4344 Installment Sales
*VIDEO EXPALANATION
ParentCo, SubOne, and SubTwo have filed consolidated returns since their inception. The members reported the following taxable incomes (losses) for the year:
ParentCo $50,000
SubOne (60,000)
SubTwo (40,000)
No member reported a capital gain or loss or charitable contributions. What is the amount of the consolidated net operating loss $0 $30,000 $50,000 $100,000
$50,000
The consolidated net operating loss is the excess of deductions over gross income for all the corporations included in the consolidated group.
For this consolidated group, the consolidated net operating loss is $50,000, computed as follows:
ParentCo $ 50,000
SubOne (60,000)
SubTwo (40,000)
---------
Consolidated NOL $(50,000)
=========
Reg 1.1502-21(a), (e)
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4636 Consolidated Returns
Of the various administrative sources available from the IRS, which is held to be the strongest and most important source Revenue Rulings Revenue Procedures Treasury Regulations Letter Rulings
Treasury Regulations
Treasury Regulations have the most weight in interpreting the IRS Code. Regulations are the interpretation of the Code by the government department responsible for administering the income tax laws. When regulations are challenged, courts will only invalidate a regulation if it does not follow the intent of Congress.
Revenue Rulings are the second most important source of administrative law. Revenue Rulings are interpreted as the position of the IRS. They are much easier to challenge in court than Treasury Regulations.
Revenue Procedures are often administrative in nature, such as announcing the adjustments for inflation for tax brackets, personal exemptions, and standard mileage rates.
Letter Rulings are issued in response to a request from a taxpayer for a ruling on his or her personal tax situation. These cannot be cited as authority by anyone else.
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4381 Authoritative Hierarchy
Under the U.C.C. Secured Transactions Article, perfection of a security interest by a creditor provides added protection against other parties in the event the debtor does not pay its debts. Which of the following parties is not affected by perfection of a security interest
Other prospective creditors of the debtor
A buyer in the ordinary course of business
The trustee in a bankruptcy case
A subsequent personal injury judgment creditor
A buyer in the ordinary course of business
A buyer in the ordinary course of business from a merchant seller takes the property free of any security interest.
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4233 Secured Transactions
Which, if any, of the following could result in penalties against an income tax return preparer
I. Knowing or reckless disclosure or use of tax information obtained in preparing a return
II. A willful attempt to understate any client’s tax liability on a return or claim for refund
Both I and II
II only
I only
Neither I nor II
Both I and II
The Internal Revenue Code (IRC Section 6713(a)) imposes a penalty for the disclosure on information obtained to prepare a tax return:
Quote
If any person who is engaged in the business of preparing or providing services in connection with the preparation of, returns of tax imposed by chapter 1, or any person who for compensation prepares any such return for any other person, and who—
(1) discloses any information furnished to him for, or in connection with, the preparation of any such return, or
(2) uses any such information for any purpose other than to prepare, or assist in preparing, any such return,
shall pay a penalty of $250 for each such disclosure or use, but the total amount imposed under this subsection on such a person for any calendar year shall not exceed $10,000.
IRC Section 6694(b) contains a penalty for an understatement due to willful or reckless conduct.
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4113 Internal Revenue Code of 1986, as Amended, and …
Under the Revised Uniform Limited Partnership Act and in the absence of a contrary agreement by the partners, which of the following events is most likely to dissolve a limited partnership
A majority vote in favor by the partners
A two-thirds vote in favor by the partners
A withdrawal of a majority of the limited partners
Withdrawal of the only general partner
Withdrawal of the only general partner
A limited partnership must have one or more general partners and one or more limited partners. A withdrawal of the only general partner would cause the partnership to dissolve, while a withdrawal of a majority of the limited partners would not. A mutual agreement of all partners (versus a majority or two-thirds) may terminate the partnership.
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4261 Advantages, Disadvantages, Implications, and …
4262 Formation, Operation, and Termination
One of the elements necessary to recover damages if there has been a material misstatement in a registration statement filed under the Securities Act of 1933 is that the:
issuer and plaintiff were in privity of contract with each other.
issuer failed to exercise due care in connection with the sale of the securities.
plaintiff gave value for the security.
plaintiff suffered a loss.
plaintiff suffered a loss.
The purpose of the Securities Act of 1933 is to protect the unsophisticated investor by requiring full and fair disclosure prior to a public offering. Consequently, under the Act, all the plaintiff/investor must prove is that the registration statement contained a material misstatement and resulted in a loss to the plaintiff.
Privity with the issuer (rare), lack of due care exercised by the issuer, and value paid by the plaintiff are neither material nor relevant to the plaintiff’s claim and are not necessary to recover damages. (Remember, due care is a standard applied to the professional, e.g., the CPA and underwriter, not the issuer.)
Securities Act of 1933, Section 11
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4251 Federal Securities Regulation
Paul Pappas owns all of the stock of an S corporation which had previously been a C corporation. The S corporation had the following balances at the beginning of its tax year:
Accumulated adjustments account $ 8,000
Accumulated earnings and profits 10,000
Paul's stock basis was $20,000 at the beginning of the tax year. The S corporation made a distribution of $19,000 to Paul during the year. What is Paul's stock basis at the end of the year $1,000 $2,000 $11,000 $12,000
$11,000
Paul’s basis is reduced by the distribution from accumulated adjustments account, but not by the distribution from accumulated earnings and profits which is taxable income to Paul. The distribution in excess of $18,000 is a tax-free return of capital and reduces Paul’s basis ($20,000 - $8,000 - $1,000 = $11,000).
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4643 Basis of Shareholder’s Interest
4644 Entity/Owner Transactions, Including Contributions and …
In the current year, an unmarried individual with modified adjusted gross income of $25,000 paid $1,000 interest on a qualified education loan entered into on July 1. How may the individual treat the interest for income tax purposes
As a $500 deduction to arrive at AGI for the year
As a $1,000 deduction to arrive at AGI for the year
As a $1,000 itemized deduction
As a nondeductible item of personal interest
As a $1,000 deduction to arrive at AGI for the year
Individual taxpayers may deduct up to $2,500 of qualified student loan interest as an above-the-line deduction to arrive at AGI. This amount is phased out for higher-income taxpayers. The deduction is not available for taxpayers who are dependents of others or for taxpayers using the married filing separately filing status. The phaseout does not apply to this taxpayer.
IRC Section 221
Note
The deduction was extended for 2010 through 2012 by the Tax Relief Act of 2010. It was extended permanently by the Taxpayer Relief Act of 2012.
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4530 Adjustments and Deductions to Arrive at Taxable Income
The adjusted basis of Smith’s interest in EVA partnership was $230,000 immediately before receiving the following distribution in complete liquidation of EVA:
Basis to EVA Fair Market Value
———— —————–
Cash $150,000 $150,000
Real estate 120,000 146,000
What is Smith’s basis in the real estate $80,000 $120,000 $146,000 $133,000
$80,000
The basis of property received in a liquidating distribution is the adjusted basis less the cash received. Smith will take an adjusted basis in the real estate of $80,000, computed as follows:
Smith’s adjusted basis prior to liquidating distribution $230,000
Less: Cash received is return of capital (150,000)
———
Adjusted basis allocated to real estate received $ 80,000
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4657 Ownership Changes, and Liquidation and Termination of …
Tom Lewis, a single taxpayer, received a stock dividend in 2015 from ABC Corp. He had the option to receive either cash or ABC stock with a fair market value of $1,000 as of the date of distribution. The par value of the stock on the date of distribution was $600. Tom must include what amount in gross income for 2015 as a result of the stock dividend $0 $400 $600 $1,000
$1,000
Since Tom had the option to receive either cash or the ABC Corp. stock with a fair market value of $1,000, the fair market value of the stock received is included in income by Tom. The Internal Revenue Code states that if a distribution (or series of distributions) results in the receipt of cash or other property by some shareholders in the corporation’s assets or earnings and profits, then stock or stock rights distributed to a shareholder on the common stock of the corporation must be treated as a taxable distribution.
IRC Section 1(h)(11)
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4512 Characterization of Income
Under the Revised Model Business Corporation Act, following what type of corporate acquisition does the acquiring corporation automatically become liable for all obligations of the acquired corporation
A leveraged buyout of assets
An acquisition of stock for debt securities
A cash tender offer
A merger
A merger
When Company A purchases Company B’s stock (in exchange for debt, Company A securities, or a cash tender offer), it controls Company B. Both companies continue to operate separately, and Company B is still liable for its own obligations. When Company A purchases Company B’s assets by borrowing money to do so (a leveraged buyout), it only acquires Company B’s assets. However, in a merger, the entire Company B is made part of Company A, liabilities and all. Company A would now be liable for all the obligations of Company B.
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4262 Formation, Operation, and Termination
In addition to its charitable, religious, or educational purpose, an organization must show which of the following in order to be exempt from federal income taxation under IRC Section 501(c)(3)
I. No part of the organization’s net earnings will inure to the benefit of any private shareholder or individual.
II. The organization will not, as a substantial part of its activities, attempt to influence legislation.
III. The organization will not participate or intervene in any political campaign for or against any candidate for political office.
I only
I and II
II and III
I, II, and III
I, II, and III
In order to qualify for exemption from federal income taxation under IRC Section 501(c)(3), the organization must meet the following conditions in addition to its charitable, religious, or educational purpose:
-No part of the organization’s net earnings will inure to the benefit of any private shareholder or individual.
-No substantial part of the organization’s activities include carrying on propaganda, or otherwise attempting, to influence legislation.
-The organization does not participate in, or intervene in any political campaign on behalf of (or in opposition to) any candidate for political office.
IRS Publication 557, chapter 3 (Rev 10-2013); IRC Section 501(c)(3)
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4671 Types of Organizations
Noll gives Carr a written power of attorney. Which of the following statements is correct regarding this power of attorney
It must be signed by both Noll and Carr.
It must be for a definite period of time.
It may continue in existence after Noll’s death.
It may limit Carr’s authority to specific transactions.
It may limit Carr’s authority to specific transactions.
A power of attorney delegates authority from the principal (Noll) to the agent (Carr). This authority may be general or it may be limited or specific. It must be signed only by the principal (the agent need not sign the power of attorney), and it has force and effect for an indefinite time, unless otherwise stated, but will not be effective after the death of the principal. (A Last Will and Testament is required or some other testamentary document such as a trust is required for disposition after death.)
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4211 Formation and Termination
Which of the following are two of the major four national accounting regulatory agencies IASB and AICPA AICPA and CBA CPA and MBA CBA and FASB
IASB and AICPA
Both the International Accounting Standards Board (IASB) and the American Institute of CPAs (AICPA) are organizations and/or agencies that regulate the CPA practice.
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4112 AICPA Statements on Standards for Tax Services
4122 Role of State Boards of Accountancy
Grey Corp. sells computers to the public. Grey sold and delivered a computer to West on credit. West executed and delivered to Grey a promissory note for the purchase price and a security agreement covering the computer. West purchased the computer for personal use. Grey did not file a financing statement. Is Grey’s security interest perfected
Yes, because Grey retained ownership of the computer
Yes, because it was perfected at the time of attachment
No, because the computer was a consumer good
No, because Grey failed to file a financing statement
Yes, because it was perfected at the time of attachment
Under Article 9 of the Uniform Commercial Code (U.C.C.), West executed a security agreement creating a purchase money security interest (PMSI) in consumer goods; thus, automatic perfection occurred upon attachment of the security interest, without any further action such as filing a financing statement or possession being required. Grey sold the computer and has only the equitable security interest in the collateral; Grey has not retained legal ownership of the computer.
If a seller retains a security interest for the sales price of consumer goods, the security interest is automatically perfected; neither filing nor possession by the secured party is necessary. Filing ordinarily is not required to perfect a PMSI in consumer goods.
Automatic perfection occurs when a PMSI is in consumer goods and the requirements of attachment have been met. The facts of the problem indicate that a PMSI does exist and attachment has occurred when the security agreement was delivered by West to Grey Corp. Grey did not retain ownership, but it did perfect its security interest since it has an attached PMSI in consumer goods. Grey’s PMSI in a consumer good was perfected upon attachment without the need for filing of a financing statement.
Since West purchased the computer for personal use and the computer itself was the collateral for the security agreement, the fact pattern involves a PMSI in consumer goods. Therefore, once attachment took place, perfection was automatic.
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4233 Secured Transactions
Which of the following persons is not an insider of a corporation subject to the Securities Exchange Act of 1934 registration and reporting requirements
An attorney for the corporation
An owner of 5% of the corporation’s outstanding debentures
A member of the board of directors
A stockholder who owns 10% of the outstanding common stock
An owner of 5% of the corporation’s outstanding debentures
Directors, officers, key agents such as attorneys, and stockholders owning 10% or more of the corporation stock are considered “insiders” for registration and reporting purposes under the Securities Exchange Act of 1934. An owner of 5% of the corporation’s debentures is a creditor, not an “insider.”
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4251 Federal Securities Regulation
Under the Negotiable Instruments Article of the U.C.C., which of the following circumstances would prevent a promissory note from being negotiable
An extension clause that allows the maker to elect to extend the time for payment to a date specified in the note
An acceleration clause that allows the holder to move up the maturity date of the note in the event of default
A person having power of attorney signs the note on behalf of the maker
A clause that allows the maker to satisfy the note by the performance of services or the payment of money
A clause that allows the maker to satisfy the note by the performance of services or the payment of money
One of the essential requirements of a negotiable instrument is that it must be payable only in money. If there is a clause in the instrument allowing the maker to satisfy the obligation by performing services rather than paying money, then the instrument is nonnegotiable.
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4232 Negotiable Instruments
An agent must refrain from competing during a defined agency relationship, but he or she may compete when:
the other party provides permission.
if the regulatory agency in charge of the relationship provides written permission to do so.
the agency relationship is terminated.
None of the answer choices are correct.
the agency relationship is terminated.
When the agency relationship is terminated, the parties are again private as to each other’s interest and will be allowed to compete in all aspects of generally accepted business practices. Preparation for this competition cannot take place until after termination.
Restatement of the Law Third, Agency, 8.04 (American Law Institute, Philadelphia, PA, 2006)
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4211 Formation and Termination
4213 Duties and Liabilities of Agents and Principals
Which of the following organizations would not qualify for exemption from federal income tax
College alumni association
Social clubs that allow only limited usage by general public
Fraternal society not operating under a lodge system
Political organization
Fraternal society not operating under a lodge system
Under IRC Section 501(c)(10), domestic fraternal societies must operate under the lodge system to be exempt from federal income taxation.
College alumni associations generally qualify for exemption from federal income tax under IRC Section 501(c)(3). If it does not meet the characteristics required by IRC Section 501(c)(3), it may still be exempt as a social club if it meets the requirements described by IRC Section 501(c)(7).
A social or recreation club under IRC Section 501(c)(7) is allowed to receive up to 35% of its gross receipts from sources outside of its membership without losing its status as a tax-exempt organization. The club must have an established membership, which must be limited in some manner.
Under IRC Section 527, a political organization is considered a tax-exempt organization. It is subject to tax only on nonexempt income. Examples of exempt income include contributions, membership dues, and proceeds from a political fund-raising event.
IRS Publication 557, chapter 4 (Rev 10-2013); IRC Section 501(c)
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4671 Types of Organizations
All of the following items will increase the basis of a partner’s interest in a partnership except:
contributions of cash or property to the partnership.
assumption of liabilities for the purchase of equipment.
distributive share of nontaxable income.
partner’s share of any Section 179 expenses.
partner’s share of any Section 179 expenses.
Deductions for Section 179 expenses decrease the basis of a partner.
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4652 Basis of Partner’s/Member’s Interest and Basis of …
Under the Negotiable Instruments Article of the U.C.C., which of the following requirements must be met for a person to be a holder in due course of a promissory note
The note must be payable to bearer.
The note must be negotiable.
All prior holders must have been holders in due course.
The holder must be the payee of the note.
The note must be negotiable.
A holder in due course is a person who has acquired a negotiable instrument for value, in good faith, and without notice that the debtor may have defenses to payment. Of the items listed in the problem, the only one which is an absolute requirement to holder in due course status is that the instrument must be negotiable.
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4232 Negotiable Instruments
Wages paid for domestic services are subject to special rules for determining whether they are subject to payroll taxes. When are domestic wages subject to Social Security and Medicare tax Over $1,800 to one employee in a year Over $2,000 total wages in a year Over $1,000 total wages in a quarter Only if requested by employee
Over $1,800 to one employee in a year
Wages paid for domestic services are subject to Social Security and Medicare taxes if they exceed $1,800 in a calendar year to one employee. Only those employees whose wages exceed $1,800 for the year are subject. For calendar years after 1995, the dollar threshold of $1,000 is indexed for inflation.
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4580 Tax Computations and Credits
Which of the following individuals are eligible for the earned income credit in 2014
I. Tom and Jane Smith, both age 55, are a married couple and are filing a joint return. Their modified adjusted gross income for the year is below the threshold amount to be eligible for the earned income credit. Their only source of income for the year is their retirement pension.
II. Mike and Ann Jones, both age 50, are a married couple and are filing a joint return. Their modified adjusted gross income for the year is below the threshold amount to be eligible for the earned income credit. Mike and Ann’s sources of income for the year are wages for both and $10,000 of tax-exempt interest.
I only
II only
Both I and II
Neither I nor II
Neither I nor II
Tom and Jane are not eligible for the earned income credit in 2014 since their only source of income is their retirement pension. A pension is not considered to be “earned income.” An individual must have at least some “earned income” in order to be eligible for the earned income credit.
Mike and Ann are not eligible for the earned income credit in 2014. Tax-exempt interest is considered “disqualified income” under IRC Section 32(a). Individuals are allowed to have only up to $3,350 in 2014 of “disqualified income” in order to be eligible for the earned income credit. Disqualified income in post-1995 tax years includes an individual’s capital gain net income and net passive income in addition to interest, dividends, tax-exempt interest, and nonbusiness rents or royalties.
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4580 Tax Computations and Credits
Joe and Barb are married, but Barb refuses to sign a 2014 joint return. On Joe’s separate 2014 return, an exemption may be claimed for Barb if:
Barb was a full-time student for the entire 2014 school year.
Barb attaches a written statement to Joe’s income tax return, agreeing to be claimed as an exemption by Joe for 2014.
Barb was under the age of 19.
Barb had no gross income and was not claimed as another person’s dependent in 2014.
Barb had no gross income and was not claimed as another person’s dependent in 2014.
If a husband and wife file separate returns, generally each must take his or her own exemption on his or her Form 1040.
However, if Barb (Joe’s wife) has no gross income and is not a dependent of another taxpayer, two exemptions (one for Joe and one for Barb) may be claimed on Joe’s 2014 Form 1040.
The actual personal exemption amount is indexed for inflation each year.
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4530 Adjustments and Deductions to Arrive at Taxable Income
Under the Documents of Title Article of the U.C.C., a negotiable document of title is “duly negotiated” when it is negotiated to:
any holder by indorsement.
any holder by delivery.
a holder who takes the document in payment of a money obligation.
a holder who takes the document for value, in good faith, and without notice of any defense or claim to it.
a holder who takes the document for value, in good faith, and without notice of any defense or claim to it.
The statutory definition of “duly negotiated” is as follows: U.C.C. 7.501(d) A negotiable document of title is “duly negotiated” when it is negotiated in the manner stated in this section to a holder who purchases it in good faith without notice of any defense against or claim to it on the part of any person and for value, unless it is established that the negotiation is not in the regular course of business or financing or involves receiving the document in settlement or payment of a money obligation.
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4232 Negotiable Instruments
Which of the following professional bodies has the authority to revoke a CPA’s license to practice public accounting
State board of accountancy
National Association of State Boards of Accountancy
AICPA Professional Ethics Division
State CPA society ethics committee
State board of accountancy
State boards of accountancy are responsible for issuing or revoking CPA licenses.
The National Association of State Boards of Accountancy, a state CPA society ethics committee, and the Professional Ethics Division of the AICPA have no ability to issue or revoke licenses. They are professional organizations.
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4122 Role of State Boards of Accountancy
Under the U.C.C., a warehouse receipt:
is negotiable if, by its terms, the goods are to be delivered to bearer or to the order of a named person.
will not be negotiable if it contains a contractual limitation on the warehouser’s liability.
may qualify as both a negotiable warehouse receipt and negotiable commercial paper if the instrument is payable either in cash or by the delivery of goods.
may be issued only by a bonded and licensed warehouser.
is negotiable if, by its terms, the goods are to be delivered to bearer or to the order of a named person.
Under the U.C.C., a warehouse receipt is negotiable if, by its terms, the goods are to be delivered to bearer or to the order of a named person. Warehouse receipts, like other forms of commercial paper (notes and drafts), fall under similar rules of negotiability. Generally, in answering questions on warehouse receipts, if you understand the rules of negotiability of commercial paper, you can apply those rules to warehouse receipts.
Warehouse operations are permitted to contractually limit their liability for goods stored. The definition of an instrument must follow U.C.C. rules. The U.C.C. has specific rules for defining commercial paper and warehouse receipts that are not interchangeable. Either paper is a note or draft or it is a warehouse receipt, but it cannot be both. The reason is that in order to be a commercial paper, the instrument must be payable in money and not contain any other promises or conditions. A warehouse receipt may be issued by a warehouser who is not licensed or bonded. The U.C.C. definition of a warehouse receipt is based on the form of the instrument and not on the legal status of the entity that issues it.
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4234 Documents of Title and Title Transfer
Which of the following interests in real property gives the holder of that interest the greatest possessory interest in the property Easement Restrictive covenant License Fee simple
Fee simple
When land is owned as an estate in fee simple, the owner has control of all things above ground (surface rights) and all things below ground (mineral rights). “Fee simple,” a term from English common law, indicates the maximum of legal ownership with the greatest possible collection of rights, powers, and privileges a person may have in land. An easement, such as a utility easement, is a legal right to access the land as needed to maintain the service provided by the utility.
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4234 Documents of Title and Title Transfer
In the filing of a consolidated tax return for a corporation and its wholly owned subsidiaries, intercompany dividends between the parent and subsidiary corporations are:
not taxable.
included in taxable income to the extent of 20%.
included in taxable income to the extent of 80%.
fully taxable.
not taxable.
In the filing of a consolidated tax return for a corporation and its wholly owned subsidiaries, intercompany dividends between the parent and subsidiary corporations are not taxable. One of the advantages of filing a consolidated return is that all (100%) of the intercompany dividends are tax-free. Or reworded, there is a “100%” dividends-received deduction.
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4636 Consolidated Returns
For an individual business owner, which of the following would typically be classified as a capital asset for federal income tax purposes
Accounts receivable
Marketable securities
Machinery and equipment used in a business
Inventory
Marketable securities
Capital assets are investment property and personal-use property. Capital assets do not include the following:
- Property held for resale (inventory)
- Real or depreciable property used in a trade or business
- Accounts or notes receivable acquired in normal business operations
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4410 Types of Assets
Under the Negotiable Instruments Article of the U.C.C., which of the following statements is correct regarding a check
A check is a promise to pay money.
A check is an order to pay money.
A check does not need to be payable on demand.
A check does not need to be drawn on a bank.
A check is an order to pay money.
A check is an order (to the bank) to pay money. A check is a draft on a bank and payable on demand. The payee can go directly to the bank for payment of the check or deposit it in the payee’s bank account and let it clear through the banking system.
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4232 Negotiable Instruments
Starr, a self-employed individual, purchased a piece of equipment for use in Starr’s business. The costs associated with the acquisition of the equipment were:
Purchase price $55,000
Delivery charges 725
Installation fees 300
Sales tax 3,400
What is the depreciable basis of the equipment $55,000 $58,400 $59,125 $59,425
$59,425
The depreciable basis of purchased equipment is its cost. Included in cost are all incidental costs related to acquiring and placing the equipment in service such as delivery, installation, and sales taxes. Therefore, the depreciable basis of Starr’s piece of equipment is:
Purchase price $55,000
Delivery charges 725
Installation fees 300
Sales tax 3,400
-------
Total $59,425
=======
IRC Section 1012
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4420 Basis and Holding Periods of Assets
Under the 2005 Bankruptcy Reform Act, certain changes were made to Chapter 7 of the Bankruptcy Code. Consider the following items and determine which are applicable to Chapter 7 bankruptcy:
I. Consumer debts for more than $650 for luxury goods or services provided within 90 days of the order of relief may be discharged.
II. Cash advances totaling more than $925 from a credit card obtained within 70 days of the order may not be discharged, subject to a rebuttable presumption.
III. An unsecured claim is now allowed for death resulting from the operation of a motor vehicle while the debtor was under drug or alcohol influence.
IV. Penalties resulting from federal election law penalties remain dischargeable.
II, III, and IV
II and III
I, III, and IV
I, II, and IV
II and III
Changes made by the 2005 Bankruptcy Reform Act to Chapter 7 of the Bankruptcy Code include the following:
- Cash advances totaling more than $925 from a credit card obtained within 70 days of the order may not be discharged, subject to a rebuttable presumption.
- An unsecured claim for death resulting from the operation of a motor vehicle while the debtor was under drug or alcohol influence is a newly added item related to unsecured creditors.
The following are not changes made by the 2005 Act to Chapter 7:
- “Consumer debts for more than $650 for luxury goods or services provided within 90 days of the order of relief may be discharged.” This would be correct if it said the debt was nondischargeable.
- “Penalties resulting from federal election law penalties remain dischargeable.” These penalties are now nondischargeable under the 2005 Act.
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Sections 223, 310, and 1235
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4242 Bankruptcy and Insolvency
To prevail in common-law action for fraud in the inducement, a plaintiff must prove that the:
misrepresentations were in writing.
defendant made the misrepresentations with knowledge of their falsity and with an intention to deceive.
defendant was an expert with regard to the misrepresentations.
plaintiff was in a fiduciary relationship with the defendant
defendant made the misrepresentations with knowledge of their falsity and with an intention to deceive.
Fraud in the inducement is a false representation of a material fact intentionally made, justifiably relied upon, and resulting in injury. Consequently, the plaintiff must be able to prove that the defendant intentionally made the representation and had the intent to deceive.
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4224 Discharge, Breach, and Remedies
Easel Co. has elected to reimburse employees for business expenses under a nonaccountable plan. Easel does not require employees to provide proof of expenses and allows employees to keep any amount not spent. Under the plan, Mel, an Easel employee for a full year, gets $400 per month for business automobile expenses. At the end of the year, Mel informs Easel that the only business expense incurred was for business mileage of 12,000 at a rate of 56 cents per mile, the IRS standard mileage rate at the time. Mel encloses a check for $480 to refund the overpayment to Easel. What amount should be reported in Mel's gross income for the year $0 $480 $4,320 $4,800
$4,800
Had this been an accountable plan, none of the money would be included in the employee’s income. However, no accountability is required by the employer for these expenses.
Under a nonaccountable plan, all expense payments received are reported in Box 1 of the employee’s W-2. See IRS Publication 17.
So, the entire $4,800 ($400 × 12) is reported on the W-2. The employee can deduct allowable business expenses on Schedule A, if the employee itemizes deductions.
Regulation Sections 1.62-2(c)(5) and (c)(3)(i)
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4512 Characterization of Income
Dan owes debts to four different creditors. To satisfy these debts, Dan transfers his property to a trustee. The trustee converts the property to cash and pays it to all of the creditors on a pro rata basis. If all of the creditors only receive partial payments of the amounts they are due:
the debtor will be released from liability for the balance due unless the creditors expressly reserve the right to collect the full amount.
the debtor will be released from liability for the balance due since this is a composition agreement.
the debtor will not be released from liability for the balance due because an assignment for the benefit of creditors does not require the consent of the creditors.
the debtor will not be released from liability for the balance due unless the trustee agrees to the release.
the debtor will not be released from liability for the balance due because an assignment for the benefit of creditors does not require the consent of the creditors.
In an assignment for the benefit of creditors, the debtor transfers property to a trustee who sells the property and uses the funds to make payments to the creditors. Since this arrangement does not involve the consent of the creditors, the debtors will not be released from liability for any balance.
Any agreement under which partial payments will release the debtor from further liability must be made between the debtor and the creditors. The trustee has no such power.
Finally, a composition agreement involves a direct agreement between the debtor and its creditors and does not generally involve transfer of the debtor’s property to a trustee. However, in the above instance, a composition agreement for a lesser payment of individuals claims would, in fact, discharge the balance if it were so agreed.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Parker, whose spouse died during the preceding year, has not remarried. Parker maintains a home for a dependent child. What is Parker’s most advantageous filing status
Single
Head of household
Married filing separately
Qualifying widow(er) with dependent child
Qualifying widow(er) with dependent child
A taxpayer is eligible for filing status of “Qualifying widow(er) with dependent child” if they meet the following requirements:
- The taxpayer’s spouse passed away during one of the two preceding tax years.
- The taxpayer must maintain as his home a household which is the residence of their dependent child.
- The taxpayer must claim the dependency exemption for the dependent child.
- The taxpayer must not remarry before year-end.
- The taxpayer must have qualified to file a joint tax return with the deceased spouse if the spouse died.
Parker’s spouse died during the immediately preceding year and has not remarried. Parker also maintains a home for a dependent child. We can presume Parker meets the other requirements. So Parker qualifies for “Qualifying widow(er) with dependent child” filing status.
Parker would also qualify for single and head of household. However, “Qualifying widow(er) with dependent child” filing status allows the taxpayer to use the married filing joint tax brackets, which allow more income to be taxed at lower rates than any the other filing status.
For example, for 2014 the following amounts of taxable income are taxed at the 10% rate:
Single $ 9,075
Head of household 12,950
Qualifying widow(er) 18,150
IRC Sections 1 and 2(a)
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4530 Adjustments and Deductions to Arrive at Taxable Income
Roth and Dixon both claim a security interest in the same collateral. Roth’s security interest attached on January 1 and was perfected by filing on March 1. Dixon’s security interest attached on February 1 and was perfected on April 1 by taking possession of the collateral. Which of the following statements is correct
Roth’s security interest has priority because Roth perfected before Dixon perfected.
Dixon’s security interest has priority because Dixon’s interest attached before Roth’s interest was perfected.
Roth’s security interest has priority because Roth’s security interest attached before Dixon’s security interest attached.
Dixon’s security interest has priority because Dixon is in possession of the collateral.
Roth’s security interest has priority because Roth perfected before Dixon perfected.
Roth’s security interest has priority because Roth perfected before Dixon perfected. This question tests your understanding of the rules of priority of perfected security interests. The general rule is “first to file or to perfect.”
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4233 Secured Transactions
Case Corp. is incorporated in state A. Under the Revised Model Business Corporation Act, which of the following activities engaged in by Case requires that Case obtain a certificate of authority to do business in state B
Maintaining bank accounts in state B
Collecting corporate debts in state B
Hiring employees who are residents of state B
Maintaining an office in state B to conduct intrastate business
Maintaining an office in state B to conduct intrastate business
A certificate of authority is obtained primarily to avoid losing the right to use state B’s courts and to keep the corporate shield intact. In addition, if the certificate of authority is not received, state B may have enabling legislation to allow fines to be assessed against the company and/or its officers.
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4262 Formation, Operation, and Termination
Are the two items that follow used in the computation of the built-in gains tax liability for 2014 for an S corporation
Flat 35% tax rate: Yes; Deduct unexpired NOLs and C corp. capital losses: Yes
Flat 35% tax rate: Yes; Deduct unexpired NOLs and C corp. capital losses: No
Flat 35% tax rate: No; Deduct unexpired NOLs and C corp. capital losses: Yes
Flat 35% tax rate: No; Deduct unexpired NOLs and C corp. capital losses: No
Flat 35% tax rate: Yes; Deduct unexpired NOLs and C corp. capital losses: Yes
Both of the items are used. The maximum corporate rate is used to prevent tax avoidance by converting C corporation income to S corporation income. Unexpired benefits of the C corporation are deducted (NOLs, capital losses, AMT credits, and business credit carryforwards).
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4645 Built-In Gains Tax
Under the Uniform Partnership Act, which of the following statements is (are) correct regarding the effect of the assignment of an interest in a general partnership
I. The assignee is personally responsible for the assigning partner’s share of past and future partnership debts.
II. The assignee is entitled to the assigning partner’s interest in partnership profits and surplus on dissolution of the partnership.
I only
II only
Both I and II
Neither I nor II
II only
Assignment transfers rights under a contract to another (not liabilities). The assignee obtains the right to the assignor’s share of partnership profits and what the assignor would receive if the partnership would be dissolved.
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4264 Rights, Duties, Legal Obligations, and Authority of …
Under the U.C.C. Secured Transactions Article, which of the following events will always prevent a security interest from attaching
Failure to have a written security agreement
Failure of the creditor to have possession of the collateral
Failure of the creditor to give present consideration for the security interest
Failure of the debtor to have rights in the collateral
Failure of the debtor to have rights in the collateral
A security interest can attach only when:
- there is a security agreement between the debtor and the secured party. (This may also be created by obtaining the asset and does not have to be in writing.)
- the secured party has given value.
- the debtor has rights in the collateral.
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4233 Secured Transactions
Where the parties have entered into a written contract intended as the final expression of their agreement, which of the following agreements will be admitted into evidence because they are not prohibited by the parol evidence rule
Subsequent oral agreements
Prior written agreements
Both subsequent oral agreements and prior written agreements
Neither subsequent oral agreements nor prior written agreements
Subsequent oral agreements
The parol evidence rule prevents the trier of fact (i.e., a court) from taking into account evidence of prior or contemporaneous agreements that contradict a writing intended as the final expression of the intention of the parties. Subsequent agreements (written or oral), on the other hand, are admissible, since parties are always free to amend contracts by mutual agreement. In the problem stated, subsequent oral agreements would not be prohibited by the parol evidence rule, but prior written agreements would be prohibited.
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4222 Performance
Burke stole several negotiable warehouse receipts from Grove Co. The receipts were deliverable to Grove’s order. Burke indorsed Grove’s name and sold the warehouse receipts to Federated Wholesalers, a bona fide purchaser. In an action by Federated against Grove:
Grove will prevail, because Burke cannot validly negotiate the warehouse receipts.
Grove will prevail, because the warehouser must be notified before any valid negotiation of a warehouse receipt is effective.
Federated will prevail, because the warehouse receipts were converted to bearer instruments by Burke’s endorsement.
Federated will prevail, because it took the negotiable warehouse receipts as a bona fide purchaser for value.
Grove will prevail, because Burke cannot validly negotiate the warehouse receipts.
In an action by Federated against Grove, Grove will prevail because Burke cannot validly negotiate the warehouse receipts. Forgery is a real defense and is valid against everyone including Federated, a holder in due course. According to U.C.C. 4-102, dealing with forgers and thieves is the same for warehouse receipts as it is for commercial paper.
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4234 Documents of Title and Title Transfer
Which of the following statements concerning an initial intrastate securities offering made by an issuer residing in and doing business in that state is correct
The offering would be exempt from the registration requirements of the Securities Act of 1933.
The offering would be subject to the registration requirements of the Securities Exchange Act of 1934.
The offering would be regulated by the SEC.
The shares of the offering could not be resold to investors outside the state for at least one year.
The offering would be exempt from the registration requirements of the Securities Act of 1933.
Intrastate (i.e., within a state only) offerings are exempt from the registration requirements of the Securities Act of 1933. Exemption requirements are that 80% of the issuing company’s business must be in a particular state, and all of the investors must be in that state. According to Rule 147, promulgated by the SEC, during the 12-month sales period and for nine months thereafter, the securities cannot be resold to nonresidents of the state.
The registration requirements of the Securities Exchange Act of 1934 apply to issuers, underwriters, brokers, and exchanges, rather than to the securities offering. The purpose of this Act is more the regulation and supervision of market activities than of individual offerings.
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4251 Federal Securities Regulation
Which of the following fiduciary entities are required to use the calendar year as their taxable period for income tax purposes
Estates
Trusts (except those that are exempt)
Both estates and trusts (except those that are exempt)
Neither estates nor trusts (except those that are exempt)
Trusts (except those that are exempt)
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.
This means trusts must use a calendar year. Partnerships must use the same tax year as the partners. S corporations must use a calendar year. Generally, personal service corporations also use a calendar year.
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4662 Income and Deductions
The amount required to be paid in estimated tax installments by a corporation is the lesser of 100% of the tax shown on its return for the preceding 12-month tax year (if some income tax was due) or what percentage of the tax shown on its return for the current year (determined on the basis of actual income or annualized income) 100% 97% 95% 90%
100%
The estimated tax payment required in installments is the lesser of:
- 100% of the tax shown on the return for the preceding year or
- 100% of the tax shown for the current year.
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4326 Penalties
4631 Determination of Taxable Income/Loss
Dart Corp., a calendar-year S corporation, had 60,000 shares of voting common stock and 40,000 shares of nonvoting common stock issued and outstanding. On February 23, 2013, Dart filed a revocation statement with the consent of shareholders holding 30,000 shares of its voting common stock and 5,000 shares of its nonvoting common stock. Dart's S corporation election: did not terminate. terminated as of January 1, 2013. terminated on February 24, 2013. terminated as of January 1, 2014.
did not terminate.
Under IRC Section 1362(d), an S corporation terminates when the shareholders holding a majority of the total voting and nonvoting shares of stock consent. Revocation does not require more than one-half of each class of stock, only one-half of the total outstanding shares. Thus, more than 1/2 (60,000 shares + 40,000 shares), or at least 50,001 shares are needed for consent to terminate.
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4641 Eligibility and Election
Green was unable to repay a loan from State Bank when due. State refused to renew the loan unless Green provided an acceptable surety. Green asked Royal, a friend, to act as surety of the loan. To induce Royal to agree to become a surety, Green fraudulently represented Green’s financial condition and promised Royal discounts on merchandise sold at Green’s store. Royal agreed to act as surety and the loan was renewed. Later, Green’s obligation to State was discharged in Green’s bankruptcy. State wants to hold Royal liable. Royal may avoid liability:
if Royal can show that State was aware of the fraudulent representations.
if Royal was an uncompensated surety.
because the discharge in bankruptcy will prevent Royal from having a right of reimbursement.
because the arrangement was void at the inception.
If Royal can show that State was aware of the fraudulent representations.
A surety is a person who agrees to be secondarily liable for the debt of another party. If this agreement was elicited by fraud on the part of the debtor (primary party), the surety remains liable unless the surety can show that the creditor was aware of the fraud committed by the debtor.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Bass Corp., a calendar-year C corporation, made qualifying year 2014 estimated tax deposits equal to its actual 2013 tax liability. On March 15, 2015, Bass filed a timely automatic extension request for its 2014 corporate income tax return. Estimated tax deposits totaled $7,600. This amount was 100% of the total tax shown on Bass’s final 2013 corporate income tax return. Bass paid $400 additional tax on the final 2014 corporate income tax return filed before the extended due date. Bass was subject to:
I. interest on the $400 tax payment made with tax return.
II. a penalty for underpayment of estimated taxes.
I only
II only
Both I and II
Neither I nor II
I only
Since Bass Corp. made estimated tax deposits (which totaled $7,600), and this was 100% of the total tax shown on Bass’ final 2013 corporate income tax return, Bass will not have to pay a penalty for underpayment of estimated taxes.
A “safe harbor” provision allows that no penalty for underpayment of estimated taxes will be imposed on a corporation if the estimated tax deposits equal the lesser of 100% of the current-year tax or 100% of last year’s tax.
Bass will pay interest on the $400 paid with the return, accrued from the original due date, March 15 through the date of payment.
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4326 Penalties
A secured creditor wants to file a financing statement to perfect its security interest. Under the U.C.C. Secured Transactions Article, which of the following must be included in the financing statement
A listing or description of the collateral
An after-acquired property provision
The creditor’s signature
The collateral’s location
A listing or description of the collateral
Under the Uniform Commercial Code (U.C.C.) Secured Transaction Article, a secured creditor who wants to perfect a security interest by filing a financing statement must include a listing or description of the collateral. U.C.C. Section 9-402 describes the requirements for a financing statement, which include:
- names of the debtor and the secured party,
- signed by the debtor,
- secured party’s address,
- debtor’s mailing address, and
- a statement indicating the types, or describing the items of collateral.
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4233 Secured Transactions
State boards of accountancy are generally in charge of maintaining records of all members and following up on continuing professional education (CPE) requirements presented by licensed members. Although state board requirements differ, licensees must normally:
get pre-approval from the jurisdiction as to CPE courses.
attend only board CPE sessions.
wait for the accrediting body to provide the courses necessary for recertification.
attest that they have met their jurisdiction’s CPE requirements.
attest that they have met their jurisdiction’s CPE requirements.
State boards typically require that the licensees attest to their jurisdiction that they have completed the requirements for continuing education. Most jurisdictions will run random audits to determine that reporting was both accurate and timely.
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4122 Role of State Boards of Accountancy
When business equipment such as machinery that has been held for 12 months or less is sold at a gain, how is the gain reported for taxes Ordinary gains Short-term capital gains Long-term capital gains Gains on collectibles
Ordinary gains
Fixed assets used in business that have been held for a short-term holding period are taxed as ordinary gains. Business assets include all furniture, equipment, and machinery used in a business venture. Ordinary gains are reported on IRS Form 4797.
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4410 Types of Assets
Spencer, who itemizes deductions, had adjusted gross income of $60,000 this year. The following additional information is available:
Cash contribution to church $4,000
Purchase of art object at church bazaar
(with a fair market value of $800 on
the date of purchase) 1,200
Donation of used clothing to Salvation
Army (fair value evidenced by receipt
received) 500
What is the maximum amount Spencer can claim as a deduction for charitable contributions this year $5,400 $5,200 $4,900 $4,400
$4,900
Spencer can deduct the following charitable contributions in the current year:
Cash to church $4,000
FMV of clothing donated to the Salvation Army 500
Purchase of an art object ($1,200 amount paid less
$800 FMV of the work of art) 400
------
Maximum charitable contribution $4,900
====== Regulation Section 1.170A-1(h)
Note
Any deduction for noncash contributions that exceeds $500 (total of all noncash contributions) triggers a requirement for the filing of Form 8283. This form requires the name and address of the donee and an itemization of the articles donated plus an estimate of the fair market value of the item. The estimate of the value is the responsibility of the donor taxpayer and not the charity. For any donation of personal property exceeding $5,000 in total value, an independent qualified appraisal is required.
Comment
Any contributions made on or after January 1, 1994, of $250 or more must be substantiated with written acknowledgment from the donee or organization. The acknowledgment must include the following information: (1) the amount of cash and a description, but not the value of any property other than cash contributed, (2) whether the donee organization provided any goods or services in consideration, in whole or in part, for any property contributed, and (3) a description and good faith estimate of the value of any goods or services provided by the donee organization or, if such goods or services consist solely of intangible religious benefits, a statement to that effect. The substantiation must be in the taxpayer’s records on or before the earlier of (1) the date the taxpayer files a return for the taxable year in which the contribution was made, or (2) the due date, including extensions, for filing the return.
The Pension Protection Act of 2006 strengthened the substantiation requirements for cash gifts of less than $250. Effective for contributions made in tax years beginning after August 17, 2006, a charitable contribution deduction is not allowed for any contribution of cash, a check, or other monetary gift unless the donor maintains as a record of such contribution a bank record or a written communication from the donee showing the donee’s name and the date and amount of the contribution.
IRC Section 170(f)(17)
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4530 Adjustments and Deductions to Arrive at Taxable Income
Under the provisions of a decedent’s will, the following cash disbursements were made by the estate’s executor:
A charitable bequest to the American Red Cross
Payment of the decedent’s funeral expenses
What deduction(s) is (are) allowable in determining the decedent’s taxable estate
I only
II only
Both I and II
Neither I nor II
Both I and II
In computing the taxable estate for estate tax purposes, a deduction is allowed for bequests to charitable organizations, and there is no percentage limitation.
A deduction is also allowed for funeral expenses, reducing the taxable estate.
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4473 Determination of Taxable Estate
Fairwell is executive vice president and treasurer of Wonder Corporation. He was named as a party in a shareholder derivative action in connection with certain activities he engaged in as a corporate officer. In the lawsuit, it was determined that he was liable for negligence in performance of his duties. Fairwell seeks *indemnity from the corporation for his liability. The board would like to indemnify him. The articles of incorporation do not contain any provisions regarding indemnification of officers and directors. Indemnification:
is not permitted since the articles of incorporation do not so provide.
cannot include attorney’s fees since he was found to have been negligent.
may be permitted by court order despite the fact that Fairwell was found to be negligent.
is permitted only if he is found not to have been grossly negligent.
*imdemnity - security against or exemption from legal responsibility for one’s actions.
may be permitted by court order despite the fact that Fairwell was found to be negligent.
A corporate officer generally may not be indemnified by the corporation if there is misconduct by the officer. This indemnification would have to be permitted by court order.
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4262 Formation, Operation, and Termination
Which of the following statements is correct regarding a CPA’s working papers The working papers must be:
transferred to another accountant purchasing the CPA’s practice even if the client hasn’t given permission.
transferred permanently to the client if demanded.
turned over to any government agency that requests them.
turned over pursuant to a valid federal court subpoena.
turned over pursuant to a valid federal court subpoena.
Working papers are the property of the accountant. As these papers may contain confidential client information, the accountant is generally under an obligation not to transfer such papers to third parties without the consent of the client. However, the common law does not recognize an “accountant-client” privilege, so that such papers must be turned over to a federal court pursuant to a valid subpoena. Although some states by statute recognize an “accountant-client” privilege, the privilege is not recognized by federal law and is not enforceable in federal courts.
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4133 Privileged Communications, Confidentiality, and …
To which of the following parties may a CPA partnership provide its working papers, without being lawfully subpoenaed or without the client’s consent
The IRS
The FASB
Any surviving partner(s) on the death of a partner
A CPA before purchasing a partnership interest in the firm
Any surviving partner(s) on the death of a partner
Without a subpoena or client consent, a CPA partnership may provide its working papers only to surviving partners on the death of a partner or under a review of the CPA’s professional practice under AICPA or State CPA Society or Board of Accountancy authorization. In most other cases, including the IRS and a CPA purchasing a partnership interest in the firm, a subpoena or the client’s consent is required.
The FASB should have no reason to need access to a practitioner’s working papers.
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4133 Privileged Communications, Confidentiality, and …
Stein, an unmarried taxpayer, had adjusted gross income of $80,000 for the year and qualified to itemize deductions. Stein had no charitable contribution carryovers and only made one contribution during the year. Stein donated stock, purchased seven years earlier for $17,000, to a tax-exempt educational organization. The stock was valued at $25,000 when it was contributed.
What is the maximum amount of charitable contributions deductible allowed on Stein's current-year income tax return $17,000 $21,000 $24,000 $25,000
$24,000
Noncash contributions are generally deductible at their fair market value.
For contributions of appreciated capital gain property, deductions are the lesser of the total fair market value or 30% of AGI for educational organizations. AGI of $80,000 × 0.30 limit = $24,000.
The deduction is limited to only $24,000. The unused $1,000 of FMV can be carried forward to the following year.
An election can be made to deduct appreciated capital gain property at cost, in which case a 50% of AGI limitation would apply. In this case, the 30% limitation using FMV results in a larger deduction.
IRC Section 170(b)(1)(C)
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4530 Adjustments and Deductions to Arrive at Taxable Income
In which of the following types of action, brought against a CPA who issues an audit report containing an unqualified opinion on materially misstated financial statements, may a plaintiff prevail without proving reliance on the audit report
An action for common law fraud
An action for common law breach of contract
An action brought under Section 11 of the Securities Act of 1933
An action brought under Rule 10b-5 of the Securities Exchange Act of 1934
An action brought under Section 11 of the Securities Act of 1933
A plaintiff does not have to prove reliance on materially misstated financial statements under Section 11 of the Securities Act of 1933.
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4132 Federal Statutory Liability
Under the Sales Article of the U.C.C., which of the following requirements must be met for a writing to be an enforceable contract for the sale of goods
The writing must contain a term specifying the price of the goods.
The writing must contain a term specifying the quantity of the goods.
The writing must contain the signatures of all parties to the writing.
The writing must contain the signature of the party seeking to enforce the writing.
The writing must contain a term specifying the quantity of the goods.
A contract for the sale of goods for a price of $500 or more must be in writing to be enforceable. The writing must meet the test of reasonable certainty and should include the names of the parties, the subject matter, and material terms and conditions. This would include the quantity of goods to be sold. To be enforceable, the writing must be signed by the party to be charged.
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4222 Performance
Under the Federal Fair Labor Standards Act, which of the following would be regulated
Minimum wage, overtime, and number of hours in the workweek
Minimum wage and number of hours in the workweek
Minimum wage and overtime
Overtime and number of hours in the workweek
Minimum wage, overtime, and number of hours in the workweek
The Federal Fair Labor Standards Act applies to all employers whose activities affect interstate commerce. It mandates a certain minimum wage and requires that overtime be paid employees who work more than 40 hours in a week. Through the overtime requirement, the number of hours in the workweek is also regulated.
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4252 Other Federal Laws and Regulations (Antitrust, …
A tax year generally must end on the last day of a month, except in the case of a: 52- or 53-week year. fiscal year. calendar year. short tax year.
52- or 53-week year.
A 52- or 53-week year ends on the same day of the week each year such as the last Friday in December. As a result, the year will vary in length from 52 to 53 weeks.
IRC Section 441(f)(1)
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4330 Accounting Periods
Under the Sales Article of the U.C.C., which of the following statements regarding liquidated damages is (are) correct
I. The injured party may collect any amount of liquidated damages provided for in the contract.
II. The seller may retain a deposit of up to $500 when a buyer defaults even if there is no liquidated damages provision in the contract.
I only
II only
Both I and II
Neither I nor II
II only
U.C.C. 2-718 provides that “damages for breach of either party may be liquidated in the agreement but only at an amount which is reasonable in the light of the anticipated or actual harm caused by the breach…” (U.C.C. 2-718). Thus, it is not correct to state that any amount of damages may be collected if provided for in the contract. This same article stipulates that the seller may retain a deposit of up to 20% of the value of total performance or $500, whichever is smaller.
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4231 Sales Contracts
During an audit of Trent Realty Corp.’s financial statements, Clark, CPA, reviewed the following instrument:
FRONT OF INSTRUMENT BACK OF INSTRUMENT
To: Pure Bank M. West
Upton, VT
Pay to C. Larr
April 5, 20X1 T. Keetin
Pay to the order of M. West $1,500.00
One Thousand Five Hundred and 00/100 Dollars C. Larr
on May 1, 20X4. Without recourse
(SIGNED) W. Fields
This instrument is: negotiable. nonnegotiable. a certified check. an incomplete instrument.
negotiable.
The instrument is negotiable since it satisfies the six requirements established by Article 3 of the Uniform Commercial Code that must be present on the face of the instrument: the instrument must:
- be in writing,
- contain an unconditional promise or order to pay a sum certain in money,
- be payable on demand or at a definite time,
- be payable to the order of or to bearer,
- contain no promise other than the payment of money, and
- be signed by the maker or drawer.
This instrument satisfies the elements of negotiability. It is not a certified check and it is a complete instrument.
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4232 Negotiable Instruments
Reid, Welsh, and May are equal partners in the RWM partnership. Reid's basis in the partnership interest is $60,000. Reid receives a liquidating distribution of $61,000 cash and land with a fair market value of $14,000 and an adjusted basis of $12,000. What gain must Reid recognize upon the liquidation of his partnership interest $0 $1,000 $13,000 $15,000
$1,000
Although generally no gain or loss is recognized by a partner upon the liquidation of a partnership interest, there are exceptions:
-Gain is recognized if cash distributed is in excess of the partner’s basis in the partnership interest.
-Loss is recognized if no property other than cash, unrealized receivables, and inventory is distributed and the cash and basis of the unrealized receivables and inventory received are less than the partner’s basis in the partnership interest.
Reid’s cash distribution exceeded his basis in his partnership interest, so he recognizes gain computed as follows:
Liquidating cash distribution $61,000
Basis in partnership interest (60,000)
——–
Gain on liquidation $ 1,000
Reid’s basis in the land is $0.
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4654 Transactions Between a Partner and the Partnership
What is the nonseparately stated income amount of an accrual-basis calendar-year S corporation with the following items
Gross receipts $200,000
Rental income 25,000
Interest income 12,000
Cost of goods sold and commissions 127,000
Net long-term capital gain 17,000
Compensation paid to shareholder 10,000
$63,000
$73,000
$117,000
$127,000
$63,000
The nonseparately stated income amount is calculated as follows:
Gross receipts $200,000
Less: Cost of goods sold 127,000
Compensation paid to shareholder $ 10,000
--------
Total $ 63,000
========
All other items are separately stated. Any item of income, loss, deduction, or credit which could affect the tax liability of a shareholder must be separately stated. These items are passed through pro rata to the shareholders with the same character.
IRS Form 1120S Instructions
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4642 Determination of Ordinary Income/Loss and Separately …
Which of the following items is not listed on Schedule K, Form 1120S, as a separately stated item
Net income from rental real estate
Royalty income
Pension expense
Interest expense related to portfolio income
Pension expense
Expenses related to pensions, profit sharing, etc. are included in the computation of ordinary income and are not on Schedule K.
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4642 Determination of Ordinary Income/Loss and Separately …
Kent, without authority, contracted to buy computer equipment from Fox Corp. for Ace Corp. Kent told Fox that Kent was acting on Ace’s behalf. For Ace to ratify the contract with Fox:
Kent must be a general agent of Ace.
Ace must know all material facts relating to the contract at the time it is ratified.
Ace must notify Fox that Ace intends to ratify the contract.
Kent must have acted reasonably and in Ace’s best interest.
Ace must know all material facts relating to the contract at the time it is ratified.
For Ace to ratify the contract with Fox, Ace must know all material facts relating to the contract at the time it is ratified. A principal must know all material facts relating to a contract to have a valid ratification of a contract.
It is not necessary that an agency relationship exist, or that the principal give notification of intent to ratify a contract to the third party, or that the agent acted reasonably in the principal’s best interest for a valid ratification.
The requirements for an enforceable ratification are—the principal must have all the material facts related to the contract and be free from duress and voluntarily accept the benefit of the contract.
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4211 Formation and Termination
Don Wolf became a general partner in Gata Associates on January 1, Year 1, with a 5% interest in Gata’s profits, losses, and capital. Gata is a distributor of auto parts. Wolf does not materially participate in the partnership business. For Year 1, Gata had an operating loss of $100,000. In addition, Gata earned interest of $20,000 on a temporary investment. Gata has kept the principal temporarily invested while awaiting delivery of equipment that is presently on order. The principal will be used to pay for this equipment. Wolf’s passive loss for Year 1 is: $6,000. $0. $5,000. $4,000.
$5,000.
Don Wolf’s passive loss is $5,000, or 5% of Gata Associates’ $100,000 loss. Interest earned on the temporary investment is not considered in determining Gata Associates’ passive loss.
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4540 Passive Activity Losses
West, Inc., and Barton entered into a contract. After receiving valuable consideration from Egan, West assigned its rights under the Barton contract to Egan. In which of the following circumstances would West not be liable to Egan West released Barton. West breached the contract. Egan released Barton. Barton paid West.
Egan released Barton.
When a contract is assigned, one party transfers rights under the contract to another person who was not a party to the original contract. In this question, West has transferred its rights under the Barton contract to Egan for valuable consideration (a contract has been made between West and Egan). Barton is now liable to Egan to perform duties under the contract. Egan has all the rights that West originally had to demand performance by Barton. West is liable to make sure that Egan receives those rights under performance of the contract made between it and Egan.
After the assignment, West no longer has the right to release Barton from the contract. If West breaches the contract, Barton is no longer liable to West or Egan. However, West may continue to be liable to Egan for consideration given for the assignment. If Barton pays West, then West is liable to pay Egan.
Only if Egan releases Barton is West no longer liable to Egan.
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4222 Performance
Under the Negotiable Instruments Article of the U.C.C. (Article 3), which of the indorser's liabilities are disclaimed by a “without recourse” indorsement Contract liability only Warranty liability only Both contract and warranty liability Neither contract nor warranty liability
Contract liability only
One definition of a qualified indorsement is that it is a type of indorsement that disclaims any contract liability on the instrument (e.g., “without recourse”). Without recourse means the indorser assumes no responsibility to pay the instrument if it is dishonored. For example: “Pay to Allison Jones, without recourse.”
Accordingly, the other answer choices fail since they do not deal exclusively with the contract liability issue. Notice that (transfer) warranties are defined as implied warranties, made by any person who transfers an instrument for consideration to subsequent transferees and holders who take the instrument in good faith, that (1) the transferor is entitled to enforce the instrument; (2) all signatures are authorized and authentic; (3) the instrument has not been altered; (4) the instrument is not subject to a defense or claim of any party that can be asserted against the transferor; and (5) the transferor has no knowledge of any insolvency proceedings against the maker, the acceptor, or the drawer of the instrument. Warranty liability extends to any subsequent holder who takes in good faith an instrument transferred by indorsement. If, on the other hand, the instrument is transferred for consideration and without indorsement, liability extends only to the immediate transferee.
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4232 Negotiable Instruments
Gem Corp. purchased all the assets of a sole proprietorship, including the following intangible assets:
Goodwill $50,000 Covenant not to compete 13,000 For tax purposes, what amount of these purchased intangible assets should Gem amortize over the specific statutory cost recovery periods $63,000 $50,000 $13,000 $0
$63,000
Intangibles are qualifying assets acquired and held in connection with the conduct of a trade or business. These include goodwill, going-concern value, trademarks, and franchises. These intangibles are allowed to be amortized over 15 years. In this example, the goodwill of $50,000 plus the covenant not to compete of $13,000 equals $63,000 subject to amortization.
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4430 Cost Recovery (Depreciation, Depletion, and …
Under the Secured Transactions Article of the U.C.C., all of the following are needed to create an enforceable security agreement except: authentication by the debtor. possession for purposes of security. identifying the collateral. filing a financing statement.
filing a financing statement.
A security agreement is a contract between a borrower and a secured lender that specifies which asset is promised as security. A financing statement is filed to give public notice of a security interest, not the security agreement.
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4233 Secured Transactions
Partnership Abel, Benz, Clark & Day is in the real estate and insurance business. Abel owns a 40% interest in the capital and profits of the partnership, while Benz, Clark, and Day each owns a 20% interest. All use a calendar year. At November 1, the real estate and insurance business is separated, and two partnerships are formed: Partnership Abel & Benz takes over the real estate business, and Partnership Clark & Day takes over the insurance business. Which one of the following statements is correct for tax purposes
In forming Partnership Clark & Day, partners Clark and Day are subject to a penalty surtax if they contribute their entire distributions from Partnership Abel, Benz, Clark & Day.
Before separating the two businesses into two distinct entities, the partners must obtain approval from the IRS.
Before separating the two businesses into two distinct entities, Partnership Abel, Benz, Clark & Day must file a formal dissolution with the IRS on the prescribed form.
Partnership Abel & Benz is considered to be a continuation of Partnership Abel, Benz, Clark & Day.
Partnership Abel & Benz is considered to be a continuation of Partnership Abel, Benz, Clark & Day.
A partnership is considered terminated only if there has been a sale or exchange of 50% or more of the total interest in partnership capital and profits.
Together Able and Benz own 60%, so the original partnership will continue with them.
There is no penalty surtax, no one must get permission from the IRS, and a formal dissolution is not necessary.
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4657 Ownership Changes, and Liquidation and Termination of …
Which of the following can be an advantage of a limited liability company over an S corporation
Double taxation of profits is avoided.
Owners receive limited liability protection.
Appreciated property can be distributed tax-free to an owner.
Incentive stock options can be used to compensate owners.
Appreciated property can be distributed tax-free to an owner.
An S corporation recognizes a gain on the distribution of appreciated property to a shareholder. The transaction is treated as a “sale” of the property to the shareholder at fair market value (FMV).
Distributions from a limited liability company (LLC) are assigned a portion of adjusted basis of the LLC interest.
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4613 Distributions
Forrest Corp. owned 100% of both the voting stock and total value of Diamond Corp. Both corporations were C corporations. Forrest's basis in the Diamond stock was $200,000 when it received a lump-sum liquidating distribution of property as a result of the redemption of all of Diamond stock. The property had an adjusted basis of $270,000 and a fair market value of $500,000. What amount of gain did Forrest recognize on the distribution $0 $70,000 $270,000 $500,000
$0
When a subsidiary distributes property to its parent corporation (80% ownership or more), no gain is recognized by the parent. Generally, the property received by the parent has the same basis that it had in the hands of the subsidiary.
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4634 Entity/Owner Transactions, Including Contributions and …
After serving as an active director of Lee Corp. for 20 years, Ryan was appointed an honorary director with the obligation to attend directors’ meetings with no voting power. In 20X1, Ryan received an honorary director’s fee of $5,000. This fee is:
reportable by Lee as employee compensation subject to Social Security tax.
reportable by Ryan as self-employment income subject to Social Security self-employment tax.
taxable as “other income” by Ryan, not subject to any Social Security tax.
considered to be a gift not subject to Social Security, self-employment, or income tax.
reportable by Ryan as self-employment income subject to Social Security self-employment tax.
Ryan is clearly not an employee of Lee Corporation. Thus, Ryan should report the director’s fee as self-employment income, having provided professional services for compensation. This income is subject to Social Security self-employment tax as well as personal income tax. (A gift would be a donation out of detached and disinterested generosity which is not the case here.)
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4252 Other Federal Laws and Regulations (Antitrust, …
Which of the following disqualifies an individual from the earned income credit
The taxpayer’s qualifying child is a 17-year-old grandchild.
The taxpayer has earned income of $5,000.
The taxpayer’s 5-year-old child lived in the taxpayer’s home for only eight months.
The taxpayer has a filing status of married filing separately.
The taxpayer has a filing status of married filing separately.
In the case of an individual who is married, the earned income credit (EIC) only applies if a joint return is filed.
A qualifying child for purposes of the earned income credit must meet several tests:
Relationship test: The child must be a child of the taxpayer or a descendent of such a child, or a brother, sister, stepbrother, or stepsister or descendant of any such relative.
Residency test: the child must have the same principal place of abode as the taxpayer for more than one-half of the taxable year.
Age test: The qualifying child must be younger than the taxpayer and have not obtained the age of 19 at the end of the year (unless the child is a student, and then the age is 19).
Filing status: The qualifying child must not have filed a joint return (other than to claim a refund).
Therefore, neither being a 17-year-old nor being a grandson disqualify the child from being a qualifying child as the age limit of 19 is not met and the relationship of a grandchild is also within the requirements. The support test used for the dependency requirements does not apply to the qualifying child for purposes of the earned income credit. The 5-year-old is not disqualified by age or by having only lived with the taxpayer for 8 months as the age limit is 19 and the residency requirement is more than 6 months.
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4580 Tax Computations and Credits
Which of the following activities regularly conducted by a tax-exempt organization will result in unrelated business income
I. Selling articles made by handicapped persons as part of their rehabilitation, when the organization is involved exclusively in their rehabilitation
II. Operating a grocery store almost fully staffed by emotionally handicapped persons as part of a therapeutic program
I only
II only
Both I and II
Neither I nor II
Neither I nor II
Neither of the following activities regularly conducted by a tax-exempt organization will result in unrelated business income:
-Selling articles made by handicapped persons as part of their rehabilitation, when the organization is involved exclusively in their rehabilitation.
-Operating a grocery store almost fully staffed by emotionally handicapped persons as part of a therapeutic program.
Unrelated business taxable income must be derived from an activity that constitutes a trade or business that is regularly carried on and is not substantially related to the organization’s tax-exempt purposes. Generally, a small-scale operation will be exempt but as growth causes the operation to grow to large-scale, the IRS may challenge it as UBIT.
Revenue Rulings 76-94, 68-581, and 75-472; IRC Section 512
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4673 Unrelated Business Income
The president of Deal Corp. wrote to Boyd, offering to sell the Deal factory for $300,000. The offer was sent by Deal on June 5 and was received by Boyd on June 9. The offer stated that it would remain open until December 20. The offer:
may be revoked by Deal any time prior to Boyd’s acceptance.
is a firm offer under the U.C.C. because it is in writing.
is a firm offer under the U.C.C. but will be irrevocable for only three months.
constitutes an enforceable option.
may be revoked by Deal any time prior to Boyd’s acceptance.
To create a contract, the offer must be accepted before a termination of the contract. Under common law, an offer can be revoked any time before its acceptance.
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4231 Sales Contracts
A corporation’s penalty for underpaying federal estimated taxes is:
not deductible.
fully deductible in the year paid.
fully deductible if reasonable cause can be established for the underpayment.
partially deductible.
not deductible.
A corporation’s penalty for underpaying federal estimated taxes is not deductible. No deduction is allowed for a federal tax penalty.
IRC Section 162
Note
A fine or a penalty paid to any government for the violation of any law is not a deductible business expense.
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4326 Penalties
Chapter 13 bankruptcy was revised under the 2005 Bankruptcy Reform Act. Some of the more material changes and additions include:
I. the repayment period cannot exceed five years; the time period is based on the family income as computed.
II. the confirmation of the plan must result in a hearing no sooner than 20 days or more than 45 days after the meeting with the creditors.
III. when considering disposable income of the debtor, the Bankruptcy Code excludes up to 15% of the debtor’s gross income for charitable contributions.
IV. when considering disposable income of the debtor, reasonable costs of health insurance for the debtor and the debtor’s family may be considered.
I only
I and II only
I, II, and III only
I, II, III, and IV
I, II, III, and IV
The 2005 Bankruptcy Reform Act revised Chapter 13 of the Bankruptcy Code, which deals with personal reorganizations (similar to Chapter 11) for individuals. All of the items noted in this question were changed or added by the 2005 Act: The repayment period cannot exceed five years; the time period is based on the family income as computed. The confirmation of the plan must result in a hearing no sooner than 20 days or more than 45 days after the meeting with the creditors. When considering disposable income of the debtor, the Bankruptcy Code excludes up to 15% of the debtor’s gross income for charitable contributions, and reasonable costs of health insurance for the debtor and the debtor’s family may be considered.
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Sections 102, 317, 318, and 323
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4242 Bankruptcy and Insolvency
Johns leased an apartment from Olsen. Shortly before the lease expired, Olsen threatened Johns with eviction and physical harm if Johns did not sign a new lease for twice the old rent. Johns, unable to afford the expense to fight eviction, and in fear of physical harm, signed the new lease. Three months later, Johns moved and sued to void the lease claiming duress. The lease will be held:
void because of the unreasonable increase in rent.
voidable because of Olsen’s threat to bring eviction proceedings.
void because of Johns’ financial condition.
voidable because of Olsen’s threat of physical harm.
voidable because of Olsen’s threat of physical harm.
The lease will be held voidable because of Olsen’s threat of physical harm. Duress is a defense to a contract that may be held voidable.
Courts do not attempt to measure the value of consideration and will not hold the lease void because of the “unreasonable increase in rent.” Olsen’s threat to evict the tenants if they do not sign a new lease is perfectly legal, since Olsen has the right to determine what rent and under what kind of conditions he will rent the apartment. Nor will a court declare a contract void just because one of the parties is in poor financial condition.
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4221 Formation
The federal estate tax may be reduced by a credit for:
I. foreign death taxes.
II. tax on prior transfers.
I only
II only
Both I and II
Neither I nor II
Both I and II
The federal estate tax may be reduced by both a credit for foreign death taxes and/or a credit for tax on prior transfers.
Note
The following credits are allowed against the federal estate tax: The applicable (unified) tax credit—the maximum amount is $2,081,800 for 2014, which is equivalent to $5,340,000 worth of property in 2014. The estate tax was reinstated in 2011 by the Tax Relief Act of 2010 and made permanent by the Taxpayer Relief Act of 2012.
IRC Section 2010
A credit is allowed for any federal gift taxes paid on gifts included in the donor-decedents’ taxable estate. Only taxable gifts made before 1976 are added to the donor’s taxable estate.
IRC Section 2012
After 1976 the unified transfer system took effect. Taxable gifts made after 1976 are taken into account in determining the rate of tax applied to the estate but generally are not included in the taxable estate. (See also IRC Section 2001.)
A credit is allowed against the federal estate tax if a person inherits from someone who also paid a federal estate tax and died within the prior 10 years (credit for tax on prior transfers).
IRC Section 2013
A credit is allowed for foreign death taxes paid.
IRC Section 201
The credit for state death taxes was reduced each year beginning in 2002 until it was repealed in 2005 and replaced with a deduction for state death taxes paid.
IRC Section 2011
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4473 Determination of Taxable Estate
Allen owns 100 shares of Prime Corp., a publicly traded company, which Allen purchased on January 1, 2009, for $10,000. On January 1, 2014, Prime declared a 2-for-1 stock split when the fair market value (FMV) of the stock was $120 per share. Immediately following the split, the FMV of Prime stock was $62 per share. On February 1, 2014, Allen had his broker specifically sell the 100 shares of Prime stock received in the split when the FMV of the stock was $65 per share.
What amount should Allen recognize as long-term capital gain income on his Form 1040, U.S. Individual Income Tax Return, for 2014 $300 $750 $1,500 $2,000
$1,500
The basis in the original stock must be allocated between the original shares and the new shares received in a stock split. The new shares have the same holding period as the original shares.
Allen purchased 100 shares of Prime Corp for $10,000. When Prime Corp had a 2-for-1 stock split, the basis must be allocated to 200 shares (100 original shares and 100 new shares). So, the original 100 shares have a basis of $5,000 and the new 100 shares have a basis of $5,000.
The long-term capital gain that Allen must report on his income tax return is $1,500, computed as follows:
Sales price $65 x 100 shares $6,500
Basis in new 100 shares 5,000*
------
Long-term capital gain $1,500
======
IRC Section 305
*10,000 x 100 = 1,000,000 / 200 = $5,000
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4512 Characterization of Income
Tom Lewis, an individual taxpayer, paid the following expenses in 2014:
I. Credit card interest of $1,000
II. Real estate taxes of $3,000 on behalf of his mother, on property owned by his mother
Which of the amounts is deductible as an itemized deduction on Tom's 2014 tax return I only II only Both I and II Neither I nor II
Neither I nor II
Credit card interest is considered personal interest and is not deductible on an individual’s tax return.
In order to be deductible, real estate taxes must be levied against the taxpayer and not someone else (among other requirements). A taxpayer cannot create a deduction for himself by paying someone else’s real estate taxes. In addition, the person whom the taxes were actually levied against also may not deduct the taxes since they did not pay the taxes from their own funds. Had Tom gifted the money to his mother and she had used the money to pay her taxes, she would then be entitled to claim the deduction.
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4530 Adjustments and Deductions to Arrive at Taxable Income
Simon, a C corporation, had a deficit in accumulated earnings and profits of $50,000 at the beginning of the year and had current earnings and profits of $10,000. At year-end, Simon paid a dividend of $15,000 to its sole shareholder. What amount of the dividend is reported as income $0 $5,000 $10,000 $15,000
$10,000
Corporate distributions to shareholders are considered taxable dividends to the extent of earnings and profits. When there is a deficit in accumulated earnings and profits and no deficit in current-year earnings and profits, then the distribution will be taxable to the extent of the current-year earnings and profits. Only $10,000 of the $15,000 distribution is taxable because there is only $10,000 in current-year earnings and profits.
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4635 Earnings and Profits
Dean, Inc., a publicly traded corporation, paid a $10,000 bribe to a local zoning official. The bribe was recorded in Dean's financial statements as a consulting fee. Dean's unaudited financial statements were submitted to the SEC as part of a quarterly filing. Which of the following federal statutes did Dean violate Federal Trade Commission Act Securities Act of 1933 Securities Exchange Act of 1934 North American Free Trade Act
Securities Exchange Act of 1934
This question is testing your basic knowledge of various federal regulations and acts.
The Securities Exchange Act of 1934 provides for regulation of the publicly held securities and stock exchanges. This includes the prohibition of manipulation or deception in financial statements, specifically under Rule 10b-5, as well as other rules which include quarterly and annual filings. This is the obvious answer without going into more detail of the Act, as it involves illegal actions of an existing company and inappropriate filings and financial statement presentation.
The Securities Act of 1933 deals with the offering or sale of stock by businesses to the public. It does not deal specifically with the question fact pattern.
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4251 Federal Securities Regulation
Quigley, Roberk, and Storm form a corporation. Quigley exchanges $25,000 of legal fees for 30 shares of stock. Roberk exchanges land with a basis of $10,000 and a fair market value of $100,000 for 60 shares of stock. Storm exchanges $10,000 cash for 10 shares of stock. What amount of income should each shareholder recognize
Quigley $0, Roberk $0, and Storm $0
Quigley $25,000, Roberk $90,000, and Storm $0
Quigley $25,000, Roberk $90,000, and Storm $10,000
Quigley $0, Roberk $90,000, and Storm $0
Quigley $25,000, Roberk $90,000, and Storm $0
The general rule is that transfers of property to a corporation in exchange for stock will be tax-free as long as the transferors are in control of the corporation immediately after the exchange. Control is defined as 80% of both the voting power and number of shares of the stock.
Quigley contributed services, and services are not considered part of the 80% control group; therefore, he would have to include in income $25,000. Roberk and Storm are the only ones left to be included in the 80% control group; they do not add up to 80% either, so Roberk would include $90,000 in income ($100,000 - $10,000). Storm would include nothing in income as he contributed cash for the stock.
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4634 Entity/Owner Transactions, Including Contributions and …
What is the percentage depletion rate allowed by the Internal Revenue Code for the recovery of capital invested in mining coal 5% 10% 15% 20%
10%
The percentage depletion rate for coal mined in the United States is 10%. Some types of mining for clay are allowed a 5% depletion rate. The 15% rate for mining includes gold, silver, copper, and iron ore.
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4430 Cost Recovery (Depreciation, Depletion, and …
A partner’s interest in specific partnership property is:
assignable to the partner’s individual creditors.
subject to attachment by the partner’s individual creditors.
both assignable to and subject to attachment by the partner’s individual creditors.
neither assignable to nor subject to attachment by the partner’s individual creditors.
neither assignable to nor subject to attachment by the partner’s individual creditors.
A partner’s interest in specific partnership property is not assignable to the partner’s individual creditors. A partner’s interest in specific partnership property is not subject to attachment by the partner’s individual creditors. A creditor may not obtain a partner’s interest in specific partnership property of the partnership. A court will not award a partner’s creditor with a *lien on specific partnership property.
*lien - a right to keep possession of property belonging to another person until a debt owed by that person is discharged.
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4263 Financial Structure, Capitalization, Profit and Loss …
4264 Rights, Duties, Legal Obligations, and Authority of …
A first-time homebuyer, for purposes of favorable IRA distribution treatment, is one who has not had a present ownership interest in another principal residence for what minimum period before a new principal residence is purchased One year Two years Three years Five years
Two years
IRA distributions qualify as made for first-time homebuyer expenses if:
-the homebuyer is the taxpayer, spouse, child or grandchild of either, or ancestor of either,
-the home is used as a principal residence by the homebuyer,
-the homebuyer (and if married, the homebuyer’s spouse) has not had a present ownership interest in another principal residence within the 2-year period ending on the date that the current principal residence is acquired, and
-the distribution is used within 120 days to pay for qualified acquisition expenses, such as buying, building or reconstructing the residence, as well as usual or reasonable settlement, financing, or other closing costs.
Only $10,000 of *aggregate distributions received by an individual can be treated as made for qualified first-time homebuyer expenses. This is a lifetime limit.
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4560 Taxation of Retirement Plan Benefits
*aggregate - formed or calculated by the combination of many separate units or items; total.
On January 4, 2014, Smith and White contributed $4,000 and $6,000 in cash, respectively, and formed the Macro General Partnership. The partnership agreement allocated profits and losses 40% to Smith and 60% to White. In 2014, Macro purchased property from an unrelated seller for $10,000 cash and a $40,000 mortgage note that was the general liability of the partnership. Macro’s liability:
increases Smith’s partnership basis by $16,000.
increases Smith’s partnership basis by $20,000.
increases Smith’s partnership basis by $24,000.
has no effect on Smith’s partnership basis.
increases Smith’s partnership basis by $16,000.
0.40 (40%) × $40,000 mortgage = $16,000
Any time a partnership borrows money, each partner’s basis increases by the partner’s profits and losses ratio times the total amount borrowed.
Caution
Partners’ shares of partnership liabilities depend upon whether the liability is “recourse” or “nonrecourse.”
-Liabilities are “recourse” to the extent that a partner bears the economic risk of loss if the liability is not satisfied by the partnership. Recourse liabilities are allocated in accordance with the partners’ loss ratio.
-Nonrecourse liabilities are those for which no partner bears the economic risk of loss.
-Nonrecourse liabilities are generally allocated in accordance with the partners’ profits ratio.
IRS Publication 541
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4652 Basis of Partner’s/Member’s Interest and Basis of …
To avoid tax return preparer penalties for a return’s understated tax liability due to an intentional disregard of the regulations, which of the following actions must a tax preparer take
Audit the taxpayer’s corresponding business operations.
Review the accuracy of the taxpayer’s books and records.
Make reasonable inquiries to determine if the taxpayer’s information is incomplete.
Examine the taxpayer’s supporting documents.
Make reasonable inquiries to determine if the taxpayer’s information is incomplete.
Tax return preparer penalties are covered in Circular 230. An audit or review is not required and examination of the taxpayer’s supporting documents is only sometimes required. Reasonable inquiries, however, are generally required.
Regulation Section 1.6694-1(e)
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4113 Internal Revenue Code of 1986, as Amended, and …
Which of the following payments would require the donor to file a gift tax return
$30,000 to a university for a spouse’s tuition
$40,000 to a university for a cousin’s room and board
$50,000 to a hospital for a parent’s medical expenses
$80,000 to a physician for a friend’s surgery
$40,000 to a university for a cousin’s room and board
When gifts are made for tuition of any other person at a university, the gift is not subject to federal gift tax. When gifts are made directly to hospitals and other medical providers for expenses incurred for another person, the gifts are not subject to federal gift tax.
In the case of gifts to pay for university room and board, no such exclusion exists. A payment for room and board would be taxable by the federal gift tax.
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4472 Annual Exclusion and Gift Tax Deductions
Which of the following transactions will be exempt from the full registration requirements of the Securities Act of 1933
All intrastate offerings
All offerings made under Regulation A
Any resale of a security purchased under a Regulation D offering
Any stockbroker transaction
All offerings made under Regulation A
Under Regulation A, an issuer is permitted to offer up to $5 million of securities including a maximum of $1.5 million by selling security holders in any 12-month period without registration with the SEC. However, a Regulation A “filing” would be required (this is less detailed than a formal registration). Not all “intrastate” offerings are exempt from registration requirements, since there are numerous limitations on the intrastate exception (for example, at least 80% of the issuer’s assets must be located within the state of issuance). Stockbroker transactions and issuances under Regulation D that involve a resale are not exempt from registration.
Note
As of the July 2014 publication date of this review, a rules change is pending from the SEC permitting an issuer to offer up to $50 million of securities without registration with the SEC.
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4251 Federal Securities Regulation
Quick Corp. agreed to purchase 200 computers from Union Suppliers, Inc. Union is a wholesaler of appliances and Quick is an appliance retailer. The contract required Union to ship the computers to Quick by common carrier, “FOB Union Suppliers, Inc., Loading Dock.” Which of the parties bears the risk of loss during shipment
Union, because the risk of loss passes only when Quick receives the computers
Union, because both parties are merchants
Quick, because title to the computers passed to Quick at the time of shipment
Quick, because the risk of loss passes when the computers are delivered to the carrier
Quick, because the risk of loss passes when the computers are delivered to the carrier
The U.C.C. Sales Article recognizes that sales might be made “FOB” (“free on board”). If the terms are FOB shipping point (as in this case), risk of loss shifts to the buyer when the goods are placed in the possession of the carrier. The philosophy of the U.C.C. is that “risk of loss” does not always accompany “legal title.”
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4231 Sales Contracts
What is the tax treatment for start-up expense incurred in May 2014
Not deductible
Deduct up to $5,000; amortize the excess over 60 months
Deduct up to $5,000; amortize the excess over 180 months
Current deduction for all start-up expenses
Deduct up to $5,000; amortize the excess over 180 months
For start-up expenses incurred after August 16, 2011, taxpayers may deduct up to $5,000 in the taxable year in which the business begins. The $5,000 amount is reduced by the amount by which the cumulative cost of start-up expenditures exceeds $50,000. Any remaining start-up expenditures not deducted are amortized over a 15-year period (180 months).
IRC Section 195
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4611 Formation
A parent and child currently own and operate a farm as equal partners. Under the Revised Uniform Partnership Act, what effect would the death of the parent have on the partnership
The estate of the deceased partner automatically becomes a partner.
The surviving partner could continue the partnership.
The partnership would be dissolved and wound up.
A partnership agreement could not have governed the continuation of the partnership.
The partnership would be dissolved and wound up.
If a partner dies, according to the Revised Uniform Partnership Act (RUPA), the partnership is dissolved but not terminated, since the partnership must continue until the winding up of partnership affairs is completed.
A partner cannot be substituted for another (the estate for the parent) without ending the original partnership, and a single person cannot continue a partnership.
The RUPA governs in absence of a partnership agreement. A partnership agreement, if one existed, would govern the continuation of the partnership if the parent did not die.
Revised Uniform Partnership Act, Part VI
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4262 Formation, Operation, and Termination
Sunex Co., an accrual-basis, calendar-year domestic C corporation, is taxed on its worldwide income. In the current year, Sunex’s U.S. tax liability on its domestic and foreign source income is $60,000 and no prior-year foreign income taxes have been carried forward. Which factor may affect the amount of Sunex’s foreign tax credit available in its current-year corporate income tax return
Income source
The foreign tax rate
Both income source and the foreign tax rate
Neither income source nor the foreign tax rate
Both income source and the foreign tax rate
The income source must be foreign to generate a tax credit.
The foreign tax credit is the lesser of the foreign tax paid (foreign tax rate times foreign taxable income) or U.S. tax rate on the foreign income.
IRC Sections 901 and 904
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4580 Tax Computations and Credits
Which of the following pairs of elements must a client prove to hold an accountant liable for common-law negligence?
Willful misrepresentation and breach of the accountant’s duty of care
Scienter and a violation of GAAP
Breach of the accountant’s duty of care and loss
Freedom from contributory negligence and privity
Breach of the accountant’s duty of care and loss
An accountant has a liability due to client’s negligence when:
- The accountant breached duty owed of a an average reasonable accountant; and
- Damages or losses resulted from the breach
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4131 Common Law Duties and Liability to Clients and Third …
Omega Corp. owned a factory that was encumbered by a mortgage securing Omega’s note to Eagle Bank. Omega sold the factory to Spear, Inc., which assumed the mortgage note. Later, Spear defaulted on the note, which had an outstanding balance of $15, 000. To recover the outstanding balance, Eagle:
must sue both Spear and Omega.
may sue either Spear or Omega.
must sue Spear first and then proceed against Omega for any deficiency.
may sue Spear only after suing Omega.
may sue either Spear or Omega.
There does not appear to be a novation (substituted contract that dissolves a previous contractual duty) of the original contract in this problem. The creditor has not agreed to release Omega from the contract, so both Spear and Omega continue to be liable for debt.
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4224 Discharge, Breach, and Remedies
Bronson is a residential tenant with a 10-year written lease. In the absence of specific provisions in the lease to the contrary, which of the following statements is correct
The landlord’s death will automatically terminate the lease.
The premises may not be sublet for less than the full remaining lease term.
Bronson’s purchase of the property will terminate the lease.
Bronson may not assign the lease.
Bronson’s purchase of the property will terminate the lease.
Termination of a contract occurs when the contract can no longer be discharged. When Bronson purchases the property, it is no longer possible for Bronson to lease the property and the contract is terminated.
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4224 Discharge, Breach, and Remedies
According to the Securities Act of 1933, which of the following statements is correct regarding an issuer of securities
All securities issuers must provide potential investors with a prospectus containing specified information.
An issuer is permitted to advertise an initial offering of securities only through distribution of the prospectus.
All securities issuers must register the securities offering with the Securities and Exchange Commission (SEC).
If an issuer sells a security and fails to meet certain disclosure requirements, the purchaser may sell it back to the issuer and recover the price paid.
If an issuer sells a security and fails to meet certain disclosure requirements, the purchaser may sell it back to the issuer and recover the price paid.
If securities are offered and sold and the registration statement contains material misstatements and/or omissions, the investor can sue for recovery of losses. The issuer can be sued and is absolutely liable for all misstatements.
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4251 Federal Securities Regulation
Under the Secured Transactions Article of the U.C.C., a secured party generally must comply with each of the following duties except:
filing or sending the debtor a termination statement when the debt is paid.
confirming, at the debtor’s request, the unpaid amount of the debt.
using reasonable care in preserving any collateral in the secured party’s possession.
assigning the security interest to another party at the debtor’s request.
assigning the security interest to another party at the debtor’s request.
A secured party is a lender who has a security interest in personal property (collateral) that secures payment from a debtor. A security agreement must be in writing, unless the secured party has possession of the collateral.
If the secured party has possession of the collateral, she must exercise reasonable care to preserve the collateral. The secured party is also responsible to send a termination statement once the debt is paid and to communicate the amount of the unpaid debt at the debtor’s request.
When a contract is assigned, one party transfers rights under the contract to another person who was not a party to the original contract. Assigning a security interest to another person would prevent the original secured party from collecting the debt owed. The debtor cannot request that the secured party assign the security interest to another party.
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4233 Secured Transactions
Which of the following conditions, if any, must a debtor meet to file a voluntary bankruptcy petition under Chapter 7 of the Federal Bankruptcy Code
I. Insolvency
II. Three or more creditors
III. Pre-petition credit counseling
I and II
I only
II only
III only
III only
Per the Bankruptcy Code: “A voluntary case…is commenced by the filing…of a petition…by…a debtor…”—no requirements are stated. Thus, neither insolvency nor a three-or-more-creditor rule is applicable to a voluntary petition under Chapter 7. Under the Bankruptcy Reform Act of 2005, before the debtor may file a petition, they must receive credit counseling.
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4242 Bankruptcy and Insolvency
Under the Negotiable Instruments Article of the U.C.C. (Article 3), which of the following parties will be a holder but not be entitled to the rights of a holder in due course
A party who, knowing of a real defense to payment, received an instrument from a holder in due course
A party who found an instrument payable to bearer
A party who received, as a gift, an instrument from a holder in due course
A party who, in good faith and without notice of any defect, gave value for an instrument
A party who found an instrument payable to bearer
Generally, a holder is a person who is in possession of an instrument drawn, issued or indorsed to him, to his order, or in blank (U.C.C. 1-201(20)). A holder obtains only the rights that the transferor had (i.e., he is subject to the defenses that could be asserted against the transferor). A holder in due course takes the instrument free of the defenses (U.C.C. 3-302). To be a holder in due course, the person must be a holder, must take for value, must take in good faith, and must take without notice (U.C.C. 3-302).
In the case of a party who knowing of a real defense to payment, received an instrument from a holder in due course, involves the shelter principle of U.C.C. 3-203(b), where a holder who cannot otherwise qualify as a holder in due course nonetheless has the same rights of a holder in due course if the holder obtained the title to the instrument through a holder in due course. Thus, this is correct, despite the knowledge of the defense.
In the case of a party who found an instrument payable to bearer, the person did not acquire the instrument through the holder in due course. In other words, there is no transfer or negotiation. Here there is simple loss and the traits of a holder in due course do not accompany such a loss.
While generally a person must give value for an instrument (U.C.C. 3-303) to be a holder in due course, the gift by a holder in due course to another transfers the same rights the holder in due course originally had. This is another example of the shelter principle. (See U.C.C. 3-203(b).) Thus, this is correct.
A party who, in good faith and without notice of any defect, gave value for an instrument would have a holder in due course status since here the holder gave value, in good faith, and without notice (i.e., the classic definition of a holder in due course). (U.C.C. 3-302)
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4232 Negotiable Instruments
*VIDEO EXPLANATION 11/27
Baker, an unmarried individual, sold a personal residence, which has an adjusted basis of $70,000, for $165,000. Baker owned and lived in the residence for seven years. Selling expenses were $10,000. Four weeks prior to the sale, Baker paid a handyman $1,000 to paint and fix up the residence. What is the amount of Baker's recognized gain? $85,000 $95,000 $0 $84,000
$0
If a taxpayer has owned and occupied a personal residence for at least two out of the last five years, $250,000 of a gain may be excluded from income for a single taxpayer. As Baker’s gain does not exceed this amount, it is irrelevant the amount of selling expenses and fixing up costs. Baker’s recognized gain is zero, answer A.
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4440 Taxable and Nontaxable Sales and Exchanges
Dowd, Elgar, Frost, and Grant formed a general partnership. Their written partnership agreement provided that the profits would be divided so that Dowd would receive 40%; Elgar, 30%; Frost, 20%; and Grant, 10%. There was no provision for allocating losses. At the end of its first year, the partnership had losses of $200,000. Before allocating losses, the partners’ capital account balances were: Dowd, $120,000; Elgar, $100,000; Frost, $75,000; and Grant, $11,000. Grant refuses to make any further contributions to the partnership. Ignore the effects of federal partnership tax law.
After losses were allocated to the partners’ capital accounts and all liabilities were paid, the partnership’s sole asset was $106,000 in cash.
How much would Elgar receive on dissolution of the partnership $37,000 $40,000 $47,500 $50,000
$37,000
If after losses are allocated to partners’ capital accounts the partnership has $106,000 in cash, Elgar would receive $37,000. The computation is as follows:
Elgar’s share of loss .30 x $200,000 = $60,000
Grant’s share of loss .10 x $200,000 = $20,000
$20,000 - $11,000 (his contribution) = $9,000
Since Grant will not contribute, the additional $9,000 must be made up by the other three partners. Therefore, Elgar’s contribution of $100,000 is reduced by his loss ($100,000 - $60,000 = $40,000) and then reduced by the $3,000 share of Grant’s loss ($40,000 - $3,000 = $37,000).
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4262 Formation, Operation, and Termination
Which of the following liens generally requires the lienholder to give notice of legal action before selling the debtor’s property to satisfy the debt
Mechanic’s lien
Artisan’s lien
Both a mechanic’s and an artisan’s lien
Neither a mechanic’s nor an artisan’s lien
Both a mechanic’s and an artisan’s lien
Mechanic’s liens and artisan’s liens are liens created by statute for the benefit of creditors who have rendered services associated with specific property. In order to enforce these statutory liens, the lienholder is required to give notice of impending legal action before selling the debtor’s property. Notice exists in multiple capacities and may include any of the following:
- Mailing a notice to the owner
- Posting a notice on the courthouse door or a bulletin board near the courthouse door in the county where the work was done
- Publishing the notice in the newspaper once a week for two weeks
- Posting a sign at the worker’s business and on the receipt or invoice for the work
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4233 Secured Transactions
Under Section 11 of the Securities Act of 1933, which of the following standards may a CPA use as a defense
Generally accepted accounting principles
Generally accepted fraud detection standards
Both generally accepted accounting principles and generally accepted fraud detection standards
Neither generally accepted accounting principles nor generally accepted fraud detection standards
Generally accepted accounting principles
Under Section 11 of the Securities Act of 1933, the CPA has potential liability for the issuance of materially misleading financial statements. In order to avoid this liability, the CPA must prove that he or she acted with “due diligence.” Adherence to “generally accepted accounted principles” will in most cases be evidence of due diligence. There is no such thing as “generally accepted fraud detection standards.”
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4132 Federal Statutory Liability
Which of the following elements must be contained in a valid deed
Purchase price
Description of the land
Both purchase price and description of the land
Neither purchase price nor description of the land
Description of the land
A deed is the document which indicates the transfer of title from the previous owner (the transferor) to the new owner (the transferee). Although a deed might indicate the actual purchase price, this is not required by law. However, the deed must include a description of the land being conveyed.
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4234 Documents of Title and Title Transfer
Chris, a freelance photographer, uses the cash method for business. The tax year ends on December 31. Which of the following should not be included in the determination of Chris’s gross income for the following year
Chris owns controlling shares of a closely-held corporation and is planning to delay the bonus payment from the corporation until January of the next year. The bonus was authorized on December 15 of the current year and may be drawn at any time.
Chris received a check from a client on December 28 of the current year for a family portrait produced on December 22 of the current year. The check was dated December 23 of the current year but was not deposited until January 4 of the following year.
A client notified Chris on December 27 of the current year that a check was ready. The check was not picked up until January 4 of the following year.
Chris received a dividend check on January 4 of the following year. The dividends were declared payable on December 30 of the current year.
Chris received a dividend check on January 4 of the following year. The dividends were declared payable on December 30 of the current year.
A cash-basis taxpayer should report income for the year in which it is either actually or constructively received. Income is constructively received by a taxpayer in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time. Income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions. The dividends declared on December 30 of the current year by an unrelated corporation would not be deemed constructively received.
Regulation Section 1.451-2(b)
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4511 Inclusions and Exclusions
A CPA decides he wishes to work for an estate planning firm that is composed of numerous owners who are not CPAs and obviously performs no attest functions. The organization is known for its high level of direct advertising. The firm wishes to use the CPA’s name and designation in a direct mailer out to nonclients. He agrees. Is this member’s action permissible under the AICPA code of ethics
The CPA has no exposure since the CPA is not working for an audit firm.
The CPA has exposure only if the recipients are offended or misled by the materials.
The CPA violates the rule against associating with non-CPAs while working in estate planning for the public.
The CPA may not associate his name with such direct mailers.
The CPA may not associate his name with such direct mailers.
The member has ethical responsibilities to the public no matter in what form of organization the CPA participates. Ethics, as you might expect, are not limited to only CPA’s working for CPA firms with attest functions.
The member has exposure whether or not the public has been offended or misled by the materials. Direct mailers to the public are not allowed. (ET 502)
The CPA may not associate his name with the direct mailers to nonclients. See ET Section 591, “Other Responsibilities and Practices,” Ruling 3, “Employment by a Non-CPA Firm.”
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4111 Treasury Department Circular 230
The organizational test to qualify a public service charitable entity as tax exempt requires the articles of organization to:
I. limit the purpose of the entity to the charitable purpose.
II. state that an information return should be filed annually with the Internal Revenue Service.
I only
II only
Both I and II
Neither I nor II
I only
The organizational test to qualify a public service charitable entity as tax exempt requires the articles of organization to limit the purpose of the entity to the charitable purpose.
The test does not require the articles of organization to state that an information return should be filed annually with Internal Revenue Service. In fact, certain charitable entities are not required to file annual returns with the IRS, such as organizations with less than $25,000 per year gross receipts.
Organizations with less than $25,000 gross receipts per year are required to file an annual notice with the IRS that includes the organization’s legal name, address, and other basic information.
IRS Publication 557, chapters 2 and 3; IRC Section 6033
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4671 Types of Organizations
4672 Obtaining and Maintaining Tax-Exempt Status
Easy Corp. is a real estate developer and regularly engages real estate brokers to act on its behalf in acquiring parcels of land. The brokers are authorized to enter into such contracts, but are instructed to do so in their own names without disclosing Easy’s identity or relationship to the transaction. If a broker enters into a contract with a seller on Easy’s behalf:
the broker will have the same actual authority as if Easy’s identity had been disclosed.
Easy will be bound by the contract because of the broker’s apparent authority.
Easy will not be liable for any negligent acts committed by the broker while acting on Easy’s behalf.
the broker will not be personally bound by the contract because the broker has express authority to act.
the broker will have the same actual authority as if Easy’s identity had been disclosed.
In some instances, the principal directs the agent not to disclose the existence of the agency (undisclosed principal). In such a case, the agent has exactly the same actual (i.e., express) authority as if the agency were disclosed. However, the broker has no apparent authority (i.e., the appearance of authority resulting from the words or actions of the principal) because the agency is undisclosed. As a result, Easy will be bound by the contract because of the broker’s actual authority, not because of any apparent authority.
Since there was not full disclosure at the time the contract was made, the agent (broker) may also be held personally liable on the contract to the third party.
Easy, as the principal, even though undisclosed, will be liable for any negligent acts committed by the broker while acting on Easy’s behalf (i.e., within the scope of the broker’s authority and in the course of the agency). This is the doctrine of respondeat superior.
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4213 Duties and Liabilities of Agents and Principals
Cobb created a $500,000 trust that provided his mother with an income interest for her life and the remainder interest to go to his sister at the death of his mother. Cobb expressly retained the power to revoke both the income interest and the remainder interest at any time.
The income interest at the trust’s creation:
is a gift of present interest.
is a gift of a future interest.
is not a completed gift.
is a complete gift to the mother but not to the sister.
is not a completed gift.
The income interest would not be a completed gift at the trust’s creation because the grantor retained the power to revoke the trust.
To be a completed gift, the grantor must relinquish all dominion and control over the transferred property. Generally, if any right is retained to revoke or change the disposition of the property the gift is not complete. A transfer in trust can be a complete gift if it is irrevocable and the grantor does not retain any powers over the trust.
A gift that is not complete is not subject to gift tax.
Regulation Section 25.2511-2(b)
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4471 Transfers Subject to the Gift Tax
Tom, a roofer, repairs a leaky roof on George’s home. They had agreed that the cost of the materials and labor involved in the repair would be $200. If George fails to pay the $200 owed for the roof repair:
Tom could create a mortgage lien on the home by filing written notice of the lien
.
Tom could create an artisan’s lien on the home by filing written notice of the lien.
Tom could create a mechanic’s lien on the home by filing written notice of the lien.
Tom could not obtain any special type of lien against the home.
Tom could create a mechanic’s lien on the home by filing written notice of the lien.
When labor, services, or materials are provided for the purpose of making improvements or repairs to real property, the creditor can place a mechanic’s lien on the property if payment is not made. This is a statutory lien controlled by state law, and generally the lien holder is required to file a written notice of the lien within a specific time period.
An artisan’s lien is a lien arising from work done on personal property. A mortgage lien is a security interest in real property given by the owner as security for a debt owed to the creditor. No specific agreement to transfer a security interest exists between George and Tom.
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4233 Secured Transactions
Link Corp. is subject to the reporting provisions of the Securities Exchange Act of 1934.
Which of the following documents must Link file with the SEC
Quarterly reports (Form 10-Q)
Proxy statements
Both quarterly reports (Form 10-Q) and proxy statements
Neither quarterly reports (Form 10-Q) nor proxy statements
Both quarterly reports (Form 10-Q) and proxy statements
Under the Securities Exchange Act of 1934, both quarterly reports (Form 10-Q) and proxy statements, among others, must be filed with the SEC.
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4251 Federal Securities Regulation
Zinco Corp. was a calendar-year S corporation. Zinco's S status terminated on April 1, when Case Corp. became a shareholder. During the year (365-day calendar year), Zinco had nonseparately computed income of $310,250. If no election was made by Zinco, what amount of the income, if any, was allocated to the S short year $233,750 $155,125 $76,500 $0
$76,500
$310,250 × (90 days ÷ 365 days) = $76,500 (rounded up)
Whenever an S corporation terminates its status (and becomes a C corporation), a daily allocation of the income (or loss) must be made.
Note
When an S corporation terminates, an election can be made (with the consent of 100% of the shareholders) and income or loss can be allocated between the two years based on the books (called “Temporary Closing of the Books”).
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4641 Eligibility and Election
4642 Determination of Ordinary Income/Loss and Separately …
Under the Revised Model Business Corporation Act, which of the following statements regarding a corporation’s bylaws is (are) correct
I. A corporation’s initial bylaws shall be adopted by either the incorporators or the board of directors.
II. A corporation’s bylaws are contained in the articles of incorporation.
I only
II only
Both I and II
Neither I nor II
I only
Either the incorporators or the board of directors may adopt the initial bylaws, or the board of directors may ratify the incorporator’s initial bylaws. Generally, the bylaws are the rules of conduct for the corporation and are not contained in the articles of incorporation as they are usually quite bulky, not yet established for the company, and are often confidential, although there usually is no express prohibition from their inclusion in the articles. The articles of incorporation merely establish the relatively brief statutory requirements necessary to technically incorporate the business to the incorporating state. The articles of incorporation typically note such items as the company name, the company address, the names and addresses of persons composing the initial board of directors, the number of authorized shares, the incorporators name and address, and the registered agent’s name and address, among other items.
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4262 Formation, Operation, and Termination
A corporation would be subject to the uniform capitalization rules if their activities included any of the following except:
produce real or tangible personal property for use in the business activity.
produce real or tangible personal property for sale to customers.
acquire property for resale (exception to this rule is if you have gross receipts that have averaged $10 million or less for the proceeding three tax years).
expenditures for research and experimentation deductible under Section 174.
expenditures for research and experimentation deductible under Section 174.
Under the uniform capitalization rules, you must capitalize direct costs and an allocable portion of most indirect costs that benefit or are incurred because of production or resale activities. Expenditures for research and experimentation are exceptions to the rule and are not required to be capitalized.
IRC Section 263A(c)
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4342 Inventory Valuation Methods, Including Uniform …
What is the maximum amount of capital losses in excess of capital gains that a C corporation may deduct in a year? $10,000 $5,000 $3,000 $0
$0
A C corporation is only able to deduct losses to the extent that they have capital gains. However, a capital loss may be carried back for 3 years and can be carried forward for up to five years as a short term loss.
The question is asking for the amount of loss allowed in “excess” of any capital gains. Since a corporation is not allowed a deduction for excess losses, then the best answer choice would be A., $0.
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4631 Determination of Taxable Income/Loss
Under the Negotiable Instruments Article of the U.C.C. (Article 3), an indorsement of an instrument “for deposit only” is an example of what type of indorsement Blank Qualified Restrictive Special
Restrictive
The wording of the question correctly relates to a restrictive indorsement. Here it requires the indorsee to comply with certain instructions—to deposit the funds only. In other words, the indorsement as shown in the question places the instrument into the bank collection process exclusively.
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4232 Negotiable Instruments
A cash-basis taxpayer should report gross income:
only for the year in which income is actually received in cash.
only for the year in which income is actually received, whether in cash or in property.
for the year in which income is either actually or constructively received in cash only.
for the year in which income is either actually or constructively received, whether in cash or in property.
for the year in which income is either actually or constructively received, whether in cash or in property.
A cash-basis taxpayer should report gross income for the year in which income is either actually or constructively received whether in cash or in property.
Regulation Section 1.446-1(c)(1)
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4511 Inclusions and Exclusions
Cable Corp., a calendar-year C corporation, contributed $80,000 to a qualified charitable organization. Cable's taxable income before the deduction for charitable contributions was $820,000 after a $40,000 dividends-received deduction. Cable also had carryover contributions of $10,000 from the prior year. What amount can Cable deduct as charitable contributions $90,000 $86,000 $82,000 $80,000
$86,000
A corporation’s contribution deduction is limited to 10% of its taxable income computed without regard to (1) the deduction for a charitable contribution, (2) the deductions for dividends received and for dividends paid on certain preferred stock of public utilities, (3) any net operating loss carryback to the tax year, (4) any capital loss carryback to the tax year, and (5) the domestic production deduction.
Cable taxable income before the deduction
for charitable contributions $820,000
Add back: dividends-received deduction + 40,000
——–
$860,000
Charitable contributions limit x .10
——–
Cable Corp. can deduct a charitable
contribution of: $ 86,000
========
Current contributions $80,000
Carryover from prior year + 6,000
——-
Total deductions $86,000
=======
Reconciliation:
Carryover from prior year $10,000
Deducted - 6,000
——-
Carryover to next year $4,000
=======
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4631 Determination of Taxable Income/Loss
Green owes unsecured creditors: Rice, $5,500; Vick, $3,000; Young, $7,000; and Zinc, $2,750. Green has not paid any creditor since January 1, 20X1. On March 15, 20X1, Green’s sole asset, a cabin cruiser, was seized by Xeno Marine Co., the holder of a perfected security interest in the boat. On July 1, 20X1, Rice, Vick, and Young petitioned Green into involuntary bankruptcy under Chapter 7 of the Federal Bankruptcy Code. If Green opposes the involuntary petition, the petition will be:
upheld, because the 3 filing creditors are owed more than $15,325.
upheld, because 1 creditor is owed more than $12,300.
dismissed, because there are less than 12 creditors.
dismissed, because the boat was seized more than 90 days before the filing.
upheld, because the 3 filing creditors are owed more than $15,325.
If Green opposes the involuntary petition, the petition will be upheld because the three filing creditors are owed more than $15,325 of unsecured debt. The key term is “involuntary bankruptcy.” An involuntary bankruptcy petition may be filed by any three or more creditors whose aggregate claims total at least $15,325 if there are more than 12 creditors. If there are fewer than 12 creditors, then any one or more of them may file when their aggregate claims total at least $15,325.
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4242 Bankruptcy and Insolvency
A parent corporation owned more than 90% of each class of the outstanding stock issued by a subsidiary corporation and decided to merge that subsidiary into itself. Under the Revised Model Business Corporation Act, which of the following actions must be taken
The subsidiary corporation’s board of directors must pass a merger resolution.
The subsidiary corporation’s dissenting stockholders must be given an appraisal remedy.
The parent corporation’s stockholders must approve the merger.
The parent corporation’s dissenting stockholders must be given an appraisal remedy.
The subsidiary corporation’s dissenting stockholders must be given an appraisal remedy.
In most cases, a merger of two corporations requires the approval of the directors and shareholders of both corporations. However, if one corporation owns at least 90% of a subsidiary corporation, it may merge without the vote of the shareholders of either corporation and without a vote by the directors of the subsidiary. In any event, the shareholders who disapprove of the merger (dissenting shareholders) are entitled to receive an appraisal remedy (i.e., to have their shares purchased by the acquiring corporation at a fair market price).
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4264 Rights, Duties, Legal Obligations, and Authority of …
Which of the following documents would most likely contain specific rules for the management of a business corporation Articles of incorporation Bylaws Certificate of authority Shareholders' agreement
Bylaws
Bylaws are rules adopted by the corporation’s board of directors for regulation and management of the affairs of the corporation.
The articles of incorporation are necessary at the inception of the corporation to outline the organization. They are filed with the state. A certificate of authority is issued by a state to a foreign corporation. Shareholders’ agreements define shareholders’ relative rights and interests.
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4261 Advantages, Disadvantages, Implications, and …
4262 Formation, Operation, and Termination
Under the reorganization provisions of Chapter 11 of the Federal Bankruptcy Code, after a reorganization plan is confirmed and a final decree closing the proceedings entered, which of the following events usually occurs
A reorganized corporate debtor will be liquidated.
A reorganized corporate debtor will be discharged from all debts except as otherwise provided in the plan and applicable law.
A trustee will continue to operate the debtor’s business.
A reorganized individual debtor will not be allowed to continue in the same business.
A reorganized corporate debtor will be discharged from all debts except as otherwise provided in the plan and applicable law.
Chapter 11 of the Federal Bankruptcy Code permits a business entity to restructure its debts in accordance with a plan approved by the bankruptcy judge. The reorganized debtor will be discharged from all debts except as provided for in the plan and applicable law.
Liquidation occurs under Chapter 7.
An individual debtor will rarely reorganize under Chapter 11, but once done, there are no prohibitions against the debtor being allowed to continue in the same business.
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4242 Bankruptcy and Insolvency
What percentage of a self-employed person's medical insurance premiums is deductible above the line in the year 2014 None 60% 70% 100%
100%
The Tax and Trade Relief Extension Act of 1998 (P.L. 105-277) phased in the deduction for a self-employed person’s medical insurance premiums over several years and now permits a full deduction. The percentage limits on the medical insurance premium deduction for self-employed persons has been:
Tax Years Allowable Beginning In: Percentage -------------- ---------- 1999-2001 60% 2002 70% 2003 and later 100%
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4530 Adjustments and Deductions to Arrive at Taxable Income
Munch has used his residence, which he bought 10 years ago, for business purposes. He has taken depreciation deductions since he bought the home. When he sells his home in May 2014, his profit is $150,000, $5,000 of which is attributable to depreciation for the period after May 6, 1997. Which of the following is a true statement
The depreciation deductions do not affect his exclusion.
Fifty percent (50%) of the depreciation deductions reduce the amount of his gain eligible for the exclusion.
Only depreciation deductions attributable to post-August 5, 1997, reduce the portion of his gain eligible for the exclusion.
$5,000 of his gain does not qualify for the home sale exclusion.
$5,000 of his gain does not qualify for the home sale exclusion.
A homeowner can claim depreciation deductions if he or she rents out part of the principal residence to others or uses part of it as a qualifying home office. These depreciation deductions reduce the owner’s basis in the home and thereby increase the gain realized when the home is sold. Under ‘97 TRA, the home sale exclusion is not available for that part of the home sale profit created through depreciation deductions. However, this rule only applies to the extent of depreciation claimed for post-May 6, 1997, periods. In other words, any depreciation taken after May 6, 1997, will be taxed upon the sale of the residence.
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4550 Loss Limitations
Which of the following statements regarding nonliquidating distributions of a corporation is true
Nonliquidating distributions of a corporation are not taxable as dividends to the shareholder if earnings and profits exist.
Nonliquidating distributions of a corporation reduce the retained earnings of the corporation.
Nonliquidating distributions of a corporation are taxable as dividends to the shareholder if earnings and profits do not exist.
Nonliquidating distributions of a corporation have no effect on the retained earnings of a corporation.
Nonliquidating distributions of a corporation reduce the retained earnings of the corporation.
Nonliquidating distributions of a corporation will reduce the retained earnings of the corporation and are taxable as a dividend to the shareholder if earnings and profits exist. The journal entry to record the distribution is generally a debit to Retained Earnings and a credit to the asset that is distributed.
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4613 Distributions
Queen paid Pax & Co. to become the surety on a loan which Queen obtained from Squire. The loan is due and Pax wishes to compel Queen to pay Squire. Pax has not made any payments to Squire in its capacity as Queen’s surety. Pax will be most successful if it exercises its right to: subrogation. contribution. exoneration. reimbursement (indemnification).
exoneration.
Exoneration allows the sureties to sue the original debtor to pay the creditor. This will take the liability out of the sureties’ responsibilities.
Remedies of the guarantor or surety include the following:
Defense: Use a defense to avoid payment to the creditor.
Reimbursement or indemnity: Get the principal debtor to pay the guarantor or surety for the amount the guarantor or surety had to pay the creditor.
Subrogation: When the guarantor or surety discharges the principal debtor’s obligation to the creditor, the guarantor or surety gets all the creditor’s rights regarding the obligation.
Contribution: From co-guarantor or co-sureties for paying more than legally obligated.
It does not appear likely that any of these would be successful.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Under the U.C.C. Sales Article, a plaintiff who proves fraud in the formation of a contract may:
be entitled to punitive damages provided physical injuries resulted from the fraud.
be entitled to rescind the contract and sue for damages resulting from fraud.
rescind the contract even if there was no reliance on the fraudulent statement.
elect to rescind the contract and need not return the consideration received from the other party.
be entitled to rescind the contract and sue for damages resulting from fraud.
A plaintiff who proves fraud in the formation of a contract may rescind or void the contract. The plaintiff may sue for damages and the judge may require the enforcement of the remainder of the contract without the fraudulent clause.
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4221 Formation
During an audit of Trent Realty Corp.’s financial statements, Clark, CPA, reviewed the following instrument:
$300,000 Belle, MD
September 15, 20X1
For value received, ten years after date, I promise to pay to the
order of Dart Finance Co. Three Hundred Thousand and 00/100 dollars
with interest at 9% per annum compounded annually until fully paid.
This instrument arises out of the sale of land located in MD.
It is further agreed that:
1. Maker will pay all costs of collection including reasonable
attorney fees.
2. Maker may prepay the amount outstanding on any anniversary date
of this instrument.
(SIGNED) G. Evans
The instrument is a: draft. promissory note. security agreement. check.
promissory note.
The instrument is a promissory note. A promissory note is a document in which the maker (Evans in this case) makes a promise to pay a sum certain of money to the order of a second person, the payee (Dart Finance in this case). The key word in this scenario is promise. Whenever this word appears in an instrument, it is almost certainly a promissory note.
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4232 Negotiable Instruments
When performing an audit, a CPA:
must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances.
must strictly adhere to generally accepted accounting principles.
is strictly liable for failing to discover client fraud.
is not liable unless the CPA commits gross negligence or intentionally disregards generally accepted auditing standards.
must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances.
When performing an audit, a CPA must exercise the level of care, skill, and judgment expected of a reasonably prudent CPA under the circumstances. This statement reflects the standard that CPAs are held to in performing audits—the standard of care defined by the tort of negligence.
Generally accepted accounting principles (GAAP) refers to the set of rules relating to the format and presentation of financial statements as opposed to audit techniques.
CPAs do not have strict liability for discovering fraud. If they discover fraud during the course of an audit, they do have the obligation to reveal it to the client. Moreover, CPAs are liable to their clients if they are negligent in performing their audit.
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4121 Liability Generally
An incorporated exempt organization subject to tax on its current-year unrelated business income:
must comply with the Code provisions regarding installment payments of estimated income tax by corporations.
must make estimated tax payments if its tax can reasonably be expected to be $100 or more.
may defer payment of the tax for up to nine months following the due date of the return.
must pay at least 70% of the tax due as shown on the return when filed, with the balance of tax payable in the following quarter.
must comply with the Code provisions regarding installment payments of estimated income tax by corporations.
An unincorporated exempt organization must make estimated tax payments on any taxable unrelated business income.
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4673 Unrelated Business Income
Chevy Corp. distributed depreciable personal property having a fair market value of $9,500 to its shareholders. The property had an adjusted basis of $5,000 to the corporation. Chevy had correctly deducted $3,000 in depreciation on the property. What is the amount of Chevy’s total recognized gain on the distribution and how much of this gain will be considered ordinary income
Total recognized gain: $4,500; Ordinary income: $0
Total recognized gain: $4,500; Ordinary income: $3,000
Total recognized gain: $4,500; Ordinary income: $4,500
Total recognized gain: $9,500; Ordinary income: $0
Total recognized gain: $4,500; Ordinary income: $3,000
Fair market value $9,500
Less: Adjusted basis 5,000
------
Recognized gain $4,500
Depreciation recapture
(ordinary income) $3,000
When a corporation distributes property other than its own obligations to a shareholder and the property’s FMV exceeds the corporation’s adjusted basis of that property, the property is treated as sold at the time of distribution. Gain is recognized on the excess of the FMV over the adjusted basis of the property.
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4430 Cost Recovery (Depreciation, Depletion, and …
4450 Amount and Character of Gains and Losses, and Netting …
4644 Entity/Owner Transactions, Including Contributions and …
Tom Lewis, an individual taxpayer who is a CPA, performs volunteer accounting work for the local Red Cross throughout the year of 2014. Tom’s adjusted gross income for the year is $80,000. He incurs the following expenses for the year:
Transportation expenses to and from the Red Cross $ 200
Estimated value of accounting services performed 3,000
How much of these expenses may Tom deduct as a charitable donation on his Schedule A (itemized deduction) form for 2014 (assuming that he can fully itemize and deduct all such expenses)
$0
$200
$3,000
$3,200
$200
Transportation expenses to and from an event in which an individual performs charitable services is deductible as a charitable contribution. The fair market value of services performed for a charitable organization is not deductible as a charitable contribution.
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4530 Adjustments and Deductions to Arrive at Taxable Income
On September 10, Harris, Inc., a new car dealer, placed a newspaper advertisement stating that Harris would sell 10 cars at its showroom for a special discount only on September 12, 13, and 14. On September 12, King called Harris and expressed an interest in buying one of the advertised cars. King was told that five of the cars had been sold and to come to the showroom as soon as possible. On September 13, Harris made a televised announcement that the sale would end at 10:00 p.m. that night. King went to Harris’ showroom on September 14 and demanded the right to buy a car at the special discount. Harris had sold the 10 cars and refused King’s demand. King sued Harris for breach of contract.
Harris’s best defense to King’s suit would be that Harris’s:
offer was unenforceable.
television announcement revoked the offer.
advertisement was not an offer.
offer had not been accepted.
advertisement was not an offer.
Advertisements generally distributed to the public are not offers because they are not made to a particular entity. Only an advertisement made to a specific offeree (the first 10 individuals to buy a car on a specific date) are valid offers. Since King was not one of the first five buyers, the advertisement was not an offer to King.
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4221 Formation
When there has been no performance by either party, which of the following events generally will result in the discharge of a party’s obligation to perform as required under the original contract
Accord and satisfaction
Mutual recission
Both accord and satisfaction and mutual recission
Neither accord and satisfaction nor mutual recission
Both accord and satisfaction and mutual recession
Accord and satisfaction is carrying out an agreement between two contracting parties where some different performance will replace the original performance. Accord and satisfaction discharges the contractual obligation.
Mutual rescission is a joint agreement to call off the contract and replace it with another.
Both accord and satisfaction and mutual rescission will discharge a party’s obligation to perform under the original contract. It is key in this question to note that there has been no performance by either party. If one party has fully performed, then an agreement to call off a contract will normally not be enforceable.
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4224 Discharge, Breach, and Remedies
Decker sold equipment for $200,000. The equipment was purchased for $160,000 and had accumulated depreciation of $60,000. What amount is reported as ordinary income under IRC Section 1245 $0 $40,000 $60,000 $100,000
$60,000
Step 1: Determine the adjusted basis of the property by subtracting the accumulated depreciation of $60,000 from the purchase price of $160,000. The adjusted basis is $100,000.
Step 2: Determine the realized gain by subtracting the adjusted basis of $100,000 from the sales price of $200,000. The realized gain is $100,000.
Step 3: Determine the character of the realized gain of $100,000. IRC Section 1245 gain, ordinary income, is the lesser of the total realized gain of $100,000 or the total amount of depreciation taken of $60,000. Therefore, the Section 1245 ordinary income is $60,000.
Amount realized $200,000
Less: Adjusted basis
Purchase price $160,000
Less: Accum. depreciation (60,000)
Adjusted basis (100,000)
———
Realized gain $100,000
Section 1245 ordinary income (lesser
of realized gain or depreciation) $ 60,000
=========
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4430 Cost Recovery (Depreciation, Depletion, and …
Which of the following securities is exempt from registration under the Securities Act of 1933
Shares of nonvoting common stock, provided their par value is less than $1.00.
A class of stock given in exchange for another class by the issuer to its existing stockholders without the issuer paying a commission.
Limited partnership interests sold for the purpose of acquiring funds to invest in bonds issued by the United States.
Corporate debentures that were previously subject to an effective registration statement, provided they are convertible into shares of common stock.
A class of stock given in exchange for another class by the issuer to its existing stockholders without the issuer paying a commission.
A class of stock given in exchange for another class by the issuer to its existing stockholders without the issuer paying a commission is exempt from registration under the Securities Act of 1933. The reason is that no “new” securities are really being offered. This is really an “exchange.” The philosophy behind the Securities Act of 1933 is to provide investors with truthful, accurate, and complete disclosure. This exchange of securities involves only existing shareholders. “Shares of nonvoting common stock, provided their par value is less than $1.00” is not the correct answer because the registration requirements are not based on par value. “Limited partnership interests sold for the purpose of acquiring funds to invest in bonds issued by the United States” is incorrect because limited partnership interests represent an investment contract whereby the investor hopes to benefit from the efforts of a third party. “Corporate debentures that were previously subject to an effective registration statement, provided they are convertible into shares of common stock” is incorrect because convertible debentures may be converted to an equity ownership and fall under the provisions of the Securities Act of 1933.
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4251 Federal Securities Regulation
A voluntary petition for bankruptcy relief may be dismissed by the court if the debtor:
I. fails to provide necessary documents within the specified time period.
II. was convicted of a drug trafficking offense or a violent crime and the victim files a motion to dismiss the petition.
III. has income over the average median family income of the state where the petition is filed.
IV. fails to pay post-petition child support or alimony payments.
I, II, and IV only
II, III, and IV only
I, III, and IV only
I, II, III, and IV
I, II, III, and IV
All of the items listed are correct. Under the 2005 Bankruptcy Reform Act, these items were added to eliminate perceived abuses of individuals using the bankruptcy forum to avoid debts they otherwise could or should pay.
A voluntary petition for bankruptcy relief may be dismissed by the court if the debtor fails to provide necessary documents within the specified time period. This item is designed to encourage prompt and complete filings of paperwork, to speed the process, and to ensure accountability for all debts. (Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Section 316)
A voluntary petition for bankruptcy relief may be dismissed by the court if the debtor was convicted of a drug trafficking offense or a violent crime and the victim files a motion to dismiss the petition. This item was included by Congress to prevent criminals from avoiding their otherwise just debts of retribution to the victim. (Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Section 102; 11 USC Section 707)
A voluntary petition for bankruptcy relief may be dismissed by the court if the debtor has income over the average median family income of the state where the petition is filed. This item deals with high-income persons attempting to avoid debts that they otherwise could pay. After a computation based on certain variables, if the party has income that exceeds the state median income by $6,000, there is a presumption of abuse. The debtor can refute the presumption of abuse if they can show good cause—for example, known upcoming health costs or similar items. (Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Section 102)
A voluntary petition for bankruptcy relief may be dismissed by the court if the debtor fails to pay post-petition child support or alimony payments. This item deals with so-called “deadbeat parents” who use the system to avoid child support or alimony. Notice, however, that it deals with post-petition domestic support obligations. (Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Section 215)
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4242 Bankruptcy and Insolvency
Baker, an individual, owned 100% of Alpha, an S corporation. At the beginning of the year, Baker's basis in Alpha Corp. was $25,000. Alpha realized ordinary income during the year in the amount of $1,000 and a long-term capital loss in the amount of $3,000 for this year. Alpha distributed $30,000 in cash to Baker during the year. What amount of the $30,000 cash distribution is taxable to Baker $0 $5,000 $7,000 $30,000
$7,000
Distributions to S corporation shareholders cannot reduce stock basis below zero. Distributions in excess of basis are taxable.
IRC Section 1368
Items that increase S corporation shareholder basis include income of the corporation that is not separately computed. In this case, there is $1,000 of ordinary income.
IRC Section 1367(a)(1)
Items that decrease S corporation shareholder basis include loss and deduction items of the corporation that are separately stated and distributions up to but not exceeding basis. In this case, these are $3,000 long-term capital loss and $23,000 of the cash distribution.
IRC Section 1367(a)(2)
The taxable portion of the $30,000 cash distribution to Baker is calculated as follows:
Basis at beginning of year $ 25,000
Ordinary income 1,000
Long-term capital loss -3,000
——–
Basis remaining 23,000
Cash distribution -30,000
Taxable distribution in excess of basis 7,000
——–
Basis at end of year $ 0
The $7,000 distribution in excess of basis would be taxable.
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4644 Entity/Owner Transactions, Including Contributions and …
On May 25, Fresno sold Bronson, a minor, a used computer. On June 1, Bronson reached the age of majority. On June 10, Fresno wanted to rescind the sale. Fresno offered to return Bronson’s money and demanded that Bronson return the computer. Bronson refused, claiming that a binding contract existed. Bronson’s refusal is:
not justified, because Fresno is not bound by the contract unless Bronson specifically ratifies the contract after reaching the age of majority.
not justified, because Fresno does not have to perform under the contract if Bronson has a right to disaffirm the contract.
justified, because Bronson and Fresno are bound by the contract as of the date Bronson reached the age of majority.
justified, because Fresno must perform under the contract regardless of Bronson’s minority.
justified, because Fresno must perform under the contract regardless of Bronson’s minority.
A contract between a minor and an adult is voidable only by the minor. The adult is bound by the contract.
If Bronson wanted out of the contract, he could disaffirm (return the computer) while still a minor, or for a reasonable period after reaching age 18. If Bronson were to expressly ratify the contract (or indirectly ratify the contract by keeping the computer for an unreasonable period of time) after turning 18, then Bronson, also, would be bound by the contract.
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4222 Performance
Chris Baker’s adjusted gross income on her 2013 tax return was $160,000. The amount covered a 12-month period. For the 2014 tax year, Baker may avoid the penalty for the underpayment of estimated tax if the timely estimated tax payments equal the required annual amount of:
I. 90% of the tax on the return for the current year, paid in four equal installments.
II. 110% of prior year’s tax liability, paid in four equal installments.
I only
II only
Either I or II
Neither I nor II
Either I or II
Because Chris Baker’s adjusted gross income on her 2013 tax return was over $150,000, the amount of her required installment to avoid the underpayment penalty is the lower of 90% of the tax shown on the current year’s return or 110% of the prior year’s tax.
A special rule applies to individuals with adjusted gross income for the previous year in excess of $150,000 ($75,000 for married individuals filing separately). These taxpayers will use 110% for their prior-year safe harbor (instead of 100%).
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4365 Impact of Estimated Tax Payment Rules on Planning
The filing of an involuntary bankruptcy petition under the Federal Bankruptcy Code:
terminates liens on exempt property.
terminates all security interests in property in the bankruptcy estate.
stops the debtor from incurring new debts.
stops the enforcement of judgment liens against property, except IRS, in the bankruptcy estate.
stops the enforcement of judgment liens against property, except IRS, in the bankruptcy estate.
An involuntary bankruptcy petition, one filed by creditors of the bankrupt under the Federal Bankruptcy Code, places a freeze or “automatic stay” on further actions by creditors (i.e., stops the enforcement of judgment liens against property in the bankruptcy estate) until the bankruptcy proceeding is organized and the bankrupt’s assets are fairly and equitably distributed.
Said filing does not of itself terminate liens, security interests, or new debts; termination or discharge is for the court to determine after the proceedings have occurred.
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4242 Bankruptcy and Insolvency
Under the provisions of the Employee Retirement Income Security Act of 1974 (ERISA), which of the following statements are correct regarding employee rights
I. Employers are required to establish either a contributory or noncontributory employee pension plan.
II. Employers are required to include employees as pension-plan managers.
I only
II only
Both I and II
Neither I nor II
Neither I nor II
There is no requirement that employers establish employee pension plans of any sort under ERISA. ERISA sets forth standards for fiduciary duties for pension-plan sponsors and managers, but does not include a requirement that employers are required to include employees and pension-plan managers.
ERISA Title 1, Part 4
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4560 Taxation of Retirement Plan Benefits
Which of the following transfers by a debtor, within 90 days of filing for bankruptcy, could be set aside as a preferential payment
Making a gift to charity
Paying a business utility bill
Borrowing money from a bank secured by giving a mortgage on business property
Prepaying an installment loan on inventory
Prepaying an installment loan on inventory
A preferential transfer is any payment made by the debtor to or for the benefit of a creditor for an antecedent debt within 90 days before a filing for bankruptcy that gives to the creditor more assets than it would have received under the bankruptcy proceeding.
Thus, prepaying an installment loan on inventory would be a preferential payment. Payments made in the ordinary course of business are not preferential. A gift to charity, payment of current utility bills, or giving a mortgage in exchange for infusion of cash would not be preferential transfers.
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4242 Bankruptcy and Insolvency
Egan contracted with Barton to buy Barton’s business. The contract provided that Egan would pay the business debts Barton owed Ness and that the balance of the purchase price would be paid to Barton over a 10-year period. The contract also required Egan to take out a decreasing term life insurance policy naming Barton and Ness as beneficiaries to ensure that the amounts owed Barton and Ness would be paid if Egan died.
Barton’s contract rights were assigned to Vim and Egan was notified of the assignment. Despite the assignment, Egan continued making payments to Barton. Egan died before completing payment, and Vim sued Barton for the insurance proceeds and the other payments on the purchase price received by Barton after the assignment.
To which of the following is Vim entitled
Payment on purchase price
Insurance proceeds
Both payment on purchase price and insurance proceeds
Neither payment on purchase price nor insurance proceeds
Both payment on purchase price and insurance proceeds
Vim is entitled to both the payment on purchase price and the insurance proceeds because Vim received Barton’s contract rights. Vim did properly notify Egan, but Egan continued to make payments to Barton. Vim’s contract or assignment is valid, and therefore, Vim is entitled to recover the payments that were incorrectly made to Barton as well as the insurance proceeds.
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4222 Performance
Charles and Marcia are married, cash-basis taxpayers. In 2014, they had interest income as follows:
$500 interest on federal income tax refund
$600 interest on state income tax refund
$800 interest on federal government obligations
$1,000 interest on state government obligations
What amount of interest income is taxable on Charles and Marcia's 2014 joint income tax return $500 $1,100 $1,900 $2,900
$1,900
$ 500 interest from federal income tax refund 600 interest on state income tax refund 800 interest on federal government obligation ------ $1,900 Total taxable interest income ======
All interest received by any taxpayer is included in gross income unless specially exempt by law.
Interest on all state and local bonds (sometimes called “municipal bond interest”) is exempt from federal income tax. The $1,000 interest on state government obligations which Charles and Marcia received is not taxable.
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4512 Characterization of Income
Hark, CPA, failed to follow generally accepted auditing standards in auditing Long Corp.’s financial statements. Long’s management had told Hark that the audited statements would be submitted to several banks to obtain financing. Relying on the statements, Third Bank gave Long a loan. Long defaulted on the loan. In a jurisdiction applying the Ultramares decision, if Third sues Hark, Hark will:
win because there was no privity of contract between Hark and Third.
lose because Hark knew that banks would be relying on the financial statements.
win because Third was contributorily negligent in granting the loan.
lose because Hark was negligent in performing the audit.
win because there was no privity of contract between Hark and Third.
In a jurisdiction applying the Ultramares decision, if Third Bank sues Hark CPA, Hark will win because there was no privity of contract between Hark and Third. The key term is the Ultramares decision, referring to the landmark case of Ultramares Corporation v. Touche. In this case, the accountants were found guilty of negligence in performing an audit.
However, the court held that the accountant had no liability to third parties for ordinary negligence even though liability to third parties could be imposed for fraud or gross negligence. Many courts still follow the Ultramares rule that since there is no privity between a third-party user of an audited financial statement and the CPA firm, there is no cause of action by the third party against the CPA firm for negligence.
The Ultramares court ruled that even if a CPA firm knows that the audited financial statements are to be used by a creditor to make lending decisions, the third-party user lacks privity with the CPA firm and cannot recover for negligence.
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4131 Common Law Duties and Liability to Clients and Third …
In order for an unlimited marital deduction to apply to the estate tax, which of the following must apply
The spouse must be a U.S. citizen.
The decedent must be married and survived by their spouse.
The spouse’s interest in the property must not be a terminable interest.
All of the answer choices are correct.
All of the answer choices are correct.
In order for an unlimited marital deduction to apply to the estate tax, all of the following must apply:
- The decedent must be married and survived by their spouse.
- The spouse must be a U.S. citizen.
- The property must be included in the decedent’s gross estate and pass to the surviving spouse.
- The spouse’s interest in the property must not be a terminable interest.
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4474 Marital Deduction
Which of the following entities has an unrestricted option in selecting the tax year to be used when filing the first tax return Sole proprietor Limited liability company S corporation C corporation
C corporation
Sole proprietors, partnerships, and limited liability entities are restricted to the tax year of the owner. S corporations are restricted to a calendar year unless IRS approval is obtained.
Only a C corporation can select any month for the close of the tax year.
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4611 Formation
In 2014, Smith, a divorced person, provided over one-half the support for his widowed mother, Ruth, and his son, Clay, both of whom are U.S. citizens. During this year, Ruth did not live with Smith. She received $9,000 in Social Security benefits—none of which was taxable. Clay, a full-time graduate student, and his wife lived with Smith. Clay had no income but filed a joint return, owing an additional $500 in taxes on his wife's income. How many exemptions was Smith entitled to claim on his 2014 tax return 4 3 2 1
2
Smith is entitled to claim only two exemptions (himself and his mother) on his tax return.
Beginning in 2005, the term “dependent” means:
-a qualifying child or
-a qualifying relative.
Both a qualifying child and a qualifying relative must pass three general tests:
- Dependent taxpayer test—Taxpayers who can be claimed as a dependent by another person cannot claim anyone else as a dependent.
- Joint return test—Taxpayers who file a joint return cannot be a dependent of anyone else unless neither the dependent nor spouse has a filing requirement, they file jointly only to get a refund of taxes withheld, and neither would have a tax liability if they filed separate returns.
- Citizen or resident test—A dependent must be a U.S. citizen, U.S. national, U.S. resident, or resident of Canada or Mexico.
A qualifying child must pass the three general tests and pass five additional tests:
- Relationship test—The child must be a child of the taxpayer or a descendant of such child or a brother, sister, stepbrother, stepsister, or descendant of any such relative.
- Age test—The child must be under age 19 at year-end or a full-time student under age 24 at year-end, or permanently and totally disabled at any time during the year regardless of age.
- Residency test—The child must live with the taxpayer for more than half the year. There are exceptions for temporary absences, children who were born or died during the year, kidnapped children, and children of divorced or separated parents.
- Support test—The child cannot provide more than half of their own support for the year.
- Special test for qualifying child of more than one person—A child can only be claimed as a dependent by one taxpayer. If a child is a qualifying child for more than one taxpayer, they can agree who takes the exemption. If they do not agree and more than one taxpayer takes the exemption, the IRS will apply a tie-breaker test to determine which taxpayer will prevail.
A qualifying relative must pass the three general tests and pass four additional tests:
- Qualifying child test—A child is not a qualifying relative if the child is a qualifying child for any taxpayer.
- Member of household or relationship test—A qualifying relative must be related to the taxpayer or a member of the taxpayer’s household.
- Gross income test—A qualifying relative cannot have gross income equal to or greater than the personal exemption amount.
- Support test—In order to take an exemption for a qualifying relative, a taxpayer must provide over half of the qualifying relative’s support.
Note
The reason Clay (his son) does not qualify is because Clay filed a joint return and owed taxes as opposed to just filing to have all withholding refunded.
Smith’s mother Ruth does not have to count the $9,000 in Social Security benefits as gross income since it is not taxable, so she meets the gross income test. The $9,000 has to be counted as support, but the problem states that Smith provides more than half her support. Smith’s mother may be counted as an exemption even though she did not live in his house.
IRC Sections 151(c) and 152; IRS Publication 501
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4530 Adjustments and Deductions to Arrive at Taxable Income
During an audit of Trent Realty Corp.’s financial statements, Clark, CPA, reviewed the following instrument:
$300,000 Belle, MD
September 15, 20X1 For value received, ten years after date, I promise to pay to the order of Dart Finance Co. Three Hundred Thousand and 00/100 dollars with interest at 9% per annum compounded annually until fully paid.
This instrument arises out of the sale of land located in MD.
It is further agreed that:
1. Maker will pay all costs of collection including reasonable attorney fees.
2. Maker may prepay the amount outstanding on any anniversary date of this instrument.
(SIGNED) G. Evans
On March 15, 20X2, Dart indorsed the instrument in blank and sold it to Morton for $275,000. On July 10, 20X2, Evans informed Morton that Dart had fraudulently induced Evans into signing the instrument. On August 15, 20X2, Trent, which knew of Evans’ claim against Dart, purchased the instrument from Morton for $50,000.
Trent could recover on the instrument from: Evans only. Dart only. Morton only. Evans, Morton, and Dart.
Evans, Morton, and Dart.
Since Trent has all of the rights of a holder in due course (because he acquired the instrument from a holder in due course), Trent can collect on the instrument from the maker (Evans). He would not be subject to the defense of fraud in the inducement, since this is only a personal defense and cannot be used against anyone with the rights of a holder in due course. Trent can also recover from Dart and Morton on contract warranty liability on the instrument: Any person selling a negotiable instrument (i.e., all indorsers) guarantees (i.e., serves as a guarantor) that all signatures are genuine, that the instrument has not been altered, and that no defense of any party is good against him or her. The indorsers are liable to each other in the order of their indorsements.
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4232 Negotiable Instruments
Regulatory agencies are tasked with many responsibilities, but the ability to practice due care is tantamount to any profession. One aspect of regulation is that CPAs will practice due care by:
supervising any professional activity adequately.
attending CPA events on a regular basis.
reading scholarly journals.
ensuring that clients sign a contract prior to entering into an agreement with the CPA.
supervising any professional activity adequately.
Supervising any professional activity adequately goes to the heart of due care. The professional CPA will need to ensure that any work in which they play a role must meet the highest professional standards in order to garner the public’s trust.
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4121 Liability Generally
Which of the following statements concerning an accountant’s disclosure of confidential client data is generally correct
Disclosure may be made to any state agency without subpoena.
Disclosure may be made to any party on consent of the client.
Disclosure may be made to comply with an IRS audit request.
Disclosure may be made to comply with generally accepted accounting principles.
Disclosure may be made to any party on consent of the client.
The accountant is always permitted to disclose confidential client information if the client gives consent. An “accountant-client” privilege is not recognized in federal courts, nor is it recognized in most states. However, pursuant to the AICPA Code of Professional Conduct, the CPA may disclose confidential client information only pursuant to:
-a subpoena (court order), or applicable laws or government regulations.
-AICPA or state CPA Society or Board of Accountancy authorization.
-inquiry made by a recognized investigatory or disciplinary body.
Thus, even a state agency and the IRS must obtain a subpoena.
Generally accepted accounting principles (GAAP) do not require such disclosure although the prohibition against disclosure does not relieve the CPA of professional obligations under generally accepted auditing standards (GAAS).
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4133 Privileged Communications, Confidentiality, and …
Job, Inc., had taxable income in 2013 of $8,000. Due to a downturn in its core business operations, Job isn’t sure if he is expected to make estimated tax payments for the 2014 tax year. Which of the following statements is correct concerning Job making estimated tax payments for the 2014 tax year
Job must make installment payments of estimated tax if the company expects estimated tax to be $500 or more for 2014.
Job must make installment payments of estimated tax because the company had taxable income in the prior year.
Job must make installment payments of estimated tax if the company expects income or taxable income to be $500 or more for 2014.
Job must make installment payments of estimated tax if the company expects income to be $500 or more for 2014.
Job must make installment payments of estimated tax if the company expects estimated tax to be $500 or more for 2014.
A corporation is required to make installment payments if the estimated tax (not estimated income) is $500 or more. If the corporation does not pay the installments when they are due, it could be subject to an underpayment penalty.
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4365 Impact of Estimated Tax Payment Rules on Planning
Dunn received 100 shares of stock as a gift from Dunn's grandparent. The stock cost Dunn's grandparent $32,000 and it was worth $27,000 at the time of the transfer to Dunn. Dunn sold the stock for $29,000. What amount of gain or loss should Dunn report from the sale of the stock $0 $2,000 gain $3,000 gain $3,000 loss
$0
Because of the special situation in this gift, neither a gain nor a loss can be computed on the sale of this stock received as a gift. In this situation, the selling price is less than the basis for gain and more than the basis for loss.
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4420 Basis and Holding Periods of Assets
Wright cosigned King’s loan from Ace Bank. Which of the following events would release Wright from the obligation to pay the loan
Ace seeking payment of the loan only from Wright.
King is granted a discharge in bankruptcy.
Ace is paid in full by King’s spouse.
King is adjudicated mentally incompetent.
Ace is paid in full by King’s spouse.
A surety has agreed to pay a debt if the principal debtor should default. This liability is not affected by the principal debtor’s bankruptcy or mental incompetency, since these defenses can be used only by the debtor himself. If, however, the debt is in fact paid by anyone (such as the debtor’s spouse) then the surety’s liability no longer exists.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Under constructive ownership rules, a taxpayer is considered to own stock that is owned by close relatives. Which of the following is not included His mother His partner in a partnership His wife His aunt
His aunt
While some relatives may disagree with the rule, IRC Section 267 determines that because of the constructive ownership rule, a shareholder may be considered to own shares that are owned by his mother, his business partner, and his wife. Normally, an aunt is not included in the close family group.
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4460 Related Party Transactions
A corporate taxpayer’s capital gains and losses are as follows:
Short-term capital gain $7,000
Short-term capital loss (43,000)
Long-term capital gain 9,000
Long-term capital loss 21,000
What amount of capital loss deduction is the taxpayer entitled to use to offset against ordinary income? $48,000 $12,000 $3,000 $0
$0
All short term capital gains and losses are netted together and then all long term capital gains and losses are netted together. Then the short term is netted with the long term.
For this corporate taxpayer, the short term capital items net to $36,000 capital loss. The long term items net to $12,000 capital loss. As the taxpayer does not have any capital gains to offset against the capital losses, none of the capital losses may be used to reduce business ordinary income per tax law, answer A. The capital losses may be carried back to offset capital gains for three years and forward five years.
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4450 Amount and Character of Gains and Losses, and Netting …
Raff died in 2013, leaving her entire estate to her only child. Raff's will gave full discretion to the estate's executor with regard to distributions of income. For 2014, the estate's distributable net income was $15,000, of which $9,000 was paid to the beneficiary. None of the income was tax exempt. What amount can be claimed on $9,000the estate's 2014 fiduciary income tax return for the distributions deduction $0 $6,000 $9,000 $15,000
$9,000
Distributable net income (DNI) is an amount that sets the limit on the deduction of an estate for distributions to beneficiaries. Since Raff’s estate had DNI of $15,000 and $9,000 was paid to the beneficiary, the estate is allowed a $9,000 deduction.
The beneficiary will report $9,000 as taxable income assuming that all $15,000 of DNI was composed of taxable income.
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4662 Income and Deductions
Mane Bank lent Eller $120,000 and received securities valued at $30,000 as collateral. At Mane’s request, Salem and Rey agreed to act as uncompensated co-sureties on the loan. The agreement provided that Salem’s and Rey’s maximum liability would be $120,000 each.
Mane released Rey without Salem's consent. Eller later defaulted when the collateral held by Mane was worthless and the loan balance was $90,000. Salem's maximum liability is: $30,000. $45,000. $60,000. $90,000.
$45,000.
The correct answer is $45,000. This problem tests your understanding of the legal concept of co-sureties. Co-sureties are two or more parties who agree to be liable for the debt of the principal. Unless a contract stipulates otherwise, co-sureties share in the liability. In this problem, Salem and Roy agreed to be co-sureties for Eller. When Eller defaulted and the co-sureties became liable for $90,000, each surety would be liable for half the debt of $45,000. Since the creditor released one surety without the consent of the other, the remaining surety is not liable for any portion of the released surety’s share.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
IRC Section 267 has a special rule for sales to a related party that are unpaid at the end of the year. In which of the following cases does the rule apply
When a cash-basis seller sells to a cash-basis buyer
When an accrual-basis seller sells to an accrual-basis buyer
When a cash-basis seller sells to an accrual-basis buyer
When an accrual-basis seller sells to a cash-basis buyer
When a cash-basis seller sells to an accrual-basis buyer
The rule applies when the seller is on the cash basis and the buyer is on the accrual basis. The buyer may not deduct the expense until the seller has reported the income.
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4460 Related Party Transactions
A self-employed taxpayer had gross income of $57,000. The taxpayer paid self-employment tax of $8,000, health insurance of $6,000, and $5,000 of alimony. The taxpayer also contributed $2,000 to a traditional IRA. What is the taxpayer's adjusted gross income $55,000 $50,000 $46,000 $40,000
$40,000
The self-employed taxpayer can deduct one-half of the self-employment tax ($4,000) for AGI, 100% of the health insurance cost ($6,000), and 100% of the alimony ($5,000). The taxpayer is also able to deduct the $2,000 for the IRA contribution.
The taxpayer’s AGI is $40,000 ($57,000 - $4,000 - $6,000 - $5,000 - $2,000).
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4590 Alternative Minimum Tax
Jans, an individual, owns 80% and 100% of the total value and voting power of A and B Corps., respectively, which in turn own the following (both value and voting power):
Ownership
--------------------
Property A Corp. B Corp.
--------- ------- -------
C Corp. 80% -
D Corp. - 100%
All companies are C corporations except B Corp., which had elected S status since inception. Which of the following statements is correct with respect to the companies’ ability to file a consolidated return
A, C, and D may file as a group.
A and C may not file as a group, and B and D may not file as a group.
A and C may file as a group, and B and D may file as a group.
A and C may file as a group, but B and D may not file as a group.
A and C may file as a group, but B and D may not file as a group.
A Corp. and C Corp. are members of an affiliated group since A Corp owns at least 80% of C Corp. (parent/subsidiary relationship). As such, A Corp. and C Corp. may file a consolidated return. S corporations are prohibited from being members of an affiliated group, although they are now permitted to have C corporation subsidiaries. As such, B Corp. (an S corporation) is prohibited from filing a consolidated return with D Corp. (a C corporation).
IRC Sections 1504(b)(8) and 1563(a)(1)
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4636 Consolidated Returns
Under the Secured Transactions Article of the U.C.C., which of the following security agreements does not need to be in writing to be enforceable
A security agreement collateralizing a debt of less than $500
A security agreement where the collateral is highly perishable or subject to wide price fluctuations
A security agreement where the collateral is in the possession of the secured party
A security agreement involving a purchase money security interest
A security agreement where the collateral is in the possession of the secured party
When the secured party can take possession of the collateral as part of the security agreement, the agreement is enforceable without writing.
A security agreement collateralizing a debt under $500, where the collateral is in the possession of the secured party, or involving a purchase money security interest (PMSI) must be in writing.
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4233 Secured Transactions
An individual paid taxes 27 months ago, but did not file a tax return for that year. Now the individual wants to file a claim for refund of federal income taxes that were paid at that time. The individual must file the claim for refund within which of the following time periods after those taxes were paid One year Two years Three years Four years
Two years
The claim for refund must be filed within three years from the date on which the tax return that relates to the refund was filed or within two years of the actual payment of the tax, whichever is later. If no return was filed, the claim for refund must be filed within two years from the date of payment.
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4327 Statute of Limitations
An individual taxpayer (whose adjusted gross income is above $150,000 in the previous year) may avoid the penalty for failure to pay estimated tax for 2014 by:
paying at least ________ of the tax shown on the current year’s return, or
________ of the tax shown on the prior year’s return (assuming that the prior year’s return was for a full 12-month period).
90%; 100%
110%; 110%
90%; 110%
110%; 90%
90%; 110%
Individuals may generally avoid the penalty for failure to pay estimated tax for 2014 by:
- paying at least 90% of the tax shown on the current year’s return,
- paying 110% of the tax shown on the prior year’s return (for individuals with AGIs of more than $150,000 in the previous year), or
- paying installments on a current basis under an annualized income installment method. An individual may not use the 100%-of-prior-year’s-tax safe harbor if the prior year was not a 12-month period or if the individual did not file a return for such preceding taxable year.
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4326 Penaltie
In 2014, Amanda set up Coverdell education savings accounts for each of her four grandchildren, aged 7, 9, 14, and 16. She would like to contribute the annual maximum to each savings account when she usually makes other annual-election gifts every year on December 31. The annual maximum for 2014 is $2,000. How much can she contribute in total to the Coverdell education savings accounts in 2014 and each of the next four years $2,000 $8,000 $32,000 $40,000
$32,000
Contributions to Coverdell education savings accounts must be made before the account beneficiaries are 18 years old. Therefore, only two years’ contributions to the 16-year-old (age 16 and 17) qualify, and four years’ contributions to the 14-year-old qualify (age 14, 15, 16, 17). Therefore, a total of $32,000 would be contributed over five years, as follows:
7-year-old (5 x $2,000) = $10,000
9-year-old (5 x $2,000) = $10,000
14-year-old (4 x $2,000) = $ 8,000
16-year-old (2 x $2,000) = $ 4,000
-------
$32,000
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4512 Characterization of Income
A client suing a CPA for negligence must prove each of the following factors except: breach of duty of care. proximate cause. reliance. injury.
reliance.
To establish negligence, a client must show that:
- the CPA owed a legal duty,
- the CPA breached that duty,
- the CPA’s action was the proximate cause of the resulting injury to the client, and
- the CPA’s actions caused the damage or loss.
The client does not have to prove reliance on the CPA’s advice.
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4131 Common Law Duties and Liability to Clients and Third …
On January 1, Year 0, Kane owned all 100 issued shares of Manning Corp., a calendar-year S corporation. On the 41st day of Year 0, Kane sold 25 of the Manning shares to Rodgers. For the year ended December 31, Year 0 (a 366-day calendar year), Manning had $73,200 in nonseparately stated income and made no distributions to its shareholders. What amount of nonseparately stated income from Manning should be reported on Kane’s Year 0 tax return $16,300 $56,900 $54,900 $0
$56,900
Items of income and/or loss for an S corporation are passed through to the shareholders based on their pro rata share of each separately or nonseparately stated item, whether distributed or not. Kane will report $56,900 of nonseparately stated income from Manning Corporation for Year 0, computed as follows:
Kane’s pro rata share of 100% ownership of
Manning Corp. ($73,200 × 40/366) $ 8,000
Kane’s pro rata share of 75% ownership of
Manning Corp. ($73,200 × 0.75 × 326/366) 48,900
——-
Total $56,900
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4642 Determination of Ordinary Income/Loss and Separately …
Which of the following acts constitute(s) grounds for a tax preparer penalty
I. Without the taxpayer’s consent, the tax preparer disclosed taxpayer income tax return information under an order from a state court.
II. At the taxpayer’s suggestion, the tax preparer deducted the expenses of the taxpayer’s personal domestic help as a business expense on the taxpayer’s individual tax return.
I only
II only
Both I and II
Neither I nor II
II only
Taxpayer return information may be disclosed without penalty if the information is (1) to a tax processor to file electronically, (2) for peer review of the preparer, (3) for administrative order by a state agency or state court order. Preparers are subject to a $1,000 penalty for a willful attempt to understate tax liability or a reckless or intentional disregard of the rules and regulations. The rules and regulations clearly do not permit a deduction for a taxpayer’s personal domestic help as a business expense.
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4111 Treasury Department Circular 230
Which of the following statements is incorrect for limited liability companies (LLC)
LLCs have complete pass-through of tax attributes generated by operations.
Every member is allowed to participate in an LLC.
Every member of an LLC has liability protection.
None of the members of an LLC have liability protection.
None of the members of an LLC have liability protection.
The following three statements are all true for LLCs:
- LLCs have complete pass-through of tax attributes generated by operations.
- Every member is allowed to participate in an LLC.
- Every member of an LLC has liability protection.
Therefore, the statement, “None of the members of an LLC have liability protection,” is incorrect as it directly contradicts the third item in the list.
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4612 Operation
For the year 2014, the Herb Company had an increase in its liabilities. Does the increase in its liabilities affect the basis of the owners if the company is a partnership or is an S corporation
Affect shareholder’s basis in S corporation stock: Yes; Affect partners of partnership interest: No
Affect shareholder’s basis in S corporation stock: No; Affect partners of partnership interest: No
Affect shareholder’s basis in S corporation stock: Yes; Affect partners of partnership interest: Yes
Affect shareholder’s basis in S corporation stock: No; Affect partners of partnership interest: Yes
Affect shareholder’s basis in S corporation stock: No; Affect partners of partnership interest: Yes
An S corporation shareholder does not include a proportionate share of S corporation debt in his basis. A partner’s basis is increased by his share of an increase in liabilities.
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4643 Basis of Shareholder’s Interest
4652 Basis of Partner’s/Member’s Interest and Basis of …
4655 Treatment of Partnership Liabilities
Dean is a 25% partner in Target Partnership. Dean’s tax basis in Target was $20,000. Dean received a nonliquidating cash distribution of $8,000 from Target. Target’s 2014 accounts recorded the following items:
Municipal bond interest income $12,000
Ordinary income 40,000
What was Dean’s tax basis in Target at the end of the year
$15,000
$23,000
$25,000
$30,000
$25,000
Dean’s tax basis in Target Partnership is calculated as follows:
Beginning basis $20,000
Less Distribution - 8,000
Add: 0.25 x $12,000
Municipal bond interest income + 3,000
Add: 0.25 x $40,000
Ordinary income + 10,000
——–
Dean’s tax basis in Target on 12/31/14 $25,000
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4652 Basis of Partner’s/Member’s Interest and Basis of …
Eastern Corp., a calendar-year corporation, was formed January 3, 2014, and on that date placed 5-year property in service. The property was depreciated under the general MACRS system. Eastern did not elect to use the straight-line method. The following information pertains to Eastern:
Eastern’s 2014 taxable income $300,000
Adjustment for the accelerated
depreciation taken on 2014
5-year property 1,000
2014 tax-exempt interest from
specified private activity bonds
issued after August 7, 1986 5,000
What was Eastern's 2014 alternative minimum taxable income before the adjusted current earnings (ACE) adjustment $306,000 $305,000 $304,000 $301,000
$306,000
Eastern’s 2014 taxable income $300,000
(1) Adjustment for the accelerated
depreciation taken on 2014
5-year property 1,000
(2) 2014 tax-exempt interest from
specified private activity bonds
issued after August 7, 1986 5,000
——–
AMTI $306,000
========
Note 1
Alternative minimum tax rules have been devised to ensure that at least a minimum amount of income tax is paid by corporate and high-income noncorporate taxpayers (including estates and trusts).
Depreciation for AMT is usually calculated using 150% DB (or) straight-line over the same life as regular tax. This is called an “adjustment.”
“Tax-exempt interest” from private activity bonds is taxable for AMT. This add-back is called a preference.
Note 2
For property placed in service in or before 1998, AMT depreciation was computed using 150% DB or straight-line over a longer life than used for regular tax.
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4590 Alternative Minimum Tax
4632 Tax Computations and Credits, Including Alternative …
Your audit firm has grown explosively over the last several years due to your outstanding work ethic and impeccable professional standards. Your available space at your office has become strained. Your new staff member has suggested moving or discarding the old files, especially those over five years old. You:
say “fine” as long as the audit work papers are kept.
say “fine” as long as the materials are at least eight years of age, and then only with great caution.
say “no” and have them shipped to a storage facility you had heard about from a neighbor, which unknown to you, has a terrible record of losing documents.
say “fine” as long as the items are digitized. However, you do not oversee the process, and documents are incorrectly handled and data is lost.
say “fine” as long as the materials are at least eight years of age, and then only with great caution.
In the wake of Enron and other high profile corporate scandals, it would be hazardous to callously discard audit materials. At the minimum, the Sarbanes-Oxley Act (SOX) requires retention for seven years (SOX 103). The suggested answer is more conservative, and thus the better solution of the answer pool. Keeping the audit workpapers seems reasonable but would also require the retention of the “other information” related to the audit report. Shipping the files to a storage facility seems somewhat reasonable at first glance, but you are still responsible for the materials despite what seems to be an otherwise appropriate solution (if you did due diligence and were assured of quality storage and reviewed their client list, etc., this probably would be the best solution, but these facts were not in the question). Digitizing the files is similar in result to shipping the files to a storage facility where seemingly “best efforts” still do not justify the results to an investigator, especially when it seems too much of a “coincidence” that critical records are somehow missing, not unlike the Richard Nixon “tape gap.”
Notice that SOX has a longer retention time than the Corporate and Criminal Fraud Accountability Act of 2002, which requires retention of “all audit or review work papers” for five years.
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4123 Requirements of Regulatory Agencies
Krete, an unmarried taxpayer with income exclusively from wages, filed her initial income tax return for the 2014 calendar year. By December 31, 2014, Krete's employer had withheld $16,000 in federal income taxes and Krete had made no estimated tax payments. On April 15, 2015, Krete timely filed an extension request to file her individual tax return and paid $300 of additional taxes. Krete's 2014 income tax liability was $16,500 when she timely filed her return on April 30, 2015, and paid the remaining income tax liability balance. What amount would be subject to the penalty for the underpayment of estimated taxes $0 $200 $500 $16,500
$0
The penalty for underpayment of estimated taxes is imposed for making inadequate tax payments during the year. There are several exceptions to the penalty:
- If the amount of unpaid tax is $1,000 or less
- If there was no tax liability on the prior-year tax return and the return was for a full year
- If at least 90% of the current-year tax is paid
- If at least 100% of the tax liability on the prior-year tax return is paid (if AGI is over $150,000—110% of the prior-year tax)
- Waiver for various circumstances such as retirement or disability
In this case, $16,000 was paid in during the year through withholding. This is more than 90% of the tax liability of $16,500, so none of the payment is subject to the penalty for underpayment of estimated taxes. Alternatively, the amount of tax underpaid is less than $1,000 so no penalty is due.
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4326 Penalties
Fil and Breed are 50% partners in F&B Cars, a used-car dealership. F&B maintains an average used-car inventory worth $150,000. On January 5, National Bank obtained a $30,000 judgment against Fil and Fil’s child on a loan that Fil had cosigned and on which Fil’s child had defaulted. National sued F&B to be allowed to attach $30,000 worth of cars as part of Fil’s interest in F&B’s inventory. Will National prevail in its suit
No, because the judgment was not against the partnership
No, because attachment of the cars would dissolve the partnership by operation of law
Yes, because National had a valid judgment against Fil
Yes, because Fil’s interest in the partnership inventory is an asset owned by Fil
No, because the judgment was not against the partnership
According to Section 305(a) and (b) of the Uniform Partnership Act, “A partnership is liable for loss or injury caused to a person, or for a penalty incurred, as a result of a wrongful act or omission, or other actionable conduct, of a partner acting in the ordinary course of business of the partnership or with authority of the partnership….If, in the course of the partnership’s business or while acting with authority of the partnership, a partner receives or causes the partnership to receive money or property of a person not a partner, and the money or property is misapplied by a partner, the partnership is liable for the loss.”
In the situation described in this question, Fil was not acting on behalf of the partnership nor did he act with the authority of the partnership when he cosigned on his child’s auto loan; therefore, National will not prevail.
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4264 Rights, Duties, Legal Obligations, and Authority of …
Under the Federal Bankruptcy Code, which of the following rights or powers does a trustee in bankruptcy not have
The power to prevail against a creditor with an unperfected security interest
The power to require persons holding the debtor’s property at the time the bankruptcy petition is filed to deliver the property to the trustee
The right to use any grounds available to the debtor to obtain the return of the debtor’s property
The right to avoid any statutory liens against the debtor’s property that were effective before the bankruptcy petition was filed
The right to avoid any statutory liens against the debtor’s property that were effective before the bankruptcy petition was filed
A trustee is an individual or corporation appointed by the court or elected by the creditors to represent the debtor’s estate.
While the trustee has duties to the debtor, such as collecting all claims owed to the debtor and even temporarily running the debtor’s business if necessary, the trustee has certain rights afforded it under bankruptcy law.
The trustee steps into the shoes of the debtor and has:
- strong-arm power, or priority over an unperfected secured party to the debtor’s property,
- the power to require persons holding the debtor’s property at the time the petition is filed to deliver the property to the trustee,
- specific powers of avoidance, or the ability to set aside a sale or transfer to take the debtor’s property back, and
- the ability to use any grounds available to the debtor to insure the return of the debtor’s property.
The trustee can avoid certain statutory liens against the debtor’s property, such as statutory liens that first became effective against the debtor when the bankruptcy petition was filed or when the debtor became insolvent. The trustee cannot avoid “any statutory liens against the debtor’s property that were effective before the bankruptcy petition was filed.”
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4242 Bankruptcy and Insolvency
Green is self-employed as a human resources consultant and reports on the cash basis for income tax purposes. Select the appropriate tax treatment on Form 1040 (U.S. Individual Income Tax Return) for qualifying contributions to a simplified employee pension plan.
Fully deductible on Form 1040 to arrive at adjusted gross income
Reported in Schedule A—Itemized Deductions (deductibility subject to threshold of 2% of adjusted gross income)
Fully deductible in Schedule C—Profit or Loss From Business
Partially deductible in Schedule C—Profit or Loss From Business
Fully deductible on Form 1040 to arrive at adjusted gross income
Qualifying contributions to a simplified employee pension plan (SEP) are fully deductible on Form 1040 to arrive at adjusted gross income.
IRC Section 408(k)
Note
Annual contributions of an employer under a SEP are excluded from the participant’s gross income to the extent that they do not exceed the lesser of 25% of the participant’s compensation (not exceeding $250,000) or $52,000 for 2014. Contributions limits were increased effective 2002 by the Job Creation and Work Assistance Act of 2002.
If the employer exceeds this limit, the participant must withdraw the excess amount before the date for filing his tax return. If he does not, he will be liable for the 6% excise tax on excess contributions.
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4530 Adjustments and Deductions to Arrive at Taxable Income
Green is self-employed as a human resources consultant and reports on the cash basis for income tax purposes. Select the appropriate tax treatment on Form 1040 (U.S. Individual Income Tax Return) for interest expense on a home-equity line of credit for an amount borrowed to finance Green’s business.
Not deductible as a business expense
50% deductible on Form 1040 to arrive at adjusted gross income
Fully deductible in Schedule C—Profit or Loss From Business
Partially deductible in Schedule C—Profit or Loss From Business
Fully deductible in Schedule C—Profit or Loss From Business
Interest expense on a home equity line of credit for an amount borrowed to finance Green’s business is fully deductible in Schedule C, Profit or Loss From Business.
Even though the home was used as equity for the loan, the interest is fully deductible as a business expense on Green’s Schedule C.
(This is possible by electing under Regulation 1.163-10T(o)(5) to not treat it as home mortgage interest but instead to use the tracing rules under Regulation 1.163-8T(c) to treat it as business expense since the proceeds were used for this business.)
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4530 Adjustments and Deductions to Arrive at Taxable Income
What amount of a decedent's taxable estate is effectively tax-free in 2014 if the maximum applicable (unified) estate and gift tax credit is taken $192,800 $1,500,000 $5,000,000 $5,340,000
$5,340,000
The Tax Relief Act of 2010 raised the gift tax lifetime exemption to $5,000,000 for 2011 and $5,120,000 for 2012. The Taxpayer Relief Act of 2012 made these provisions permanent and the inflation-adjusted amount of the exemption became $5,250,000 for 2013 and $5,340,000 for 2014. The maximum gift tax rate is 40%, making the estate and gift tax credit unified. If a decedent’s taxable estate is equal to or less than $5,340,000 in 2014, the estate will pay no estate taxes.
Example
Taxable estate $5,340,000
Estate tax on $5,340,000 $2,081,800
Less: Applicable (Unified) Credit -(2,081,800)
————
Estate tax $ 0
============
Note
The estate tax form is IRS Form 706.
The applicable credit amount is the amount of taxable estate that corresponds to a given unified credit. So for 2014, the applicable (unified) credit is $2,081,800, and this would correspond to an applicable exemption of $5,340,000.
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4473 Determination of Taxable Estate
Private foundations may be subject to several taxes. Which of the following taxes is a private foundation not subject to
Tax on accumulated earnings
Tax on investment income
Tax on failure to distribute income for exempt purposes
Tax on excess business holdings
Tax on accumulated earnings
Private foundations are not subject to an accumulated earnings tax, but may be subject to the following taxes:
- Tax on investment income
- Tax on self-dealing
- Tax on failure to distribute income for exempt purposes
- Tax on excess business holdings
- Tax on speculative investments that jeopardize the foundation’s assets
- Tax on expenditures that should not be made by private foundations
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4672 Obtaining and Maintaining Tax-Exempt Status
During 2014, Blake transferred a corporate bond with a face amount and fair market value of $20,000 to a trust for the benefit of his 16-year-old child. Annual interest on this bond is $2,000, which is to be accumulated in the trust and distributed to the child on reaching the age of 21. The bond is then to be distributed to the donor or her successor-in-interest in liquidation of the trust. Present value of the total interest to be received by the child is $8,710. What is the amount of the gift that is excludable from taxable gifts $20,000 $10,000 $8,710 $0
$0
An “annual exclusion” of gifts made to any one person during a calendar year is excludable from taxable gifts. This amount is indexed for inflation and is $14,000 for 2014.
However, the annual exclusion only applies to a “gift of a present interest.”A present interest gift is an unrestricted right to the immediate use, possession, or enjoyment of the property or of the related income.
There is an exception to the present interest rule. A transfer for the benefit of a person who has not attained age 21 is considered a gift of a present interest if all of the following conditions are satisfied:
-Both the property and its income may be spent by or for the benefit of the minor before she or he reaches 21 years old.
-Any portion of the property or its income not expended for the minor before reaching 21 years of age must go to the minor at 21 years of age.
-If the minor dies before reaching 21 years of age, the property and its income must be payable to the minor’s estate or as the minor directs (under a “general power of appointment”). (IRC Section 2503(c))
Since this question states that only the interest income is to go to the minor (not the corporate bond itself), it does not qualify for the $14,000 annual exclusions. None of the gift ($8,170) is excludable from taxable gifts.
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4471 Transfers Subject to the Gift Tax
A tax return preparer is subject to a penalty for knowingly or recklessly disclosing corporate tax return information, if the disclosure is made:
to enable a third party to solicit business from the taxpayer.
to enable the tax processor to electronically compute the taxpayer’s liability.
for peer review.
under an administrative order by a state agency that registers tax return preparers.
to enable a third party to solicit business from the taxpayer.
A tax return preparer can be assessed a penalty for “improper” disclosure or use of information. A disclosure made to enable a third party to solicit business from the taxpayer is “improper.” The civil penalty is $250 for each improper disclosure ($10,000 maximum per calendar year) as well as a criminal penalty. (IRC Sections 6713(a) and 7216; Regulation Section 301.7216-2)
Note
A tax return preparer is not subject to a penalty for disclosing corporate tax return information if the disclosure is made:
- to enable the tax processor to electronically compute the taxpayer’s liability.
- for peer review.
- under an administrative order by a state agency that registers tax return preparers.
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4113 Internal Revenue Code of 1986, as Amended, and …
Which of the following items is tangible personal property Share of stock Trademark Promissory note Oil painting
Oil painting
“Tangible” property is property which has a physical existence and can be seen or touched. This can be exemplified by an oil painting. Stock, trademarks, and promissory notes all represent “intangible” property rights, even though the rights themselves might be represented by some physical document, such as a stock certificate.
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4231 Sales Contracts
4233 Secured Transactions
Tom Lewis, an individual taxpayer, donated used clothes and various household items to his local church during the current year. Select the appropriate tax treatment for the current year.
Not deductible on Form 1040
Deductible in full on Schedule A—Itemized Deductions
Deductible on Schedule A—Itemized Deductions, subject to a threshold amount of 2% of adjusted gross income
Deductible on Schedule A—Itemized Deductions, subject to a limitation of 50% of adjusted gross income
Deductible on Schedule A—Itemized Deductions, subject to a limitation of 50% of adjusted gross income
A contribution to a church or a convention or association of churches is considered to be a contribution to a “50% organization.” This means that the charitable deduction is limited to 50% of an individual’s adjusted gross income. If the charitable contribution is made in property other than money, the amount of the contribution is generally the fair market value of the property at the time of the contribution. For contributions of clothing or household items, no deduction is allowed unless the items are in good used condition or better.
IRC Section 170(b)(1)
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4530 Adjustments and Deductions to Arrive at Taxable Income
Which of the following is considered capital assets for tax purposes Inventory Land used in a business Novel copyright held by the author Mineral deposits sold in place
Mineral deposits sold in place
Mineral and similar natural resources deposits are considered to be capital assets when sold in place. The sale of mineral deposits, which are removed and sold in units, results in ordinary income. Copyrights held by the creator are not capital assets; however, purchased copyrights are capital assets. Inventory and land used in a business are specifically excluded from the definition of capital assets.
IRC Section 1221
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4410 Types of Assets
Under the U.C.C. Sales Article, a plaintiff who proves fraud in the formation of a contract may:
be entitled to punitive damages provided physical injuries resulted from the fraud.
be entitled to rescind the contract and sue for damages resulting from fraud.
rescind the contract even if there was no reliance on the fraudulent statement.
elect to rescind the contract and need not return the consideration received from the other party.
be entitled to rescind the contract and sue for damages resulting from fraud.
A plaintiff who proves fraud in the formation of a contract may rescind or void the contract. The plaintiff may sue for damages and the judge may require the enforcement of the remainder of the contract without the fraudulent clause.
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4221 Formation
When Norma Pell moved into a brand-new retirement village, she gave her 1931 Philco console radio with the original radio tubes to her nephew, since space was limited. She had paid $120 in 1931 for the radio. Her nephew Bradley found a buyer on the Internet and sold the radio for $1,100. What is the recognized gain for Bradley of the radio sale $1,100 $980 $490 $120
$980
When property is acquired by gift, the basis to the new owner is the same as that of the donor. Bradley takes the place of Norma in this case and everything received above $120 is a capital gain. His aunt’s holding period also tacks on, making it a long-term gain.
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4420 Basis and Holding Periods of Assets
The alternative minimum tax (AMT) is computed as the:
excess of the regular tax over the tentative minimum tax.
excess of the tentative minimum tax over the regular tax.
the tentative minimum tax plus the regular tax.
lesser of the tentative minimum tax or the regular tax.
excess of the tentative minimum tax over the regular tax.
The alternative minimum tax (AMT) is computed as the excess of the tentative minimum tax over the regular tax.
IRC Section 55(a)
Example
A taxpayer has the following:
Tentative Minimum Tax (TMT) $65,000
- Regular Tax - 45,000
-------
Alternative Minimum Tax (AMT) $20,000
======= The taxpayer must pay the IRS $65,000 (Regular Tax of $45,000 + AMT OF $20,000).
Note
Form 6251 must be used by individuals to compute the AMT, and Form 4626 must be used by corporations.
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4590 Alternative Minimum Tax
Olson, Wayne, and Hogan are equal partners in the OWH partnership. Olson's basis in the partnership interest is $70,000. Olson receives a liquidating distribution of $10,000 cash and land with a fair market value of $63,000, and a basis of $58,000. What is Olson's basis in the land $58,000 $60,000 $63,000 $70,000
$60,000
The basis of property (other than money) distributed by a partnership to a partner in liquidation of the partner’s interest is equal to the adjusted basis of the partner’s interest in the partnership reduced by any money distributed in the same transaction. In this case:
Olson’s basis in partnership interest $70,000
Cash liquidating distribution (10,000)
——–
Basis in property liquidating distribution (land) $60,000
If this was a nonliquidating distribution, different rules would apply for determining basis in the land.
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4654 Transactions Between a Partner and the Partnership
The minimum total voting power that a parent corporation must have in a subsidiary's stock in order to be eligible for the filing of a consolidated return is: 20%. 50%. 51%. 80%.
80%.
The minimum total voting power that a parent corporation must have in a subsidiary’s stock in order to be eligible for the filing of a consolidated return is 80%. An affiliated group of corporations may file consolidated tax returns.
Once a consolidated return is filed, the group must continue to file consolidated returns.
A consolidated group is one in which the common parent directly owns at least 80% of the total voting power and 80% of the total value of the stock in at least one other “includible” corporation.
“Includible corporations” are all corporations, except the following:
Tax-exempt organizations
Life insurance companies (Exception: Affiliated groups composed only of life insurance companies can file consolidated returns.)
Foreign corporations (Exception: Certain Mexican or Canadian subsidiaries of a U.S. parent can file consolidated returns.)
Corporations that have a possessions tax credit under IRC Section 936
Regulated investment companies
Real estate investment trusts
A DISC or former DISC
An S corporation
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4636 Consolidated Returns
Pierce owed Duke $3,000. Pierce contracted with Lodge to paint Lodge's house and Lodge agreed to pay Duke $3,000 to satisfy Pierce's debt. Pierce painted Lodge's house, but Lodge did not pay Duke the $3,000. In a lawsuit by Duke against Pierce and Lodge, who will be liable to Duke Pierce only Lodge only Both Pierce and Lodge Neither Pierce nor Lodge
Both Pierce and Lodge
Pierce is still liable to Duke for $3,000. Since Lodge agreed to pay Duke $3,000 if Pierce would paint Lodge’s house, Lodge is now also liable to Duke for $3,000 and Lodge has breached the contract by nonpayment. Duke can collect from both Pierce and Lodge, but only for the $3,000. Unjust enrichment prohibition would require payment from Lodge. However, Pierce is still a debtor to Duke no matter what Lodge does.
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4221 Formation
4224 Discharge, Breach, and Remedies
Under Chapter 7 of the Federal Bankruptcy Code, what effect does a bankruptcy discharge have on a judgment creditor when there is no bankruptcy estate
The judgment creditor’s claim is nondischargeable.
The judgment creditor retains a statutory lien against the debtor.
The debtor is relieved of any personal liability to the judgment creditor.
The debtor is required to pay a liquidated amount to vacate the judgment.
The debtor is relieved of any personal liability to the judgment creditor.
This is the heart, soul and substance of the Bankruptcy Code Chapter 7 is the liquidation of the assets of the debtor to pay the debts and relief of the debts. If there is no estate, and thus no assets, the same effect occurs in that the Chapter 7 proceeding gives the debtor a fresh start by eliminating the debt (as well as their good credit for at least seven years!).
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4242 Bankruptcy and Insolvency
The eligibility to participate standard means that a group term life insurance plan is not discriminatory if:
the plan benefits 70% of all employees.
the plan benefits 70% of all rank and file employees.
the plan benefits 70% of only key employees.
the plan benefits 50% of all employees.
the plan benefits 70% of all employees.
The eligibility to participate standard means that a group term life insurance plan is not discriminatory if the plan benefits 70% of all employees.
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4512 Characterization of Income
Rich purchased property from Sklar for $200,000. Rich obtained a $150,000 loan from Marsh Bank to finance the purchase, executing a promissory note and a mortgage. By recording the mortgage, Marsh protects its:
rights against Rich under the promissory note.
rights against the claims of subsequent bona fide purchasers for value.
priority against a previously filed real estate tax lien on the property.
priority against all parties having earlier claims to the property.
rights against the claims of subsequent bona fide purchasers for value.
A mortgage (lien) on real property is a security interest given to a creditor. Upon the debtor’s default, the creditor would have the right to seize the property and have it sold in order to pay off the outstanding indebtedness. Although not legally required, it would be in the best interests of the creditor to record this mortgage in the county courthouse where the property is located. While this recordation does not affect the rights of the creditor against the debtor or against creditor holding previously filed mortgages, it will preserve the creditor’s mortgage against the claims of subsequent bona fide purchasers for value.
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4233 Secured Transactions
Income from a trust where the grantor has a reversionary interest exceeding 5% of the value of the assets is taxed to the: grantor. beneficiaries. trust. whoever receives the income.
grantor.
Reversionary trust income is taxed to the grantor, even though the income is distributed to the beneficiaries.
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4663 Determination of Beneficiary’s Share of Taxable Income
Which of the following is correct concerning the LIFO method (as compared to the FIFO method) in a period when prices are rising
Deferred tax and cost of goods sold are lower.
Current tax liability and ending inventory are higher.
Current tax liability is lower and ending inventory is higher.
Current tax liability is lower and cost of goods sold is higher.
Current tax liability is lower and cost of goods sold is higher.
LIFO treats the last items added to inventory as being the first ones charged to cost of goods sold. In a period of rising prices, this would result in a higher cost of goods sold compared to FIFO. With a higher cost of goods sold, current taxable income would be reduced resulting in a lower current tax liability.
IRC Section 472
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4342 Inventory Valuation Methods, Including Uniform …
Pulse Corp. maintained a warehouse where it stored its manufactured goods. Pulse received an order from Star. Shortly after Pulse identified the goods to be shipped to Star, but before moving them to the loading dock, a fire destroyed the warehouse and its contents. With respect to the goods, which of the following statements is correct?
Pulse has title and an insurable interest.
Star has title and an insurable interest.
Star has title but no insurable interest.
Pulse has title but no insurable interest.
Pulse has title and an insurable interest.
Title passes from the seller to the buyer only if the goods are identified in the sales contract. A buyer has an insurable interest from the time the goods are identified in the contract.
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4231 Sales Contracts
Which of the following corporations would be taxed as a personal service corporation? An architecture and engineering firm A catering service A groundskeeping firm A real estate brokerage
An architecture and engineering firm
A personal service corporation is an entity whose principal activities involve performing personal services in the area(s) of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting.
Neither the real estate brokerage, the catering service, nor the groundskeeping firm perform personal services in any of the areas listed above.
The architecture and engineering firm is one of the categories listed, therefore, they would be considered a personal service corporation and would be taxed as such.
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4632 Tax Computations and Credits, Including Alternative …
Able, as agent for Baker, an undisclosed principal, contracted with Safe to purchase an antique car. In payment, Able issued his personal check to Safe. Able could not cover the check, but expected Baker to give him cash to deposit before the check was presented for payment. Baker did not do so and the check was dishonored. Baker’s identity became known to Safe.
Safe may not recover from: Baker individually on the contract. Able individually on the contract. Baker individually on the check. Able individually on the check.
Baker individually on the check.
Safe may not recover from Baker individually on the check. When an agent writes a personal check to cover a contractual obligation made on behalf of an undisclosed principal and the check bounces, the third party may hold the principal liable on the contract, but may not recover from the principal on the basis of the personal check written by the agent. The agent is not personally liable on the contract as long as the third party knew the agent was acting for an undisclosed party. Since the agent wrote a personal check for the contract, the third party may recover from the agent individually on the check.
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4213 Duties and Liabilities of Agents and Principals
Drain Corp. has two classes of stock—100,000 shares of authorized, issued, and outstanding voting common stock and 10,000 shares of authorized, issued, and outstanding nonvoting 5% cumulative, nonparticipating preferred stock with a face value of $100 per share. In 20X1, Drain’s officers and directors intentionally allowed pollutants to be discharged by Drain’s processing plant. These actions resulted in Drain having to pay penalties. Solely as a result of the penalties, no dividends were declared for the years ended December 31, 20X1, and December 31, 20X2. The total amount Drain paid in penalties was $1,000,000. In 20X2, Drain was able to recover the full amount of the penalties from an insurance company that had issued Drain a business liability policy. Drain’s directors refused to use this money to declare a dividend and decided to hold the $1,000,000 in a special fund to pay future bonuses to officers and directors.
Please choose the best answer to complete the following statement. A stockholder’s derivative suit, if successful, probably would result in the $1,000,000 being considered:
available for distribution as a dividend.
surplus or earnings held for expansion.
stock dividend.
illegal dividend.
available for distribution as a dividend.
If the derivative lawsuit by a stockholder is successful, the $1,000,000 would probably be made available for distribution as a dividend as a result of the court decision. To suspend dividends due to a loss, then use the insurance recovery for director and officer bonuses while still not paying dividends would probably be a conflict of interest.
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4264 Rights, Duties, Legal Obligations, and Authority of …
During 2015, Lee Smith had $100,000 of mortgage debt canceled because he was insolvent. Immediately prior to the debt cancellation, Smith's adjusted basis in his home was $150,000. As a result of the cancellation, Lee Smith will recognize income of: $100,000. $50,000. $0. $150,000.
$0.
Discharge of debt due to debtor insolvency is generally not included in gross income. Instead, the adjusted basis of assets is reduced by the amount of debt forgiven. In this case, Lee Smith’s adjusted basis of his home will become $50,000 ($150,000 - $100,000). The mortgage debt forgiveness act was extended through the end of 2016. Therefore, Lee will not have to recognize the $100,000 as income.
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4512 Characterization of Income
Under the Federal Bankruptcy Code, which of the following rights or powers does a trustee in bankruptcy not have
The power to prevail against a creditor with an unperfected security interest
The power to require persons holding the debtor’s property at the time the bankruptcy petition is filed to deliver the property to the trustee
The right to use any grounds available to the debtor to obtain the return of the debtor’s property
The right to avoid any statutory liens against the debtor’s property that were effective before the bankruptcy petition was filed
The right to avoid any statutory liens against the debtor’s property that were effective before the bankruptcy petition was filed
A trustee is an individual or corporation appointed by the court or elected by the creditors to represent the debtor’s estate.
While the trustee has duties to the debtor, such as collecting all claims owed to the debtor and even temporarily running the debtor’s business if necessary, the trustee has certain rights afforded it under bankruptcy law.
The trustee steps into the shoes of the debtor and has:
strong-arm power, or priority over an unperfected secured party to the debtor’s property,
the power to require persons holding the debtor’s property at the time the petition is filed to deliver the property to the trustee,
specific powers of avoidance, or the ability to set aside a sale or transfer to take the debtor’s property back, and
the ability to use any grounds available to the debtor to insure the return of the debtor’s property.
The trustee can avoid certain statutory liens against the debtor’s property, such as statutory liens that first became effective against the debtor when the bankruptcy petition was filed or when the debtor became insolvent. The trustee cannot avoid “any statutory liens against the debtor’s property that were effective before the bankruptcy petition was filed.”
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4242 Bankruptcy and Insolvency
Ingot Corp. lent Flange $50,000. At Ingot’s request, Flange entered into an agreement with Quill and West for them to act as compensated co-sureties on the loan in the amount of $100,000 each. Ingot released West without Quill’s or Flange’s consent, and Flange later defaulted on the loan. Which of the following statements is correct
Quill will be liable for 50% of the loan balance.
Quill will be liable for the entire loan balance.
Ingot’s release of West will have no effect on Flange’s and Quill’s liability to Ingot.
Flange will be released for 50% of the loan balance.
Quill will be liable for 50% of the loan balance.
The release of one co-surety without the knowledge and consent of the debtor and other co-surety (without a reservation of rights) generally releases the other co-surety to the extent of the proportionate responsibility of the co-surety who was released.
In this case, since each surety is equally responsible for the debt, the release of one will have the effect of releasing the other for 50% of the outstanding debt. (Normally, if the co-surety merely could or would not pay, the other co-surety would be responsible to the creditor for the entire obligation and assume the right of subrogation against both the debtor and the defaulting co-surety.)
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Your CPA firm has been engaged by a publicly traded company for the preparation of its corporate tax return. Your firm is not engaged in the audit of the public company in any fashion, and thus accepts the engagement and prepares the corporate return. You have completed the return, signed it as its preparer. You take the return to be signed to:
the chief executive officer.
the chief financial officer.
the head of the company’s audit committee.
the comptroller.
the chief executive officer.
While it might seem the CEO is too busy for such things, according to the “intent of Congress” as part of the Sarbanes-Oxley Act (SOX), the “federal income tax return of a corporation should be signed by the chief executive officer of such corporation.” While in the past the chief financial officer usually performed such a task, SOX has changed this tradition to make the CEO more accountable and aware of the conditions in the company.
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4123 Requirements of Regulatory Agencies
Which of the following statements is correct regarding the taxes payable under the Federal Unemployment Tax Act (FUTA)?
Liability arises only when wages are actually, not constructively, paid to employees.
Credits for this tax are allowed to employers for certain state unemployment taxes paid by the employer.
The amount is determined as a percentage of all compensation paid to an employee.
The amount is withheld from the wages of all employees.
Credits for this tax are allowed to employers for certain state unemployment taxes paid by the employer.
FUTA earnings include all earnings – even constructively received. FUTA is paid by employers, not employees. Compensation in excess of $7,000 is not subject to FUTA. There is a credit available for payments to a state unemployment fund.
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4252 Other Federal Laws and Regulations (Antitrust, …
Joe is the trustee of a trust set up for his father. Under the Internal Revenue Code, when Joe prepares the annual trust tax return, IRS Form 1041, he:
must obtain the written permission of the beneficiary prior to signing as a tax return preparer.
is not considered a tax return preparer.
may not sign the return unless he receives additional compensation for the tax return.
is considered a tax return preparer because his father is the grantor of the trust.
is not considered a tax return preparer.
An individual may represent a member of their immediate family before the IRS. Since Joe is the trustee of a trust set up for his father, he is representing his father.
Circular 230 allows individuals who are not CPAs, attorneys, or enrolled agents to engage in limited practice before the IRS.
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4111 Treasury Department Circular 230
A farm with over $1 million in assets is located in an empowerment zone. Which of the following tax benefits would it qualify for
Increased Section 179 deduction
Wage credit
Both increased Section 179 deduction and wage credit
Neither increased Section 179 deduction or wage credit
Neither increased Section 179 deduction or wage credit
To qualify for either the employment credit or the increased Section 179 deduction, a business must be located in the zone and engaged in an active trade or business within the zone and at least 35% of its employees must live in the zone. Certain businesses are not eligible, including golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, racetrack, gambling, liquor stores, and farms with owned or leased assets over $500,000.
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4632 Tax Computations and Credits, Including Alternative …
Which of the following would be unenforceable because the subject matter is illegal
A contingent fee charged by an attorney to represent a plaintiff in a negligence action
A restrictive covenant in an employment contract prohibiting a former employee from using the employers trade secrets
An arbitration clause in a supply contract
An employer’s promise not to press embezzlement charges against an employee who agrees to make restitution
An employer’s promise not to press embezzlement charges against an employee who agrees to make restitution
A contract must have a legal purpose. Since the subject of the contract, embezzlement, is a criminal act, the contract does not have a legal purpose and is not enforceable.
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4221 Formation
4222 Performance
Which of the following is a capital asset
Inventory held primarily for sale to customers
Accounts receivable
A computer system used by the taxpayer in a personal accounting business
Land held as an investment
Land held as an investment
Capital assets include investment property such as land held as an investment. Capital assets do not include the following:
- Property held for resale (inventory)
- Real or depreciable property used in a trade or business
- Accounts or notes receivable acquired in normal business operations
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4410 Types of Assets
Which of the following statements is correct concerning the similarities between a limited partnership and a corporation
Each is created under a statute and must file a copy of its certificate with the proper state authorities.
All corporate stockholders and all partners in a limited partnership have limited liability.
Both are recognized for federal income tax purposes as taxable entities.
Both are allowed statutorily to have perpetual existence.
Each is created under a statute and must file a copy of its certificate with the proper state authorities.
A limited partnership and a corporation are both created under a statute and must file a copy of their certificate with the proper state authorities. A limited partnership must have both a general partner and limited partners. The general partner is 100% personally liable for the debts of the partnership. A limited partnership is not recognized as a taxable entity for federal income tax purposes, and limited partnerships must have definite life—only corporations are permitted to have perpetual existence.
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4261 Advantages, Disadvantages, Implications, and …
Smith paid the following unreimbursed medical expenses:
Dentist and eye doctor fees $ 5,000
Contact lenses 500
Facial cosmetic surgery to improve Smith’s personal
appearance (surgery is unrelated to personal injury or
congenital deformity) 10,000
Premium on disability insurance policy to pay him if he is
injured and unable to work 2,000
What is the total amount of Smith's tax-deductible medical expenses before the adjusted gross income limitation $17,500 $15,500 $7,500 $5,500
$5,500
Medical expenses means amounts paid for:
- the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body,
- related transportation,
- qualified long-term care, and
- health insurance and qualified long-term care health insurance.
There are some specific exceptions. Cosmetic surgery is a qualified medical expense only if it repairs a congenital abnormality, personal injury, or disfiguring disease. Disability insurance premiums are not deductible because the proceeds from disability insurance are not taxable and expenses relating to tax-exempt income are not deductible.
So, Smith will have tax-deductible medical expenses of $5,500. computed as follows:
Dentist and eye doctor fees $5,000
Contact lenses 500
------
Total $5,500
======
IRC Section 213
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4530 Adjustments and Deductions to Arrive at Taxable Income
Tom Lewis, an individual taxpayer and employee of ABC Corp., paid insurance premiums this year that covered the possible loss of earnings resulting from disability. Select the appropriate tax treatment for the payment of these premiums.
Not deductible on Form 1040
Deductible in full on Schedule A—Itemized Deductions
Deductible on Schedule A—Itemized Deductions, subject to a threshold amount of 2% of adjusted gross income
Deductible on Schedule A—Itemized Deductions, subject to a limitation of 50% of adjusted gross income
Not deductible on Form 1040
remiums paid for insurance against an individual’s possible loss of earnings are not deductible under the Internal Revenue Code.
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4511 Inclusions and Exclusions
A family farmer with regular annual income may file a voluntary petition for bankruptcy under any of the following Chapters of the Federal Bankruptcy Code except: 7. 9. 11. 13.
9.
Chapter 9 of the Bankruptcy Code deals with the debts of a municipality.
Chapter 7 deals with individual liquidation, Chapter 11 deals with reorganization of debts, and Chapter 13 deals with adjustment of debts (repayment) and all are applicable to an individual or a farmer.
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4242 Bankruptcy and Insolvency
A CPA, while employed as an employee in a securities company, prepares misleading financial records for the company at his superior’s directive. He knows what the correct entry should be, yet does not make the correct entry, although the actual making of such an entry is under his control. The CPA has chosen to look the other way due to his superior’s orders. Which of the choices listed is the best answer concerning the CPA’s responsibilities
The CPA has no responsibility since he prepared the materials under the orders of his superior. The superior has the responsibility.
The CPA has responsibility only if he has not documented his objection.
The CPA is a bad person and should be fired since he made incorrect entries.
The CPA is responsible for the accuracy of the financial records prepared by himself.
The CPA is responsible for the accuracy of the financial records prepared by himself.
The CPA certainly could document his objections in writing, but he is still ethically bound to prepare correct financial records. See Interpretation 501-4, “Negligence in the preparation of financial statements or records” (ET 501.01, .05)
The CPA is responsible for the accuracy of the financial records he or she prepares. An ethical violation is committed if the CPA:
makes, or permits or directs another to make, materially false and misleading entries in the financial statements or records of an entity,
fails to correct an entity’s financial statements that are materially false and misleading when the member has the authority to record an entry, or
signs, or permits or directs another to sign, a document containing materially false and misleading information.
ET 501.05
See also ET Section 102.05 (Interpetation102-4, “Subordination of judgment by a member”). Rule 102.01 prohibits a member from knowingly misrepresenting facts or subordinating his or her judgment when performing professional services. Under this rule, if a member and his or her supervisor have a disagreement or dispute relating to the preparation of financial statements or the recording of transactions, the member should take the following steps to ensure that the situation does not constitute a subordination of judgment:
The member should consider whether (a) the entry or the failure to record a transaction in the records, or (b) the financial statement presentation or the nature or omission of disclosure in the financial statements, as proposed by the supervisor, represents the use of an acceptable alternative and does not materially misrepresent the facts. If, after appropriate research or consultation, the member concludes that the matter has authoritative support and/or does not result in a material misrepresentation, the member need do nothing further.
If the member concludes that the financial statements or records could be materially misstated, the member should make his or her concerns known to the appropriate higher level(s) of management within the organization (for example, the supervisor’s immediate superior, senior management, the audit committee or equivalent, the board of directors, the company’s owners). The member should consider documenting his or her understanding of the facts, the accounting principles involved, the application of those principles to the facts, and the parties with whom these matters were discussed.
If, after discussing his or her concerns with the appropriate person(s) in the organization, the member concludes that appropriate action was not taken, he or she should consider his or her continuing relationship with the employer. The member also should consider any responsibility that may exist to communicate to third parties, such as regulatory authorities or the employer’s (former employer’s) external accountant. In this connection, the member may wish to consult with his or her legal counsel.
The member should at all times be cognizant of his or her obligations under Interpretation 102-3; see ET Section 102.04.
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4131 Common Law Duties and Liability to Clients and Third …
Baker, a sole proprietor CPA, has several clients that do business in Spain. While on a 4-week vacation in Spain, Baker took a 5-day seminar on Spanish business practices that cost $700. Baker's round-trip airfare to Spain was $600. While in Spain, Baker spent an average of $100 per day on accommodations, local travel, and other incidental expenses, for total expenses of $2,800. What amount of educational expense can Baker deduct on Form 1040, Schedule C, Profit or Loss From Business $700 $1,200 $1,800 $4,100
$1,200
For an international trip, airfare would not be deductible if the trip is primarily personal, as indicated by the word “vacation.”
IRC Section 274
The cost of Baker’s course of $700 would be deductible and the expenses of $100 per day for five days would also be deductible for an additional $500 and a total of $1,200.
Note
Where international travel is both personal and business, but not primarily personal, the deductible airfare is pro-rated by deducting (the number of days used for business divided by the total number of days traveled) times the round-trip airfare.
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4530 Adjustments and Deductions to Arrive at Taxable Income
A taxpayer purchased 5 acres of land for $200,000 and placed in service other tangible business assets that cost $15,000. Disregarding business income limitations and assuming that the annual Section 179 (election to expense certain depreciable business assets) limit is $500,000, what maximum amount of cost recovery can the taxpayer claim this year $5,000 $43,000 $15,000 $215,000
$15,000
Land is not depreciable and does not qualify for Section 179 automatic expensing. The only assets in this problem that qualify for Section 179 are the other tangible business assets that cost $15,000. Because the $15,000 is less than the overall limit of $500,000, all $15,000 of the other tangible business assets are allowed as Section 179 expenses.
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4430 Cost Recovery (Depreciation, Depletion, and …
A calendar-year individual filed an income tax return on April 1. This return can be amended no later than:
4 months and 15 days after the end of the calendar year.
10 months and 15 days after the end of the calendar year.
3 years, 3 months, and 15 days after the end of the calendar year.
3 years after the return was filed.
3 years, 3 months, and 15 days after the end of the calendar year.
Taxpayers generally have 3 years to file an amended tax return. The 3-year period is measured from the date you filed your original return. If you filed your return before April 15, the 3-year period begins on April 15. If you requested an extension, the 3-year period runs from October 15. Therefore, you would count the 3 months and 15 days from January 1 to April 15, and then the 3 years from April 15.
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4327 Statute of Limitations
Mike and Jane Lewis, a married couple, file a joint 2014 federal income tax return. They have one child, age 15, whom they support 100%. Both are under age 65. They have the following income and expenses for the year:
Mike’s wages $44,000
Jane’s wages 40,000
Total allowable itemized deductions 10,000
Mike’s contribution to an IRA 4,000
Jane’s contribution to an IRA 4,000
Mike is not covered by pension plan at work, while Jane is covered by a plan at hers.
The exemption amount (per exemption) for 2014 is $3,950. The standard deduction amount for married filing jointly is $12,400.
What is the Lewises' adjusted gross income for 2014 $84,000 $80,000 $76,000 $72,000
$76,000
The key factor in this question is that both Mike’s and Jane’s IRA contributions are deductible. Beginning in 1998, individuals are no longer considered participants in a company retirement plan simply because their spouses are. Since Mike is not covered by a pension plan at work and their joint adjusted gross income is under the threshold of $181,000, Mike’s IRA contribution is fully deductible. Since Jane is covered by a pension plan at work and their joint adjusted gross income is under the lower limit of $96,000, Jane’s IRA contribution is also fully deductible.
Thus, their AGI is equal to the $84,000 in combined wages less Mike’s and Jane’s deductible IRA contributions of $4,000 each.
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4560 Taxation of Retirement Plan Benefits
Under the Secured Transactions Article of the U.C.C., for which of the following types of collateral must a financing statement be filed in order to perfect a purchase money security interest Stock certificates Promissory notes Personal jewelry Inventory
Inventory
The revised U.C.C. Article 9 specifies that a financing statement must be filed for personal property in order to provide constructive notice of the security interest. Personal property is both tangible and intangible items. Tangible property includes consumer goods, farm products, inventory, and equipment. The security interest is a purchase money security interest if the security interest is perfected upon attachment.
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4233 Secured Transactions
Under the Uniform Commercial Code (U.C.C.), a bill of lading:
is issued by a consignee of goods.
is negotiable if the goods are to be delivered to bearer.
will never be negotiable unless it is endorsed.
will never be enforceable if altered.
is negotiable if the goods are to be delivered to bearer.
In order to be negotiable, a bill of lading must provide that the goods are to be delivered to bearer or to the order of a named person.
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4232 Negotiable Instruments
On May 2, Handy Hardware sent Ram Industries a signed purchase order that stated, in part, as follows:
Ship for May 8 delivery 300 Model A-X socket sets at current dealer price. Terms 2/10/net 30.
Ram received Handy’s purchase order on May 4. On May 5, Ram discovered that it had only 200 Model A-X socket sets and 100 Model W-Z socket sets in stock. Ram shipped the Model A-X and Model W-Z sets to Handy without any explanation concerning the shipment. The socket sets were received by Handy on May 8.
Assuming that a contract exists between Handy and Ram, which of the following implied warranties would result
I. Implied warranty of merchantability
II. Implied warranty of fitness for a particular purpose
III. Implied warranty of title
I only
III only
I and III only
I, II, and III
I and III only
A merchant makes an implied warranty that the goods sold are fit for the ordinary purposes for which they are intended (i.e., warranty of merchantability). Similarly, unless negated, a seller makes an implied warranty of title that the seller has the right to sell the goods free from encumbrance or prior claim as a matter of implied law under Article 2 of the U.C.C.
The warranty of fitness for a particular purpose requires that the seller know or have substantial reason to know of the purchaser’s intended use of the goods; this does not appear to be the case with respect to Handy and Ram.
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4231 Sales Contracts
Hogan exchanged a business-use machine having an original cost of $100,000 and accumulated depreciation of $30,000 for business-use equipment owned by Baker having a fair market value of $80,000 plus $1,000 cash. Baker assumed a $2,000 outstanding debt on the machine. What taxable gain should Hogan recognize $0 $3,000 $10,000 $11,000
$3,000
This transaction qualifies for Section 1031 tax-free exchange treatment because business-use personalty is being exchanged for other business-use personalty. In a Section 1031 tax-free exchange, the recognized gain is equal to the lesser of the realized gain or boot received. The boot received is $3,000 in this problem and is the recognized gain.
Amount realized:
FMV of asset received $80,000
Plus: Cash received 1,000 (boot)
Plus: Relief of liability 2,000 (boot)
——-
Amount realized $83,000
Less: Adjusted basis
Purchase price $100,000
Less: Accum. depr. (30,000)
Adjusted basis (70,000)
——–
Realized gain $13,000
========
Recognized gain To extent of boot received $ 3,000
========
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4440 Taxable and Nontaxable Sales and Exchanges
Which of the following costs are subject to the uniform capitalization rules of IRC Section 263A for manufactured tangible personal property Off-site storage Advertising Research Marketing
Off-site storage
The uniform capitalization rules are known as UNICAP. Under UNICAP, all costs are divided into three categories: production, general administrative expenses, and mixed services. The mixed services costs are allocated to production costs and general administrative expenses. Then the production costs are allocated between cost of goods sold and ending inventory. In this manner, the production costs for the period are written off (cost of goods sold) and the remaining costs are capitalized into the ending inventory.
Off-site storage costs, purchasing, and repackaging are capitalized into the finished product. Advertising, research, and marketing are included in general administrative services and expensed in the current period.
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4342 Inventory Valuation Methods, Including Uniform …
Which of the following rights is a holder of a public corporation’s cumulative preferred stock always entitled to
Conversion of the preferred stock into common stock
Voting rights
Dividend carryovers from years in which dividends were not paid, to future years
Guaranteed dividends
Dividend carryovers from years in which dividends were not paid, to future years
Preferred stockholders have no guarantee of dividends, but are entitled to dividends (if declared) in preference to common stockholders. If the stock is designated “cumulative preferred,” all dividend deficiencies from prior years (“dividends in arrears”) must be paid before common stockholders can be paid any dividends. That is, cumulative preferred stockholders are entitled to dividend carryovers from years in which dividends were not paid, to future years.
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4264 Rights, Duties, Legal Obligations, and Authority of …
Which of the following parties are responsible for enforcing federal air and water quality standards
Industry associations
Political action groups
Both industry associations and political action groups
Neither industry associations nor political action groups
Neither industry associations nor political action groups
While an industry association usually speaks for an industry, they generally have no enforcement authority over their members, other than voluntary compliance requests.
A political action group is a political influence entity that has absolutely nothing to do with the enforcement of any type of standard, be it air, water, or other quality issues. It certainly may lobby for a type of sanction, penalty, or regulation of environmental quality, but it has no enforcement authority.
The Environmental Protection Agency has the authority to enforce compliance with its standards, although other governmental agencies may establish certain quality standards, as well.
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4252 Other Federal Laws and Regulations (Antitrust, …
A subsequent holder of a negotiable instrument may cause the discharge of a prior holder of the instrument of any of the following actions, except:
unexcused delay in presentment of a time draft.
procuring certification of a check.
giving notice of dishonor the day after dishonor.
material alteration of a note.
giving notice of dishonor the day after dishonor.
A subsequent holder of a negotiable instrument may cause the discharge of a prior holder of the instrument of any of the above except giving notice the day after dishonor.
A subsequent holder of a negotiable instrument may cause the discharge of a prior holder by failure to make a timely presentment of a time draft, by procuring certification of a check, or through the material alteration of a note.
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4232 Negotiable Instruments
If securities are exempt from the registration provisions of the Securities Act of 1933, any fraud committed in the course of selling such securities can be challenged by:
the SEC.
the person defrauded.
both the SEC and the person defrauded.
neither the SEC nor the person defrauded.
both the SEC and the person defrauded.
Even though a security may be exempt from registration under the Securities Act of 1933, when fraud is committed in the course of selling the stock, it is very likely that the provisions of the Securities and Exchange Act of 1934 will be applicable. Hence, the fraudulent activity can be challenged by both the SEC and by the victim of the fraud.
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4251 Federal Securities Regulation
Smith is a member of the U.S. Armed Forces (an enlisted person) and is assigned to service in Iraq (a designated combat zone) for a period that begins on January 20 of the current year and ends on May 5 of the current year. How many months of military pay may Smith exclude from gross income for the current year 3 4 5 12
5
Smith may exclude from gross income his monthly military pay received for any month or portion of a month that he was a member of the U.S. Armed Forces and serving in Iraq. Thus, even though he only served a portion of a month in both January and May, he may still exclude the full month’s pay for these months. Smith may exclude his military pay received from January to May (five months).
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4511 Inclusions and Exclusions
Robb, a minor, executed a promissory note payable to bearer and delivered it to Dodsen in payment for a stereo system. Dodsen negotiated the note for value to Mellon by delivery alone and without indorsement. Mellon indorsed the note in blank and negotiated it to Bloom for value. Bloom’s demand for payment was refused by Robb because the note was executed when Robb was a minor. Bloom gave prompt notice of Robb’s default to Dodsen and Mellon. None of the holders of the note were aware of Robb’s minority.
Which of the following parties will be liable to Bloom Dodsen Mellon Both Dodsen and Mellon Neither Dodsen nor Mellon
Mellon
Mellon will be liable to Bloom. The problem tells you that the instrument is a bearer instrument which was negotiated by delivery alone to Mellon. Mellon indorsed the note in blank. By signing his name to the instrument, Mellon set himself up for liability on the instrument.
Dodsen is not liable to Bloom because Mellon accepted the note, indorsed it, and negotiated it to Bloom for value.
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4232 Negotiable Instruments
Don Mills, a single taxpayer, had $70,000 in taxable income before personal exemptions. Mills had no tax preferences. His itemized deductions were as follows:
State and local income taxes $5,000
Home mortgage interest on loan to
acquire residence 6,000
Miscellaneous deductions that exceed
2% of adjusted gross income 2,000
What amount did Mills report as alternative minimum taxable income before the AMT exemption $72,000 $75,000 $77,000 $83,000
$77,000
Taxable income before personal exemptions $70,000
State and local income taxes 5,000
Miscellaneous deductions that exceed 2%
of adjusted gross income 2,000
——-
$77,000
========
Itemized deductions for AMT purposes are computed the same as for regular tax purposes, with the following exceptions:
-Property and income taxes are not deductible unless they are deductible in computing adjusted gross income. (IRC Section 56(b)(1)(A)(ii))
- No deduction is allowed for miscellaneous itemized deductions. (IRC Section 56(b)(1)(A)(i))
- Medical expenses are deductible only to the extent they exceed 10% of the payer’s adjusted gross income. (IRC Section 56(b)(1)(B))
- Qualified housing interest, rather than qualified residence interest is deductible. Qualified housing interest deductible for AMT does not include interest on home equity debt and has a narrower definition of residence which, for example, excludes boats and recreational vehicles. (IRC Section 56(e))
- Net investment income (the limit on the deduction for investment interest) for AMT purposes equals the sum of the taxpayer’s interest on tax-exempt bonds that is includable in alternative minimum taxable income, net of expenses associated with that interest, plus his net investment income for regular tax purposes. (IRC Section 56(b)(1)(c))
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4590 Alternative Minimum Tax
Hal and Joy Knox are married and file a joint return in 2014. Hal had no income during the year and Joy earned $100,000. Neither spouse was a member of a qualified retirement plan. What is the maximum allowable traditional IRA deduction if both are age 64 $4,000 $5,500 $11,000 $13,000
$13,000
Because neither spouse is covered by a qualified pension plan, there is no maximum income limitation. Since Hal and Joy are at least age 50, they both can contribute $6,500 instead of $5,500. If one spouse has no income, a contribution can be made for both provided the combined income is at least equal to the contribution. If one either lives with his or her spouse or files a joint return, and one spouse is covered by a retirement plan at work, but the other is not, the deduction is phased out if modified AGI is more than $181,000 but less than $191,000. If the modified AGI is $191,000 or more, no deductions may be made for contributions to a traditional IRA.
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4530 Adjustments and Deductions to Arrive at Taxable Income
4560 Taxation of Retirement Plan Benefits
Tom Lewis, an individual taxpayer, sold his personal automobile (never used for business purposes) for $5,000 in 2014. He purchased the automobile five years earlier for $10,000. Which of the following is the correct treatment of this transaction on Tom’s 2014 tax return (assuming that Tom’s only other source of income in 2014 was from wages)
Include $5,000 as miscellaneous income on his tax return.
Deduct a $5,000 long-term capital loss on his tax return.
Deduct a $3,000 long-term capital loss on his 2014 tax return, and carry over the remaining $2,000 to the next year.
Show neither income nor loss from this transaction on his tax return.
Show neither income nor loss from this transaction on his tax return.
Tom had a $5,000 net loss ($5,000 sales price minus $10,000 basis) on the sale of his automobile. The loss is considered a personal loss and is not deductible on his individual return.
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4440 Taxable and Nontaxable Sales and Exchanges
In January 2003, Brown sold land he had owned for many years on the installment basis. Installments are to be made semi-annually on the first day of March and September. $30,000 of each installment represents Brown's profit. Brown is in the 33% bracket for 2014. How much capital gains tax must Brown pay on the two installments he receives in 2014 $9,000 $12,000 $19,800 $21,000
$9,000
Since both of the installments were received after May 5, 2004, and the property sold was held more than 12 months, both installments are taxed at the 15% capital gains rate. Thus, the capital gains tax is $9,000 ($60,000 × 0.15).
The current capital gains rates apply to installment sale proceeds collected after the effective date of the current rates (after May 5, 2004), even if the installment sale occurred before the effective date of the current rates.
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4344 Installment Sales
4450 Amount and Character of Gains and Losses, and Netting …
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
$50,000
$20,000
$0
$70,000
$50,000
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.
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4642 Determination of Ordinary Income/Loss and Separately …
Which of the following acts by a debtor could result in a bankruptcy court revoking the debtor’s discharge
I. Failure to list one creditor
II. Failure to correctly answer material questions on the bankruptcy petition
I only
II only
Both I and II
Neither I nor II
II only
Absent fraud by the bankrupt debtor, the failure to list a creditor would not revoke the debtor’s discharge. However, failure to correctly answer material questions on the bankruptcy petition is at least a latent omission tantamount to fraud which denies discharge. The debt to the one creditor omitted will not be discharged.
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4242 Bankruptcy and Insolvency
Generally, which of the following contract rights are assignable
Option contract rights
Malpractice insurance policy rights
Both option contract rights and malpractice insurance policy rights
Neither option contract rights nor malpractice insurance policy rights
Option contract rights
Most contractual rights are assignable. This would include an option contract, which is the right to have an offer held open for an agreed interval of time. However, contract rights which are personal to the individual are nonassignable. Almost all insurance policies are personal to the insured and cannot be assigned.
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4222 Performance
Which of the following transactions would illustrate a secured party perfecting its security interest by taking possession of the collateral
A bank receiving a mortgage on real property
A wholesaler borrowing to purchase inventory
A consumer borrowing to buy a car
A pawnbroker lending money
A pawnbroker lending money
A pawnbroker lending money is a valid illustration of a secured party perfecting its security interest by taking possession of the collateral. Collateral is the property that may be repossessed by the secured-party creditor in the event of nonpayment. A mortgage is an instrument representing a contractual agreement between a debtor and a creditor.
The collateral is not the mortgage agreement but the real property. The buyer is in possession of the collateral—the buyer is the debtor. In the case of the pawnbroker, the pawnbroker is the creditor who is retaining possession of collateral. When the debtor pays off the loan, he submits the “pawn ticket” to the pawnbroker, who returns the collateral.
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4233 Secured Transactions
Capital assets include:
a corporation’s accounts receivable from the sale of its inventory.
7-year MACRS property used in a corporation’s trade or business.
a manufacturing company’s investment in U.S. Treasury bonds.
a corporate real estate developer’s unimproved land that is to be subdivided to build homes, which will be sold to customers.
a manufacturing company’s investment in U.S. Treasury bonds.
Capital assets include a manufacturing company’s investment in U.S. Treasury bonds.
Note
IRC Section 1221 explains what a capital asset does not include. For example, it does not include:
- inventory,
- any depreciable property,
- a copyright, a literary, musical, or artistic composition, or
- accounts or notes receivable acquired in the ordinary course of trade or business for services.
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4410 Types of Assets
4550 Loss Limitations
Smith contracted in writing to sell Peters a used personal computer for $600. The contract did not specifically address the time for payment, place of delivery, or Peters’ right to inspect the computer. Which of the following statements is correct
Smith is obligated to deliver the computer to Peters’ home.
Peters is entitled to inspect the computer before paying for it.
Peters may not pay for the computer using a personal check unless Smith agrees.
Smith is not entitled to payment until 30 days after Peters receives the computer.
Peters is entitled to inspect the computer before paying for it.
Unless otherwise stated in the contract, the Uniform Commercial Code (U.C.C.) permits the buyer to inspect the goods prior to payment or acceptance. (“Otherwise” might be a cash-on-delivery sale.) Also, when a contract is silent as to time of payment or time or place of delivery, the U.C.C. “fills in the gaps”—payment is construed as being by any reasonable means, such as personal check at the time and place of delivery; delivery to the buyer is to be within a reasonable time and at seller’s place of business. If seller has no place of business, place of delivery is seller’s home (never buyer’s home unless stated expressly).
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4231 Sales Contracts
Smith, an individual calendar-year taxpayer, purchased 100 shares of Core Co. common stock for $15,000 on December 15, 2013, and an additional 100 shares for $13,000 on December 30, 2013. On January 3, 2014, Smith sold the shares purchased on December 15, 2013, for $13,000. What amount of loss from the sale of Core's stock is deductible on Smith's 2013 and 2014 income tax returns $0 in 2013 and $0 in 2014 $0 in 2013 and $2,000 in 2014 $1,000 in 2013 and $1,000 in 2014 $2,000 in 2013 and $0 in 2014
$0 in 2013 and $0 in 2014
Since Smith bought and sold (at a loss) 100 shares of Core Co. common stock within 30 days, the wash sale rules apply. This means the loss is not allowed in 2013 or 2014. A loss sustained when stock or securities are sold is not allowed if, within a period beginning 30 days before the date of the sale and ending 30 days after the date of the sale, the taxpayer acquires substantially identical stock or securities.
The basis of the stock that Smith acquired on December 30, 2013, needs to be addressed: Since Smith sold the stock on January 3, 2014, (for $13,000) which was acquired December 15, 2013, (for $15,000) and the $2,000 loss was not allowed, the basis of the stock which he acquired on December 30, 2013, is calculated as follows:
Cost on 12/30/13 $13,000
Loss not allowed 2,000
-------
Basis of stock $15,000
=======
Note
The “wash sale rules” do not apply to gains—only losses.
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4550 Loss Limitations
Using the percentage-of-completion method, which of the following is used in calculating the income recognized in the final year of a contract
Income previously recognized only
Neither actual costs nor income previously recognized
Actual total costs only
Both actual total costs and income previously recognized
Both actual total costs and income previously recognized
Both actual total costs and income previously recognized are used in calculating the income recognized in the final year of a contract, as illustrated below:
Total contract revenue XXX
Less actual total costs - XX
----
Total income from contract XX
Less income previously recognized - X
----
Income recognized in final year X
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4343 Accounting for Long-Term Contracts
In 2014, O'Day, an S corporation, had net income per books of $200,000 after deducting $100,000 for compensation to officers. O'Day also had a $10,000 capital loss and a $10,000 charitable contribution on its books for 2014. Depreciation per books was $20,000. MACRS depreciation is used for tax purposes and was $25,000. What is O'Day's ordinary income for tax purposes for 2014 $305,000 $325,000 $225,000 $215,000
$215,000
O'Day's ordinary income for tax purposes (Form 1120S) is
Book income $200,000
Capital loss 10,000
Charitable contribution 10,000
Additional depreciation (5,000)
---------
Ordinary income $215,000
=========
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4642 Determination of Ordinary Income/Loss and Separately …
Pierce Corp., an accrual-basis, calendar-year C corporation, had the following receipts in 2014:
Year 2015 advance rental payments for a lease ending in 2016 $250,000
Lease cancellation payment from a 5-year lease tenant 100,000
Pierce had no restrictions on the use of the advance rental payments and renders no services in connection with the rental income. What amount of gross income should Pierce report on its 2014 tax return
$350,000
$250,000
$100,000
$0
$350,000
Prepaid rents (but not refundable deposits) are treated as income when received, even by an accrual basis taxpayer. Consideration for cancellation of a lease is deemed a substitute for lease payments. Therefore, the cancellation payment is also treated as taxable income when received. Regulation Section 1.61-8(b)
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4512 Characterization of Income
Nolan agreed orally with Train to sell Train a house for $100,000. Train sent Nolan a signed agreement and a down payment of $10,000. Nolan did not sign the agreement, but allowed Train to move into the house. Before closing, Nolan refused to go through with the sale. Train sued Nolan to compel specific performance. Under the provisions of the statute of frauds:
Train will win because Train signed the agreement and Nolan did not object.
Train will win because Train made a down payment and took possession.
Nolan will win because Nolan did not sign the agreement.
Nolan will win because the house was worth more than $500.
Train will win because Train made a down payment and took possession.
Train will win because Train made a down payment and took possession. While the statute of frauds requires a writing concerning the sale or purchase of real property, if performance has taken place and there had been acquiescence, then a contract will be enforced. This is exactly the case with Train. Train offered, and Nolan accepted, a $10,000 deposit and permitted Train to take possession of the property.
The mere signing of a contract by one party does not result in a “meeting of the minds,” even if the other party does not object. However, the fact that Nolan did not sign the contract will not result in his being able to evict Train because Nolan did accept the down payment and did permit Train to take possession of the property. Since this transaction does not involve the sale of goods, the Uniform Commercial Code’s Statute of Frauds does not apply.
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4222 Performance
Under Regulation D of the Securities Act of 1933, which of the following conditions apply to private placement offerings
The securities cannot be sold for longer than a 6-month period.
The securities cannot be the subject of an immediate unregistered reoffering to the public.
The securities must be sold to accredited institutional investors.
The securities must be sold to fewer than 20 nonaccredited investors.
The securities cannot be the subject of an immediate unregistered reoffering to the public.
Rule 506 of Regulation D permits the issuance of unregistered securities by private placement. However, the securities issued under this regulation are considered “restricted,” meaning that they are for personal investment only and generally cannot be resold to the public without registration.
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4251 Federal Securities Regulation
Stone and Frazier decided to terminate the Woodwest Partnership as of December 31. On that date, Woodwest’s balance sheet was as follows:
Cash $2,000 Equipment (adjusted basis) 2,000 Capital: Stone 3,000 Capital: Frazier 1,000 The fair market value of the equipment was $3,000. Frazier's outside basis in the partnership was $1,200. Upon liquidation, Frazier received $1,500 in cash. What gain should Frazier recognize $0 $250 $300 $500
$300
Although there is generally no gain or loss recognized by a partner upon the liquidation of a partnership interest, there are exceptions:
- Gain is recognized if cash distributed is in excess of the partner’s basis in the partnership interest.
- Loss is recognized if no property other than cash is distributed and the cash is less than the partner’s basis in the partnership interest.
Frasier’s cash distribution exceeded his basis in his partnership interest so he recognized gain computed as follows:
Liquidating cash distribution $1,500
Basis in partnership interest 1,200
——
Gain on liquidation $ 300
IRC Section 731(a)
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4654 Transactions Between a Partner and the Partnership
Nash, Owen, and Polk are co-sureties with maximum liabilities of $40,000, $60,000, and $80,000 respectively. The amount of the loan on which they have agreed to act as co-sureties is $180,000. The debtor defaulted at a time when the loan balance was $180,000. Nash paid the lender $36,000 in full settlement of all claims against Nash, Owen, and Polk. The total amount that Nash may recover from Owen and Polk is: $0. $24,000. $28,000. $140,000.
$28,000.
A surety is a party who promises to pay the obligation of the principal debtor in the event of default. Co-sureties share the obligation.
The relative liabilities of the co-sureties are the pro rata share of the total obligation assumed by each surety. In this case, Nash, Owen and Polk are obligated for 2/9 ($40,000/$180,000), 1/3, and 4/9 respectively. Since the claim was settled for $36,000 by Nash and Nash’s 2/9 liability share was $8,000, Nash would have total right of contribution or recovery from Owen and Polk of 7/9 of $36,000 or $28,000.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Commerce Corp. elects S corporation status as of the beginning of year 20X1. At the time of Commerce's election, it held a machine with a basis of $20,000 and a fair market value of $30,000. In March 20X1, Commerce sells the machine for $35,000. What would be the amount subject to the built-in gains tax $0 $5,000 $10,000 $15,000
$10,000
The $10,000 is subject to the built-in gains tax since the C corporation basis was $20,000, but fair market value (FMV) was $30,000 at the time of election. When a regular C corporation converts to S corporation status, a tax may be imposed on the net increase in value that took place on the assets during the time they were held by the C corporation. The tax is imposed on the S corporation when it disposes of property within five years of the S election.
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4645 Built-In Gains Tax
Management will include an “internal control report” in its public audit report. Which of the following practices is correct for your CPA firm
I. Your CPA firm requires a separate engagement to attest to the assessment made by management.
II. Your CPA firm reviews management’s report to see if it is in accordance with attestation standards.
III. Your CPA firm reports on management’s report and does not charge an additional fee thereon.
I
II
III
Both II and III are correct.
Both II and III are correct.
According to Section 404 of the Sarbanes-Oxley Act (SOX), the CPA firm shall attest to and report on the assessment made by management. The legislative intent of the language of Section 404 was not to have this evaluation be “subject of a separate engagement or the basis for increased charges or fees.”
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4123 Requirements of Regulatory Agencies
On May 2, Mason orally contracted with Acme Appliances to buy a washer and dryer for household use for $480. Mason and the Acme salesperson agreed that delivery would be made on July 2. On May 5, Mason telephoned Acme and requested that the delivery date be moved to June 2. The Acme salesperson agreed with this request. On June 2, Acme failed to deliver the washer and dryer to Mason because of an inventory shortage. Acme advised Mason that it would deliver the appliances on July 2 as originally agreed. Mason believes that Acme has breached its agreement with Mason. Acme contends that its agreement to deliver on June 2 was not binding. Acme’s contention is:
correct, because Mason is not a merchant and was buying the appliances for household use.
correct, because the agreement to change the delivery date was not in writing.
incorrect, because the agreement to change the delivery date was binding.
incorrect, because Acme’s agreement to change the delivery date is a firm offer that cannot be withdrawn by Acme.
incorrect, because the agreement to change the delivery date was binding.
Acme’s contention is incorrect. The agreement to change the delivery date was binding.
First, note that the amount of the contract was for less than $500. Under the Uniform Commercial Code (U.C.C.) Statute of Frauds, no writing is required to have an enforceable contract if the contract is less than $500.
Second, under the U.C.C., an agreement that modifies a contract needs no consideration to be binding.
The U.C.C. Firm Offer rules do not apply because the contract was made orally and not in writing. Therefore, it is incorrect to suggest that Acme’s agreement to change the delivery date is a firm offer that cannot be withdrawn by Acme.
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4231 Sales Contracts
Noninventory goods were purchased and delivered on June 15, 20X1. Several security interests exist in these goods. Which of the following security interests has priority over the others
Security interest in future goods attached June 10, 20X1
Security interest attached June 15, 20X1
Security interest perfected June 20, 20X1
Purchase money security interest perfected June 24, 20X1
Purchase money security interest perfected June 24, 20X1
Under Section 9-312 of the Uniform Commercial Code (U.C.C.), a purchase money security interest (PMSI) in noninventory (e.g., equipment) takes priority over all other competing security interests in the same collateral if the PMSI is perfected by filing a financing statement properly within a 10-day grace period, that is, within 10 days after June 15, 20X1. Since the PMSI was perfected June 24, it has priority over the non-PMSI security interest filed on June 20. A nonpurchase money security interest is subject to the date order; that is, first to file or perfect wins. The other existing security interests will have priority over any subsequent or inferior security interests.
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4233 Secured Transactions
Which of the following defenses would a surety be able to assert successfully to limit the surety’s liability to a creditor
A discharge in bankruptcy of the principal debtor
A personal defense the principal debtor has against the creditor
The incapacity of the surety
The incapacity of the principal debtor
The incapacity of the surety
The surety becomes liable on an outstanding debt concurrently with the principal debtor. The surety promises to pay “if the debtor doesn’t.” (Note: This does not say “if the debtor can’t.”) Thus, the creditor does not need to demand payment from the debtor to collect from the surety. The surety is not permitted to use defenses which are “personal” to the debtor, such as bankruptcy or incapacity. However, the surety is able to use the defense of his own incapacity.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Clark and Hunt organized Jet Corp. with authorized voting common stock of $400,000. Clark contributed $60,000 cash. Both Clark and Hunt transferred other property in exchange for Jet stock as follows:
Other Property:
Fair Percentage
Adjusted Market of Jet Stock
Basis Value Acquired
-------- ------ ------------- Clark $ 50,000 $100,000 40% Hunt 120,000 240,000 60%
What was Clark's basis on Jet stock $0 $100,000 $110,000 $160,000
$110,000
Clark’s Basis in Jet Stock:
Cash $ 60,000
Adjusted basis-property 50,000
--------
Clark's basis in Jet Stock $110,000
========
No gain or loss is recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange the persons are in control of the corporation. Control means 80% or more of the corporation. Since Clark and Hunt own 100% of the corporation, no gain is to be recognized. The basis of Clark’s stock has to be the carryover basis, which is cash $60,000 + adjusted basis of the other property ($50,000) = $110,000.
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4420 Basis and Holding Periods of Assets
4634 Entity/Owner Transactions, Including Contributions and …
Don and Linda Grant, U.S. citizens, were married for the entire 2014 calendar year. In 2014, Don gave a $60,000 cash gift to his sister. The Grants made no other gifts in 2014. They each signed a timely election to treat the $60,000 gift as one made by each spouse. Disregarding the unified credit and estate tax consequences, what amount of the 2014 gift is taxable to the Grants for gift tax purposes $0 $32,000 $28,000 $60,000
$32,000
Each taxpayer is allowed an annual exemption from gift taxes for gifts given during the year. The exemption amount is $14,000 for 2014. If an individual is married, they can elect to split the gifts they have given with their spouse (subject to the spouse’s consent). That way they can take advantage of both their annual exclusion and their spouse’s annual exclusion.
Don gave a $60,000 cash gift to his sister. Since they each signed a timely election to treat the gift as one made by each spouse, Don can reduce the amount of the gift subject to gift tax by both his $14,000 exemption and his wife’s $14,000 exemption.
Gift $60,000
Less Don’s exemption (14,000)
Less spouse’s exemption (14,000)
——–
Taxable gift $32,000
========
IRC Section 2513
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4472 Annual Exclusion and Gift Tax Deductions
Which of the following penalties is usually imposed against an accountant who, in the course of performing professional services, breaches contract duties owed to a client Specific performance Punitive damages Money damages Rescission
Money damages
The client can sue the accountant for monetary damages if the accountant breaches contract duties. Specific performance, punitive damages, and rescission do not contribute to or offer monetary damages for a personal contract.
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4224 Discharge, Breach, and Remedies
Frey, Inc., intends to make a $2 million common stock offering under Rule 505 of Regulation D of the Securities Act of 1933. Frey:
may not sell the stock to an unlimited number of investors.
may make the offering through a general advertising.
must notify the SEC within 15 days after the first sale of the offering.
must provide all investors with a prospectus.
must notify the SEC within 15 days after the first sale of the offering.
Under Rule 505, Regulation D, the SEC must be notified within 15 days after the first sale of the offering. Furthermore, the sale can be to an unlimited number of accredited investors (i.e., sophisticated investors) and general solicitation of offerings is not permitted. Only if an investor is nonaccredited must all investors be provided a prospectus.
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4251 Federal Securities Regulation
Which of the following statements is correct regarding the scope and provisions of the Occupational Safety and Health Act (OSHA)
OSHA requires employers to provide employees a workplace free from risk.
OSHA prohibits an employer from discharging an employee for revealing OSHA violations.
OSHA may inspect a workplace at any time regardless of employer objection.
OSHA preempts state regulation of workplace safety.
OSHA prohibits an employer from discharging an employee for revealing OSHA violations.
In order to encourage workers to report hazardous conditions in the workplace, the Occupational Safety and Health Act (OSHA) regulations prohibit employers from discharging employees who report OSHA violations. OSHA is intended to reduce (but cannot entirely eliminate) the risk incurred by workers. It supplements any state regulations relating to worker safety. OSHA agents are generally required to obtain a search warrant to inspect a worksite, unless the employer consents to the search.
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4252 Other Federal Laws and Regulations (Antitrust, …
As a general partner in Greenland Associates, an individual's share of partnership income for the current tax year is $25,000 ordinary business income and a $10,000 guaranteed payment. The individual also received $5,000 in cash distributions from the partnership. What income should the individual report from the interest in Greenland $5,000 $25,000 $35,000 $40,000
$35,000
A partner reports his distributive share of partnership income whether it is received or not. A guaranteed payment is considered income to the partner receiving it. Therefore, ordinary income and guaranteed payments are included in the individual’s income.
Ordinary business income $25,000
Guaranteed payment 10,000
——-
Interest in Greenland $35,000
Cash distributions from the partnership have no bearing on the income reported by the partner. The cash distribution will decrease the partner’s basis in the partnership interest.
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4651 Determination of Ordinary Income/Loss and Separately …
In June, Mullin, a general contractor, contracted with a town to renovate the town square. The town council wanted the project done quickly and the parties placed a clause in the contract that for each day the project extended beyond 90 working days, Mullin would forfeit $100 of the contract price. In August, Mullin took a three-week vacation. The project was completed in October, 120 working days after it was begun. What type of damages may the town recover from Mullin
Punitive damages because taking a vacation in the middle of the project was irresponsible
Compensatory damages because of the delay in completing the project
Liquidated damages because of the clause in the contract
No damages because Mullin completed performance
Liquidated damages because of the clause in the contract
Since the contract included a clause stating Mullin would forfeit $100 of the contract price for every day the project extended beyond 90 working days, the town may recover liquidated damages. Liquidated damages are agreed upon by all parties involved in the contract.
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4231 Sales Contracts
Under the liquidation provisions of Chapter 7 of the Federal Bankruptcy Code, certain property acquired by the debtor after the filing of the petition becomes part of the bankruptcy estate. An example of such property is:
inheritances received by the debtor within 180 days after the filing of the petition.
child support payments received by the debtor within one year after the filing of the petition.
Social Security payments received by the debtor within 180 days after the filing of the petition.
wages earned by the debtor within one year after the filing of the petition.
inheritances received by the debtor within 180 days after the filing of the petition.
Under Chapter 7, the post-petition property (here we are not talking about the assets of the bankrupt petitioner prior to filing the petition for bankruptcy) that must become part of the estate is the property that is received by the bankrupt party within 180 days of the filing of the bankruptcy petition. Notice carefully, however, that Social Security payments are excluded as the current law exists.
In stark contrast, inheritances, divorce settlements, life insurance proceeds, and gifts to the bankrupt party are included in the bankruptcy estate. The key to this question is (a) identifying the 180-day time element, (b) knowing that inheritances can become part of the estate, and (c) knowing that Social Security benefits or payments are excluded. The Bankruptcy Reform Act of 2005 also excludes withholdings for employee benefit plans.
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4242 Bankruptcy and Insolvency
Smith (single filing status) has an adjusted gross income (AGI) of $120,000 without taking into consideration $40,000 of losses from rental real estate activities. Smith actively participates in the rental real estate activities.
What amount of the rental losses may Smith deduct in determining taxable income $0 $15,000 $20,000 $40,000
$15,000
Individuals may offset up to $25,000 ($50,000 if married filing jointly) of ordinary income with losses from rental real estate activities. This exemption is reduced (but not below zero) by 50% of the amount by which the adjusted gross income of the taxpayer for the year exceeds $100,000.
Therefore, $25,000 - (($120,000 - $100,000) × 0.50) = $15,000 deduction allowed.
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4540 Passive Activity Losses
A taxpayer lived in an apartment building and had a 2-year lease that began 16 months ago. The taxpayer's landlord wanted to sell the building and offered the taxpayer $10,000 to vacate the apartment immediately. The taxpayer's lease on the apartment was a capital asset but had no tax basis. If the taxpayer accepted the landlord's offer, the gain or loss would be which of the following An ordinary gain A short-term capital loss A long-term capital gain A short-term capital gain
A long-term capital gain
Capital assets are defined by exclusion; that is, the Internal Revenue Code (IRC) lists items that are not capital assets. All else would then be capital. The items listed as not capital items are as follows:
- Property held for resale (inventory)
- Depreciable property or real property used in a trade or business
- Accounts or notes receivable acquired in normal business operations
- A copyright or a literary, artistic, or musical composition in the hands of the creator or anyone who assumes the creator’s basis (property received through gift)
- U.S. government publications received from the government other than by purchase at the price that it is offered for sale to the public
- Certain commodities derivative instruments held by a commodities derivatives dealer
- Any hedging transaction that is clearly identified as such before the close of the day on which it is acquired, originated, or entered into
- Supplies of a type regularly used or consumed by the taxpayer in the ordinary course of a trade or business of the taxpayer
Since a leasehold is not listed, it will be a capital asset. The difference between long-term and short-term capital gain is defined as one year or less for short term. The taxpayer held the lease for 16 months; therefore, it is long term.
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4410 Types of Assets
4420 Basis and Holding Periods of Assets
The alternative minimum tax (AMT) is a quasi-flat tax designed to ensure that all corporations with economic income pay some tax. The tax rate and exemption amount for corporations is: 25% and $40,000. 20% and $40,000. 20% and $80,000. 31% and $80,000.
20% and $40,000.
The correct tax rate is 20% with an exemption of $40,000 for corporate alternative minimum tax (AMT).
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4632 Tax Computations and Credits, Including Alternative …
Jay and Co., CPAs, audited the financial statements of Maco Corp. Jay intentionally gave an unqualified opinion on the financial statements even though material misstatements were discovered. The financial statements and Jay’s unqualified opinion were included in a registration statement and prospectus for an original public offering of Maco stock.
Which of the following statements is correct regarding Jay’s liability to a purchaser of the offering under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934
Jay will be liable if the purchaser relied on Jay’s unqualified opinion on the financial statements.
Jay will be liable if Jay was negligent in conducting the audit.
Jay will not be liable if the purchaser’s loss was under $500.
Jay will not be liable if the misstatement resulted from an omission of a material fact by Jay.
Jay will be liable if the purchaser relied on Jay’s unqualified opinion on the financial statements.
Under Section 10(b) and Rule Sections/Rules 10b-5 of the Securities Exchange Act of 1934, the professional’s intentional material misstatement coupled with reasonable reliance by the purchaser results in liability. Jay’s liability under these sections/rules requires more than mere negligence (carelessness) and a misstatement or omission of material fact. Furthermore, the amount of the loss is irrelevant.
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4132 Federal Statutory Liability
What term is used to describe a partnership without a specified duration A perpetual partnership A partnership by estoppel An indefinite partnership A partnership at will
A partnership at will
A partnership that has no stated duration is called a partnership at will.
A perpetual partnership and an indefinite partnership are not actual terms. A partnership by estoppel is when a person represents himself to be in the partnership and a client reasonably relies on that representation. A court may determine that a partnership by estoppel relationship exists, and any contract created will be binding on the person who made the representation.
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4262 Formation, Operation, and Termination
During 2014, Wolfram’s qualified tuition expenses were $10,000. $1,000 of this amount was paid from a distribution from a Coverdell education savings account set up by his parents. Wolfram’s parents, who claim Wolfram as a dependent, now want to take a Lifetime Learning credit. Which of the following statements is correct
In calculating the credit, the $10,000 maximum must be reduced by the $1,000 Coverdell education savings account distribution.
A Lifetime Learning credit cannot be claimed by a taxpayer for any year in which there has been a tax-free distribution from a Coverdell education savings account for that student.
If Wolfram’s parents want to take the learning credit, he must waive tax-free treatment for the Coverdell education savings account distribution.
The Coverdell education savings account and the Lifetime Learning credit are separate programs. No adjustment needs to be made to the learning credit amount.
In calculating the credit, the $10,000 maximum must be reduced by the $1,000 Coverdell education savings account distribution.
Individuals may elect to take a nonrefundable tax credit equal to 20% of as much as $10,000 ($5,000 before 2003) of qualified tuition and related expenses for themselves, spouses, and tax dependents.
The Lifetime Learning credit may not be claimed by a taxpayer for expenses of a student for any tax year for which a Hope credit is “allowed” for the same student.
IRC Section 25A(c) and (e)
To be “allowed,” the Hope credit and the Lifetime Learning credit must be elected by the taxpayer. Thus, a taxpayer has a choice as to which credit he wants to claim. Similarly, a taxpayer can elect to have an otherwise tax-free distribution from a Coverdell education savings account not excluded from income.
Beginning in 2002, taxpayers may claim the Lifetime Learning credit (or Hope credit) for a taxable year and exclude from gross income distributions from a Coverdell education savings account as long as the distribution is not used for the same expenses for which the credit is claimed. For example, if the tuition was $15,000, the Lifetime Learning credit could be claimed on $10,000 and $5,000 used to claim the Coverdell education savings account exclusion.
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4580 Tax Computations and Credits
On February 15, Year 4, P. D. Stone obtained the following instrument from Astor Co. for $1,000. Stone was aware that Helco, Inc., disputed liability under the instrument because of an alleged breach by Astor of the referenced computer purchase agreement. On March 1, Year 4, Willard Bank obtained the instrument from Stone for $3,900. Willard had no knowledge that Helco disputed liability under the instrument.
February 12, Year 4
Helco, Inc. promises to pay to Astor Co. or bearer the sum of $4,900 (four thousand four hundred and 00/100 dollars) on March 12, Year 4, (maker may select to extend due date to March 31, Year 4) with interest thereon at the rate of 12% per annum
HELCO, INC.
By. A. J. Help, President
Reference: computer purchase agreement dated February 12, Year 4
The reverse side of the instrument is endorsed as follows:
Pay to the order of Willard Bank, without recourse
P. D. Stone
The instrument is:
nonnegotiable, because of the reference to the computer purchase agreement.
negotiable, when held by Astor, but nonnegotiable when held by Willard Bank.
negotiable, even though the maker has the right to extend the time for payment.
nonnegotiable, because the numerical amount differs from the written amount.
negotiable, even though the maker has the right to extend the time for payment.
The instrument exhibits all of the requirements for a negotiable instrument:
- It is in writing.
- It is signed by the maker or the drawer.
- It is an unconditional promise or order to pay a fixed amount of money, with or without interest or other charges described in the promise or order.
- It is payable to order or to bearer at the time it is issued or first comes into possession of a holder (unless it is a check).
- It is payable on demand or at a definite time.
- It does not state any other undertaking or instruction by the person promising or ordering to do any act in addition to the payment of money, but the promise or order may contain (1) an undertaking or promise relative to collateral to secure payment, (2) an authorization for confession of judgment, or (3) a waiver of benefit of any law intended for the advantage or protection of an obligor.
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4232 Negotiable Instruments
Davis, an inventor, developed a new product, but lacked money to get the product to the marketplace. Before creating a corporation to raise capital, Davis leased office space and equipment, entered into contracts with third parties, and identified investors. Who has liability for reincorporation debts
If this corporation is never formed, Davis is not liable.
If this corporation is never formed, the unpaid third parties must write off the debt because no corporate entity existed at the time debt was incurred.
Davis is liable until the articles of incorporation were filed.
Davis is liable until the corporation assumed the debts in novation.
Davis is liable until the corporation assumed the debts in novation.
Since there was no corporation when Davis entered in the contracts, he is liable until something happens to relieve him of the liability. The corporation becomes liable only when it agrees to become liable—a novation.
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4224 Discharge, Breach, and Remedies
Starr, a self-employed individual, purchased a piece of equipment for use in Starr’s business. The costs associated with the acquisition of the equipment were:
Purchase price $55,000 Delivery charges 725 Installation fees 300 Sales tax 3,400 What is the depreciable basis of the equipment $55,000 $58,400 $59,125 $59,425
$59,425
The depreciable basis of purchased equipment is its cost. Included in cost are all incidental costs related to acquiring and placing the equipment in service such as delivery, installation, and sales taxes. Therefore, the depreciable basis of Starr’s piece of equipment is:
Purchase price $55,000
Delivery charges 725
Installation fees 300
Sales tax 3,400
-------
Total $59,425
=======
IRC Section 1012
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4420 Basis and Holding Periods of Assets
A newly formed single member domestic limited liability company is eligible to file an election to be taxed as a: disregarded entity or a partnership. corporation or a disregarded entity. partnership. partnership or a corporation
corporation or a disregarded entity.
A single member entity is disregarded as separate from their owner. Therefore, an LLC with one member may submit IRS Form 8832 (Entity Classification Election) and elect to be a corporation or a disregarded entity for federal tax purposes.
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4350 Tax Return Elections, Including Federal Status …
*VIDEO EXPLANATION
Douglas filed a voluntary bankruptcy on November 1, 20XX. For over a year prior to that time, Douglas had been considered insolvent in the bankruptcy sense. Which of the following would be considered a “preference” payment under bankruptcy law
October 1, 20XX—Payment of $1,000 to a secured creditor on an overdue obligation (total obligation: $2,000)
September 1, 20XX—Purchase of a washer-dryer for $1,200 cash
May 1, 20XX—Payment to Douglas’ brother of $2,000 on an overdue unsecured loan
March 1, 20XX—Payment of $500 to First Bank on an overdue unsecured loan
May 1, 20XX—Payment to Douglas’ brother of $2,000 on an overdue unsecured loan
A “preference” is a payment to a previously existing creditor within 90 days prior to the date of bankruptcy which gives that creditor an unfair advantage over similarly situated creditors. If the creditor is an “insider,” such as a relative or business partner, the period of time is one year. In this case, the payment to the brother qualifies as a preference, since it occurred within one year of the date of bankruptcy.
The payment to the secured creditor would not be considered a preference, since the secured creditor would have received that amount anyway upon liquidation of the security. The purchase of the washer-dryer for cash was not a preference, as it was a contemporaneous exchange, not the payment of a previously existing debt. The payment to First Bank occurred more than 90 days prior to the date of bankruptcy, and therefore was not a preference.
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4242 Bankruptcy and Insolvency
Which of the following actions by a CPA most likely violates the profession’s ethical standards
Arranging with a financial institution to collect notes issued by a client in payment of fees due
Compiling the financial statements of a client that employed the CPA’s spouse as a bookkeeper
Retaining client records after the client has demanded their return
Purchasing a segment of an insurance company’s business that performs actuarial services for employee benefit plans
Retaining client records after the client has demanded their return
The accountant is always under the obligation to return a client’s records upon demand, even if fees have not been paid. To fail to do so is an act discreditable to the profession as defined by the AICPA Code of Professional Conduct.
Note that purchasing a segment of an insurance company’s business that performs actuarial services for employee benefit plans is not a violation of the code; performing accounting services probably would impair the accountant’s independence.
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4111 Treasury Department Circular 230
4133 Privileged Communications, Confidentiality, and …
Adams, a general contractor, Brinks, an architect, and Carson, an interior decorator, formed the Dex Home Improvement General Partnership by contributing the assets as follows:
Fair % of Partner Share
Adjusted Market in Capital
Asset Basis Value Profits and Losses
--------- -------- ------- ------------------
Adams Cash $40,000 $40,000 50%
Brinks Land $12,000 $21,000 20%
Carson Inventory $24,000 $24,000 30%
The land was a capital asset to Brinks, subject to a $5,000 mortgage, which was assumed by the partnership. Brinks' initial basis in Dex is: $21,000. $12,000. $8,000. $5,000.
$8,000.
When a general partnership is formed and a partner contributes property to the partnership subject to a liability which is assumed by the partnership, the contributing partner’s basis is calculated as follows:
Carryover Basis of Land Contributed by Brinks $12,000
LESS: Mortgage Assumed
by the Partnership - 5,000
——-
$ 7,000
ADD: 20% of Mortgage Kept
by Brinks
(.20 x $5,000) + 1,000
——-
Brink’s Initial Basis $ 8,000
=======
Or $12,000 carryover basis of land contributed by Brinks minus (.80 × $5,000) liability assumed by the other partners.
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4652 Basis of Partner’s/Member’s Interest and Basis of …
Under the unified rate schedule:
lifetime taxable gifts are taxed on a noncumulative basis.
transfers at death are taxed on a noncumulative basis.
lifetime taxable gifts and transfers at death are taxed on a cumulative basis.
the gift tax rates are 5% higher than the estate tax rates.
lifetime taxable gifts and transfers at death are taxed on a cumulative basis.
The “unified rate schedule” referred to in this question means the unified transfer tax rate schedule which is imposed on taxable gifts made after 1976 and taxable estates for deaths after 1976.
The tax base for determining the estate tax (the unified transfer tax) is based on the taxable estate plus all post-1976 taxable gifts.
The tax base for determining the gift tax (the unified transfer tax) is based on all lifetime taxable gifts.
Therefore, lifetime taxable gifts and transfers at death are taxed on a cumulative basis.
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4471 Transfers Subject to the Gift Tax
4473 Determination of Taxable Estate
Kopel was engaged to prepare Raff’s 20X0 federal income tax return. During the tax preparation interview, Raff told Kopel that he paid $3,000 in property taxes in 20X0. Actually, Raff’s property taxes amounted to only $600. Based on Raff’s word, Kopel deducted the $3,000 on Raff’s tax liability. Kopel had no reason to believe that the information was incorrect. Kopel did not request underlying documentation and was reasonably satisfied by Raff’s representation that Raff had adequate records to support the deduction. Which of the following statements is correct
To avoid the preparer penalty for willful understatement of tax liability, Kopel was obligated to examine the underlying documentation for the deduction.
To avoid the preparer penalty for willful understatement of tax liability, Kopel would be required to obtain Raff’s representation in writing.
Kopel is not subject to the preparer penalty for willful understatement of tax liability because the deduction that was claimed was more than 25% of the actual amount that should have been deducted.
Kopel is not subject to the preparer penalty for willful understatement of tax liability because Kopel was justified in relying on Raff’s representation.
Kopel is not subject to the preparer penalty for willful understatement of tax liability because Kopel was justified in relying on Raff’s representation.
In tax practice, the CPA is justified in relying in good faith upon the client’s representations. The CPA who acts in good faith is not required to obtain verification of representations made by the client.
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4113 Internal Revenue Code of 1986, as Amended, and …
Under the Negotiable Instruments Article of the UCC, which of the following defenses could be successfully asserted by the drawer of a draft against a holder in due course of that draft?
The drawer issued the draft as bearer paper, and it was transferred by the original holder to the next holder without an endorsement.
The drawer was discharged from the obligation in bankruptcy after the issuance of the draft.
The drawer issued the draft to the payee because of the payee’s fraudulent representations concerning the value of the property the payee was transferring to the drawer in return for the draft.
The drawer issued the draft as a gift to the original payee, without the drawer receiving any consideration or value for it.
The drawer was discharged from the obligation in bankruptcy after the issuance of the draft.
Personal defenses are valid against holders, but not against holders in due course. A, B, and D are personal defenses. A is fraud in the inducement. B is lack of consideration. D is the lack of endorsement and the draft was not negotiated to the holder.
Real defenses are valid against both holders and holders in due course. Bankruptcy is a real defense.
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4232 Negotiable Instruments
Under the Secured Transactions Article of the U.C.C., if a secured creditor rightfully repossesses and sells a debtor’s collateral, which of the following obligations is the first to be paid from the proceeds of the sale?
The refund of the debtor’s payments made prior to the date of the sale
The balance of the debt owed the primary secured creditor
The debt owed any creditor with a subordinate security interest in the collateral
The reasonable expenses incurred by the sale
The reasonable expenses incurred by the sale
When a secured creditor repossesses and sells collateral, the first obligations to be paid are the expenses of the sale.
§ 9-608. APPLICATION OF PROCEEDS OF COLLECTION OR ENFORCEMENT; LIABILITY FOR DEFICIENCY AND RIGHT TO SURPLUS.
(a) [Application of proceeds, surplus, and deficiency if obligation secured.] If a security interest or agricultural lien secures payment or performance of an obligation, the following rules apply:
(1) A secured party shall apply or pay over for application the cash proceeds of collection or enforcement under Section 9-607 in the following order to:
(A) the reasonable expenses of collection and enforcement and, to the extent provided for by agreement and not prohibited by law, reasonable attorney’s fees and legal expenses incurred by the secured party
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4233 Secured Transactions
Tax preference items for computing AMT are:
depletion, accelerated depreciation, and certain tax-exempt interest.
intangible drilling costs, dividends, and charitable contributions.
installment sales, capital losses, and depletion.
certain tax-exempt interest, short-term contracts, and dividends.
depletion, accelerated depreciation, and certain tax-exempt interest.
Depletion, accelerated depreciation, and certain tax-exempt interest are some examples of tax preference items.
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4590 Alternative Minimum Tax
4632 Tax Computations and Credits, Including Alternative …
Which of the following claims is generally covered under workers’ compensation statutes
Occupational disease
Employment-aggravated preexisting disease
Both occupational disease and employment-aggravated preexisting disease
Neither occupational disease nor employment-aggravated preexisting disease
Both occupational disease and employment-aggravated preexisting disease
Workers’ compensation is a system established by statute in the various states for the purpose of providing workers with a means of compensation for injuries sustained on the job. In most states, the system would include coverage for occupational diseases (such as “black lung” disease) and employment-aggravated preexisting diseases.
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4252 Other Federal Laws and Regulations (Antitrust, …
Regulation D of the Securities Act of 1933:
restricts the number of purchasers of an offering to 35.
permits an exempt offering to be sold to both accredited and nonaccredited investors.
is limited to offers and sales of common stock that do not exceed $1.5 million.
is exclusively available to small business corporations as defined by Regulation D.
permits an exempt offering to be sold to both accredited and nonaccredited investors.
Regulation D of the Securities Act of 1933 permits an exempt offering to be sold to both accredited and nonaccredited investors. The nonaccredited investors should meet the “sophisticated” investor test, meaning that they have a combination of education and experience in private placements and high risk investments. Regulation D encompasses several “rules” which define different exemptions based on amount to be raised. Regulation D is not limited to $1.5 million, nor is it exclusively available to small businesses.
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4251 Federal Securities Regulation
During an audit of Trent Realty Corp.’s financial statements, Clark, CPA, reviewed the following instrument:
FRONT OF INSTRUMENT BACK OF INSTRUMENT
To: Pure Bank M. West
Upton, VT
Pay to C. Larr
April 5, 20X1 T. Keetin
Pay to the order of M. West $1,500.00
One Thousand Five Hundred and 00/100 Dollars C. Larr
on May 1, 20X1. Without recourse
(SIGNED) W. Fields
West's indorsement would be considered a: blank indorsement. qualified indorsement. special indorsement. restrictive indorsement.
blank indorsement.
West made a blank indorsement, since he did not indicate the next person to whom the instrument would be payable. The instrument is now bearer paper.
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4232 Negotiable Instruments
Under the Securities Act of 1933, which of the following statements concerning an offering of securities sold under a transaction exemption is correct
The offering is exempt from the antifraud provisions of the 1933 Act.
The offering is subject to the registrations requirements of the 1933 Act.
Resales of the offering are exempt from the provisions of the 1933 Act.
Resales of the offering must be made under a registration or a different exemption provision of the 1933 Act.
Resales of the offering must be made under a registration or a different exemption provision of the 1933 Act.
Under the Securities Act of 1933, original offerings of securities may be made without registration (i.e., exempt from registration requirements) under one of the specified “exemptions” under Regulation D. However, any resales of the offering may be subject to registration unless another exemption provision of the Act is applicable.
No offering is exempt from the antifraud provisions of the 1933 Act.
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4251 Federal Securities Regulation
Aaron Beckett purchased a watch at a retail store for personal use. The watch is classified as a: capital asset. Section 1231 asset. Section 1245 asset. Section 1250 asset.
capital asset.
Capital assets are investment property and personal-use property. Section 1231, 1245, and 1250 assets are business-use assets.
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4410 Types of Assets
During an audit of Trent Realty Corp.’s financial statements, Clark, CPA, reviewed the following instrument:
FRONT OF INSTRUMENT BACK OF INSTRUMENT
To: Pure Bank M. West
Upton, VT
Pay to C. Larr
April 5, 20X1 T. Keetin
Pay to the order of M. West $1,500.00
One Thousand Five Hundred and 00/100 Dollars C. Larr
on May 1, 20X1. Without recourse
(SIGNED) W. Fields
Keetin's indorsement would be considered a: blank indorsement. qualified indorsement. special indorsement. restrictive indorsement.
special indorsement.
Keetin made a special indorsement, since he indicated the next person to whom the instrument would be payable (in this case, Larr). The instrument is now order paper.
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4232 Negotiable Instruments
Under which of the following circumstances is trust property with an independent trustee includible in the grantor’s gross estate
The trust is revocable.
The trust is established for a minor.
The trustee has the power to distribute trust income.
The income beneficiary disclaims the property, which then passes to the remainderman, the grantor’s friend.
The trust is revocable.
When a grantor makes a gift and sets up a trust that is revocable, the grantor has maintained too much power and control over the assets. Such a revocable trust must be included in the grantor’s gross estate when the grantor dies.
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4661 Types of Trusts
The unified credit is:
a credit that allows donors and decedents to transfer a limited amount of property without being subject to the gift or estate tax.
the amount available for charitable contributions deductions on the gift tax return only.
the amount available for all property given to a spouse.
the value of the property included in the decedent’s
gross estate and is generally the fair market value of such property at the date of the decedent’s death.
a credit that allows donors and decedents to transfer a limited amount of property without being subject to the gift or estate tax.
The unified credit is defined as a credit that allows donors and decedents to transfer a limited amount of property without being subject to the gift or estate tax. For 2014 the unified credit is $2,081,800, which exempts $5,340,000 in 2014 in transfers from the gift or the estate tax.
-“The amount available for charitable contribution
s deductions on the gift tax return only” is a charitable contribution deduction on the gift tax return.
-“The amount available for all property given to a spouse” is the marital deduction on the gift tax return.
-“The value of the property included in the decedent’s gross estate and is generally the fair market value of such property at the date of the decedent’s death” defines the gross estate for purposes of the estate tax return.
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4473 Determination of Taxable Estate
4475 Unified Credit
Under the U.C.C. Sales Article, an action for breach of the implied warranty of merchantability by a party who sustains personal injuries may be successful against the seller of the product only when:
the injured party is in privity of contract with the seller.
the seller is a merchant of the product involved.
an action based on negligence can also be successfully maintained.
an action based on strict liability in tort can also be successfully maintained.
the seller is a merchant of the product involved.
The implied warranty of merchantability applies only to a merchant dealing in the type of goods being sold.
Quote
§ 2-314. Implied Warranty: Merchantability; Usage of Trade.
(1) Unless excluded or modified (Section 2-316), a warranty that the goods shall be merchantable is implied in a contract for their sale if the seller is a merchant with respect to goods of that kind.
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4231 Sales Contracts
Before a person may file a petition for voluntary bankruptcy under the 2005 Bankruptcy Reform Act, the petitioner must:
I. receive credit counseling from an approved for-profit credit counseling agency.
II. receive credit counseling within 180 days preceding the filing.
III. provide a certificate of receiving a group or individual briefing by an approved credit agency within the last 180 days to the court.
I, II, and III
I and II only
I only
II and III only
II and III only
There is a requirement under the 2005 Act that the person receive credit counseling within 180 days preceding the filing.
The answer regarding credit counseling is incorrect because the counseling must come from an approved not-for-profit agency, not a for-profit agency. Careful reading is important!
The petitioner is required to include in his or her filing petition a certificate of receiving a personal or group briefing by an approved credit agency within 180 days of the filing.
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Section 106
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4242 Bankruptcy and Insolvency
If a security becomes worthless in the current taxable year, it is treated as sold or exchanged on
the date it is deemed worthless.
the first day of the current taxable year.
the last day of the preceding taxable year.
the last day of the current taxable year.
the last day of the current taxable year.
IRC section 165 (g) specifies that a capital asset that becomes worthless will be deemed disposed as of the last day of the taxable year no matter when the asset actually became worthless during the year.
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4420 Basis and Holding Periods of Assets
Under the Employee Retirement Income Security Act of 1974 (ERISA), which of the following areas of private employer pension plans is regulated
Employee vesting*
Plan funding
Both employee vesting and plan funding
Neither employee vesting nor plan funding
*Vesting is the process by which an employee accrues non-forfeitable rights over employer-provided stock incentives or employer contributions made to the employee’s qualified retirement plan account or pension plan.
Both employee vesting and plan funding
The Employee Retirement Income Security Act of 1974 (ERISA) regulates employer pension plans for those employers who have established such plans. Under the law, employee contributions to a pension plan must vest immediately. Employer contributions must vest after no more than five years. Also, standards on investment of funds are established to avoid mismanagement. Thus, both employee vesting and plan funding are regulated by the statute.
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4252 Other Federal Laws and Regulations (Antitrust, …
Walker transferred property used in a sole proprietorship to the WXYZ partnership in exchange for a 1/4th interest. The property had an original cost of $75,000, an adjusted tax basis to Walker of $20,000, and fair market value of $50,000. The partnership has no liabilities. What is Walker's basis in the partnership interest $0 $20,000 $50,000 $75,000
$20,000
The basis of a partner’s interest acquired in exchange for his contribution to the partnership is the amount of the money contributed plus the adjusted basis to the contributing partner of any property contributed. In this case, Walker’s basis in the partnership interest would be equal to the basis of the property contributed of $20,000.
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4652 Basis of Partner’s/Member’s Interest and Basis of …
A corporation may reduce its regular income tax by taking a tax credit for: dividends-received deduction. foreign income taxes. state income taxes. accelerated depreciation.
foreign income taxes.
A corporation may reduce its regular INCOME TAX by taking a tax credit for foreign income taxes paid.
Note
The following items reduce taxable income:
Dividends-received deduction
State income taxes
Accelerated depreciation
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4580 Tax Computations and Credits
Which of the following is not a deduction to arrive at adjusted gross income?
Unreimbursed employee business expenses
Trade or business expenses
Capital losses in excess of capital gains
Alimony payments
Unreimbursed employee business expenses
Unreimbursed employee business expenses are a miscellaneous itemized deduction (a deduction from AGI), not a deduction to arrive at AGI.
Alimony payments, trade or business expenses and excess capital losses over capital gains (limited to $3,000 per year) are deductions to arrive at AGI.
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4512 Characterization of Income
Link Corp. is subject to the reporting provisions of the Securities Exchange Act of 1934.
I. Which of the following situations would require Link to be subject to the reporting provisions of the 1934 Act II. Shares listed on a national securities exchange More than one class of stock
Both I and II
I only
II only
Neither I nor II
I only
The Securities Exchange Act of 1934 is applicable to any firm whose shares are listed on a national securities exchange and also to any firm with at least 500 shareholders and gross assets of at least $10 million. The existence of more than one class of stock would not in and of itself result in the 1934 Act being applicable.
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4251 Federal Securities Regulation
One of the requirements to qualify as a holder of a negotiable bearer check is that the transferee must:
receive the check that was originally made payable to bearer.
have possession of the check.
take the check in good faith.
give value for the check.
have possession of the check.
By definition, a “bearer” instrument must the in possession of the check.
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4232 Negotiable Instruments
The uniform capitalization rules of IRC Section 263A apply to retailers whose average gross receipts for the preceding three years exceed what amount $1,000,000 $2,500,000 $5,000,000 $10,000,000
$10,000,000
Uniform capitalization rules (or UNICAP) apply only if receipts for the previous three tax years exceed $10 million per IRC Section 263A.
IRC Section 263A(b)(2)(B) states that UNICAP rules “shall not apply to any personal property acquired during any taxable year by the taxpayer for resale if the average annual gross receipts of the taxpayer (or any predecessor) for the 3-taxable-year period ending with the taxable year preceding such taxable year do not exceed $10,000,000.”
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4342 Inventory Valuation Methods, Including Uniform …
Which of the following rights will a third party be entitled to after validly contracting with an agent representing an undisclosed principal
Disclosure of the principal by the agent
Ratification of the contract by the principal
Performance of the contract by the agent
Election to void the contract after disclosure of the principal
Performance of the contract by the agent
An undisclosed principal is a principal whose existence and identity are not known to the third party. The third party deals with the agent believing he is dealing with a principal. A third party basically has little or no right to have disclosure of principal or to void the contract after entering into an enforceable contract (except for fraud), nor may the principal be compelled to ratify the contract’s terms negotiated by the agent.
The third party, having contracted with a person (the agent) thought to be a principal, may compel the agent to perform the terms of the valid contract.
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4213 Duties and Liabilities of Agents and Principals contract by the agent
Which of the following types of entities is entitled to the net operating loss deduction Partnerships S corporations Trusts and estates Not-for-profit organizations
Trusts and estates
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)
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4633 Net Operating Losses (NOLs)
4642 Determination of Ordinary Income/Loss and Separately …
4651 Determination of Ordinary Income/Loss and Separately …
4662 Income and Deductions
Absent an election to close the books, the allocation of nonseparately stated income or loss for an S corporation shareholder that changed his ownership interest during the year is computed based on which of the following ownership percentages
Ownership percentage at the end of the S corporation year
Ownership percentage computed on a per-share, per-day basis
Ownership percentage at the beginning of the S corporation year
Ownership percentage determined as an average of the beginning and ending ownership percentages
Ownership percentage computed on a per-share, per-day basis
Each shareholder must include on the personal tax return the share of the corporation’s income or loss and special items from the corporate tax year that has ended with or within the personal tax year. Where ownership has changed during the year, each owner must recognize a pro rata share of the income or loss allocated on a daily basis.
Income is not allocated based on the ownership percentage at either the beginning or the end of the S corporation year. Income is not allocated based on the average of the beginning and ending ownership percentages.
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4642 Determination of Ordinary Income/Loss and Separately …
When the Uniform Partnership Act applies and there is no general partnership agreement, which of the following events occurs when a partner dies
I. The partnership is dissolved.
II. The deceased partner’s estate is free from any partnership liability.
Both I and II
I only
II only
Neither I nor II
I only
If a partner dies, according to section 30 of the Uniform Partnership Act (UPA), the partnership is dissolved but not terminated, since the partnership must continue until the winding up of partnership affairs is completed. The UPA (section 36) also states, “The dissolution of the partnership does not of itself discharge the existing liability of any partner.” Further, “The individual property of a deceased partner shall be liable for all obligations of the partnership incurred while he was a partner but subject to the prior payment of his separate debts.”
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4262 Formation, Operation, and Termination
Pope, a C corporation, owns 15% of Arden Corporation. Arden paid a $3,000 cash dividend to Pope. What is the amount of Pope's dividend-received deduction $3,000 $2,400 $2,100 $0
$2,100
Since the C corporation named Pope owns 15% of Arden Corporation, Pope can use a 70% dividends-received deduction to offset the dividends paid by Arden Corporation. Pope received $3,000 in taxable dividends but can offset $2,100 of that amount on its tax return (0.70 × $3,000 = $2,100).
Corporate Ownership DRD Deduction %
———————- —————
Less than 20% 70%
20% or more, under 80% 80%
80% or more 100%
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4631 Determination of Taxable Income/Loss
Which of the following costs are organizational expenditures
Professional fees to issue the corporate stock
Printing costs to issue the corporate stock
Legal fees for drafting the corporate charter
Commissions paid by the corporation to an underwriter
Legal fees for drafting the corporate charter
The only organization expenditures in this question are “legal fees for drafting the corporate charter.” All of the other expenditures relate to issuing the stock and are not organization costs.
For organizational expenditures incurred after August 16, 2011, taxpayers may elect to deduct up to $5,000 in the taxable year in which the business begins. The $5,000 amount is reduced by the amount by which the cumulative cost of organization expenditures exceeds $50,000. Any remaining organizational expenditures not deducted are amortized over a 15-year period (180 months) beginning with the month the active trade or business begins.
IRC Section 248; Regulation Section 1.248-1
Note
Organization cost included legal services, state incorporation fees, temporary directors’ fees, and organizational meeting costs.
IRC Section 248; Regulation Section 1.248-1(b)
Costs of issuing stock cannot be deducted.
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4611 Formation
Blue, a used car dealer, appointed Gage as an agent to sell Blue's cars. Gage was authorized by Blue to appoint subagents to assist in the sale of the cars. Vond was appointed as a subagent. To whom does Vond owe a fiduciary duty Gage only Blue only Both Blue and Gage Neither Blue nor Gage
Both Blue and Gage
This question is testing your knowledge of principals and agents. Blue is the principal and Gage is an agent authorized by Blue to engage subagents (Vond) to sell cars for the benefit of Blue. Notice in this situation that the principal authorized the agent to appoint subagents, which means (but which was not asked in the question) that Blue is responsible for the subagent’s actions.
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4211 Formation and Termination
A party who filed a security interest in inventory on April 1, 20X1, would have a superior interest to which of the following parties
A holder of a mechanic’s lien whose lien was filed on March 15, 20X1
A holder of a purchase money security interest in after-acquired property filed on March 20, 20X1
A purchaser in the ordinary course of business who purchased on April 10, 20X1
A judgment lien creditor who filed its judgment on April 15, 20X1
A judgment lien creditor who filed its judgment on April 15, 20X1
A party who filed a security interest in inventory on April 1, 20X1, would have a superior interest to a judgment lien creditor who filed its judgment on April 15, 20X1.
The general rule on priorities is first to file or perfect wins. The mechanic’s lien was filed first or prior to filing the security interest.
The PMSI (purchase money security interest) was filed on March 20 and therefore prior to April 1.
The other applicable rule is that buyers in the ordinary course of business prevail over security interest holders. Even though the buyer purchased the product on April 10, which is after the security interest was filed on April 1, the buyer in the ordinary course of business has priority over the creditor.
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4233 Secured Transactions
Which of the following securities would be regulated by the provisions of the Securities Act of 1933
Securities issued by not-for-profit, charitable organizations
Securities guaranteed by domestic governmental organizations
Securities issued by savings and loan associations
Securities issued by insurance companies
Securities issued by insurance companies
Certain issuances are exempt from the provisions of the Securities Act of 1933, including:
- securities issued by not-for-profit, charitable organizations,
- securities issued by domestic governmental organizations, and
- securities issued by savings and loans and similar financial institutions.
Securities issued by insurance companies are not exempt from provisions of the act.
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4251 Federal Securities Regulation
The purpose of the Resource Conservation and Recovery Act (RCRA) is to ensure that all hazardous material is properly managed: when being transported. by the buyer. during manufacturing. from creation to destruction.
from creation to destruction.
The purpose of the Resource Conservation and Recovery Act (RCRA) is to ensure that all hazardous material is properly managed from beginning to end—from creation to destruction. Creators or generators of hazardous materials as defined by the RCRA are held liable and accountable for potential environmental damage throughout the materials’ existence.
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4252 Other Federal Laws and Regulations (Antitrust, …
Teller, Kerr, and Ace are co-sureties on a $120,000 loan with maximum liabilities of $20,000, $40,000, and $60,000, respectively. The debtor defaulted on the loan when the loan balance was $60,000. Ace paid the lender $48,000 in full settlement of all claims against Teller, Kerr, and Ace. What amount may Ace collect from Kerr $0 $16,000 $20,000 $28,000
$16,000
A surety promises to pay the debt if the debtor does not. Each of the co-sureties was responsible for the following:
Responsible for
-----------------------
Teller $ 20,000 1/6 of total
Kerr 40,000 1/3 of total
Ace 60,000 1/2 of total
--------
Total $120,000
The total amount paid by Ace in full satisfaction of the debt was $48,000. If Kerr is responsible for 1/3rd of that debt, then he should pay Ace $16,000, or 1/3rd of $48,000.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Frank Supply Co. held the following instrument:
_____________________________________________
|
| Clark Novelties, Inc. April 12, Year 5
| 29 State Street
| Spokane, Washington
|
| Pay to the order of Frank Supply Co. on April 30, Year 5, ten
| thousand and 00/100 dollars ($10,000)
|
| Smith Industries, Inc.
| J.C. Kahn
| J.C. Kahn, President
|
| ACCEPTED: Clark Novelties, Inc.
| By:
| Mitchell Clark
| Mitchell Clark, President
|
| Date: April 20, Year 5
|
As a result of an audit examination of this instrument, which was properly endorsed by Frank to your client, it may be correctly concluded that:
the instrument is nonnegotiable and thus no one has rights under the instrument.
Smith was primarily liable on the instrument prior to acceptance.
no one was primarily liable on the instrument at the time of issue, April 12.
upon acceptance, Clark Novelties, Inc., became primarily liable and Smith was released from all liability.
no one was primarily liable on the instrument at the time of issue, April 12.
The due date of the instrument was April 30, Year 5. No one was yet liable on the date the instrument was drawn—April 12.
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4232 Negotiable Instruments
Under the Federal Age Discrimination in Employment Act, which of the following practices would be prohibited
Compulsory retirement of employees below the age of 70
Termination of employees between the ages of 65 and 70 for cause
Both compulsory retirement of employees below the age of 65 and termination of employees between the ages of 65 and 70 for cause are prohibited.
Neither compulsory retirement of employees below the age of 65 nor termination of employees between the ages of 65 and 70 for cause is prohibited.
Compulsory retirement of employees below the age of 70
The Federal Age Discrimination Act prohibits discrimination in employment against employees or job applicants on the basis of age if the complainant is at least 40 years of age. This would protect employees from being subjected to compulsory retirement. The act does not preclude employers from terminating an employee for cause regardless of the age of the employee.
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4252 Other Federal Laws and Regulations (Antitrust, …
Robert had current-year adjusted gross income of $100,000 and potential itemized deductions as follows:
Medical exp (before percentage limitations) $12,000
State income taxes 4,000
Real estate taxes 3,500
Qualified housing & residence mortgage interest 10,000
Home equity mortgage interest (used to consolidate personal debts) 4,500
Charitable contributions (cash) 5,000
What are Robert’s itemized deductions for the alternative minimum tax
$17,000
$19,500
$21,500
$25,500
$17,000
Robert’s itemized deductions for the alternative minimum tax (AMT) are as follows:
Medical expenses (before percentage limitation) $12,000
Medical expense percentage limitation (0.10 x $100,000) (10,000)
Qualified housing and residence mortgage interest 10,000
Charitable contributions 5,000
——–
Alternative minimum tax itemized deductions $17,000
Itemized deductions for AMT purposes are computed the same as for regular tax purposes, with the following exceptions:
- Property and income taxes (or the optional sales taxes) are not deductible unless they are deductible in computing adjusted gross income. (IRC Section 56(b)(1)(A)(ii))
- No deduction is allowed for miscellaneous itemized deductions. (IRC Section 56(b)(1)(A)(i))
- Medical expenses are deductible only to the extent they exceed 10% of the taxpayer’s adjusted gross income. (IRC Section 56(b)(1)(B))
- Qualified housing interest, rather than qualified residence interest, is deductible. Qualified housing interest deductible for AMT does not include all home equity debt and has a narrower definition of residence which, for example, excludes boats and recreational vehicles. (IRC Section 56(e))
- The limit on the deduction for investment interest (net investment income) for AMT purposes equals the sum of the taxpayer’s interest on tax-exempt bonds that is includable in alternative minimum taxable income, net of expenses associated with that interest, plus the taxpayer’s net investment income for regular tax purposes. (IRC Section 56(b)(1)(C))
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4590 Alternative Minimum Tax
In the calculation of the empowerment zone employment credit, the first $\_\_\_\_\_\_\_\_ of qualified zone wages paid to \_\_\_\_\_\_\_\_ is taken into account for purposes of the credit. 15,000; each qualified zone employee 15,000; all qualified zone employees 30,000; each qualified zone employee 30,000; all qualified zone employees
15,000; each qualified zone employee
The empowerment zone employment credit is available to all employers (not just those classified as an enterprise zone business) and is equal to 20% of the first $15,000 of qualified wages paid to each employee who is a resident of an empowerment zone and who performs substantially all employment services within the zone in a trade or business of the employer.
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4632 Tax Computations and Credits, Including Alternative …
On December 1, Gem orally contracted with Mason for Mason to manage Gem’s restaurant for one year starting the following January 1. They agreed that Gem would pay Mason $40,000 and that Mason would be allowed to continue to work for Gem if “everything worked out.” On June 1, Mason quit to take a better-paying job, alleging that the contract violated the statute of frauds. What will be the outcome of a suit by Gem for breach of contract
Gem will win because the contract was executory.
Gem will win because the contract was for services, not goods.
Gem will lose because the contract could not be performed within one year.
Gem will lose because the contract required payment of more than $500.
Gem will lose because the contract could not be performed within one year.
Since the contract could not be performed within one year, the oral contract would not be enforceable in court. Employment contracts are difficult to enforce. The employee cannot be forced to continue working for the employer, as that would be involuntary servitude, prohibited by the 13th Amendment of the U.S. Constitution.
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4224 Discharge, Breach, and Remedies
Workers’ compensation benefits are available to which of the following parties
Only those employees injured while working on workplace premises
Only those employees injured while working within the scope of employment
All agents injured while commuting to and from work
All agents injured while using the employer’s
automobile for personal use
Only those employees injured while working within the scope of employment
Workers’ compensation laws were enacted by the states to protect employees and their families from the risks of financial loss from accidental injury, death, disease, or disability resulting from their employment. Workers’ compensation benefits are nontaxable when paid under a workers’ compensation act. Both wage replacement and medical benefits are paid.
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4252 Other Federal Laws and Regulations (Antitrust, …
Which of the following assets would not be taxed at a rate of 28% (collectibles) if sold at a gain Personal automobile Stamp collection Coin collection Fine art
Personal automobile
Capital gains on long-term investments in collectibles are taxed at 28%. In the normal course of affairs, a driver’s personal automobile is not a collectible and a sale at a gain would be taxed at 15%/20%.
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4450 Amount and Character of Gains and Losses, and Netting …
For 2014, the Sage Company, an S corporation, had ordinary income of $70,000 and tax-exempt interest income of $10,000. Sage made a total cash distribution to its shareholders of $30,000. If Sam Sage owns a 50% interest, what was the increase in his basis for 2014 $35,000 $25,000 $20,000 $65,000
$25,000
A shareholder’s basis in stock of an S corporation is increased by all pass-through items, including nontaxable income. Distributions reduce the shareholder’s basis even though distributions are not taxable to the shareholder: 0.50 × ($70,000 + $10,000 - $30,000) = $25,000.
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4643 Basis of Shareholder’s Interest
Pay to Ann Tyler | Paul Tyler | Ann Tyler | Mary Thomas | Betty Ash | | Pay George Green Only | Susan Town
Susan Town, on receiving the above instrument, struck Betty Ash’s endorsement. Under the Negotiable Instruments Article of the Uniform Commercial Code (U.C.C.), which of the endorsers of the above instrument will be completely discharged from secondary liability to later endorsers of the instrument Ann Tyler Susan Town Betty Ash Mary Thomas
Betty Ash
Since none of the endorsements say “Without recourse,” all of the valid endorsements assume responsibility to pay the instrument if it is dishonored. Since Betty Ash’s name has been marked out, it is not a valid endorsement.
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4232 Negotiable Instruments
Which of the following items is a capital asset
An automobile for personal use
Depreciable business property
Accounts receivable for inventory sold
Real property used in a trade or business
An automobile for personal use
Capital assets are investment property and personal-use property. Capital assets do not include the following:
- Property held for resale (inventory)
- Real or depreciable property used in a trade or business
- Accounts or notes receivable acquired in normal business operations
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4410 Types of Assets
An appliance seller promised a restaurant owner that a home dishwasher would fulfill the dishwashing requirements of a large restaurant. The dishwasher was purchased but it was not powerful enough for the restaurant. Under the Sales Article of the U.C.C., what warranty was violated
The implied warranty of marketability
The implied warranty of merchantability
The express warranty that the goods conform to the seller’s promise
The express warranty against infringement
The express warranty that the goods conform to the seller’s promise
This deals with U.C.C. 2-312, which discusses and defines an Express Warranty as a seller’s oral or written promise, ancillary to an underlying sales or lease agreement, as to the quality, description, or performance of the goods being sold or leased. Under the U.C.C., express warranties arise when a seller indicates to the buyer/lessee that the goods:
- conform to any affirmation or promise of fact made by the seller to the buyer/lessee about the goods (i.e., there is a “dual core” processor in the machine),
- conform to any factual description of the goods (i.e., the label says it is an Intel processor), and/or
- conform to any sample or model of the goods shown to the buyer prior to purchase.
In order to give rise to an express warranty, the affirmation, promise, description, sample, or model must become part of the basis of the bargain between the seller and the buyer and constitute more than a mere statement of opinion. These warranties can be found in a seller’s advertisement, brochure or other promotional materials, as well as being made orally or expressly in a written contract. To be an express warranty, the seller does not have to specifically say “warrant” or guarantee. Rather, the buyer must have reasonably understood a representation as part of the basis of the bargain. For example, “in good mechanical condition” is presumptively part of the bargain and is held to be a warranty. A statement of opinion and value is not always easy to separate. Puffing is always around: “This is the best used car to come around in years; it has four new tires and a 150-horsepower engine rebuilt this year.” You only have a case for the tires and the engine in this situation. A statement that something is “worth a fortune” or “you’d pay $500 elsewhere” does not usually create a warranty.
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4231 Sales Contracts
Which of the following is not required by the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), also known as Superfund
The creation of a fund to clean up hazardous waste sites
The development of standards for management of hazardous waste by those who transport them
The identification of sites in the United States where hazardous waste has been disposed
The ranking of hazardous waste sites based upon the severity of risk
The development of standards for management of hazardous waste by those who transport them
CERCLA provides for the creation of a fund to clean up hazardous waste sites and is administered by the EPA. The EPA is also required to identify U.S. sites where hazardous waste has been disposed of, stored, abandoned, or spilled and to rank the sites based on severity of risk. The Resource Conservation and Recovery Act (RCRA) empowers the EPA to develop standards for management of hazardous waste by those who either generate or transport them.
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4252 Other Federal Laws and Regulations (Antitrust, …
Moore, a single taxpayer, had $50,000 in adjusted gross income for 2014. During 2014, she contributed $18,000 to her church. She had a $10,000 charitable contribution carryover from her 2013 church contribution. What was the maximum amount of properly substantiated charitable contributions that Moore could claim as an itemized deduction for 2014 $10,000 $18,000 $25,000 $28,000
$25,000
The maximum cash contribution a taxpayer may deduct in each tax year is limited to 50% of the taxpayer’s AGI so long as the recipient charities are qualified for this ceiling. See additional limits discussed as follows:
50% x $50,000 AGI = $25,000
($7,000 carryover from 2013 + $18,000 = $25,000 for 2014)
($10,000 - $7,000 = $3,000 carryover to 2015)
Regulation Section 1.170A-10
Note
There is a ceiling on the amount an individual may deduct each year as a charitable contribution based both on the type of property contributed and the type of charity to which the contribution is made.
The ceilings are as follows (based on adjusted gross income (AGI)):
- “50% charities” (where charitable contributions are limited to 50% of an individual’s AGI) include churches (or church conventions or associations); tax-exempt educational organizations; tax-exempt hospitals and certain medical research organizations; certain organizations holding property for state and local colleges and universities; certain governmental units and subdivisions; certain exempt religious, charitable, scientific, literary, or educational organizations. (IRC Section 170(b)(1)(A))
- “30% charities” are qualifying charitable organizations that are not “50% charities” such as war veterans organizations, fraternal orders, cemetery companies, and certain private nonoperating foundations. (Regulation Section 1.170A-8; IRC Section 170(b)(1)(B))
- 30% ceiling generally applies to gifts of appreciated long-term capital gain property to a 50% charity.
- 20% ceiling applies to gifts of appreciated long-term capital gain property to a 30% charity.
- If an individual’s charitable gifts for a tax year exceed the percentage ceilings for the year, the excess may be carried forward and deducted for up to five years (subject to the later year’s ceiling). (IRC Section 170(d)(1))
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4530 Adjustments and Deductions to Arrive at Taxable Income
Dart, Inc., a closely held corporation, was petitioned involuntarily into bankruptcy under the liquidation provisions of Chapter 7 of the Federal Bankruptcy Code. Dart contested the petition.
Dart has not been paying its business debts as they became due, has defaulted on its mortgage loan payments, and owes back taxes to the IRS. The total cash value of Dart’s bankruptcy estate after the sale of all assets and payment of administration expenses is $100,000.
Dart has the following creditors:
- Fracon Bank is owed $75,000 principal and accrued interest on a mortgage loan secured by Dart’s real property. The property was valued at and sold, in bankruptcy, for $70,000.
- The IRS has a $12,000 recorded judgment for unpaid corporate income tax.
- JOG Office Supplies has an unsecured claim of $3,000, which was timely filed.
- Nanstar Electric Co. has an unsecured claim of $1,200, which was not timely filed.
- Decoy Publications has a claim of $18,000, of which $2,000 is secured by Dart’s inventory, which was valued and sold, in bankruptcy, for $2,000. The claim was timely filed.
What dollar amount would Nanstar Electric Co. receive $0 $800 $1,000 $1,200
$0
Listed creditors will receive notification from the bankruptcy court and are required to file their claims within six months of the first creditors’ meeting. Creditors who fail to file forfeit their rights. In this case, Nanstar Electric did not file its unsecured claim in a timely fashion and therefore forfeited its rights in the bankruptcy proceeding.
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4242 Bankruptcy and Insolvency
Rice contracted with Locke to build an oil refinery for Locke. The contract provided that Rice was to use United pipe fittings. Rice did not do so. United learned of the contract and, anticipating the order, manufactured additional fittings. United sued Locke and Rice. United is:
entitled to recover from Rice only, because Rice breached the contract.
entitled to recover from either Locke or Rice because it detrimentally relied on the contract.
not entitled to recover because it is a donee beneficiary.
not entitled to recover because it is an incidental beneficiary.
not entitled to recover because it is an incidental beneficiary.
United is not entitled to recover because it is an incidental beneficiary. The primary parties to the contract were Rice and Locke. The contract stated that Rice would use fittings purchased from United. United was not a donee beneficiary because it is not a party to the contract. United has no cause of action against Rice because Rice never entered into any contract with United to make the fittings. While United detrimentally relied on the contract between Rice and Locke, United does not have legal standing to sue. Rice was not in privity with either party (neither party entered into contract with United).
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4223 Third-Party Assignments
Which of the following is true regarding dividends that qualify for the dividends-received deduction
Days when the corporation is protected from loss on the stock by a put option do count toward the 45-day holding period requirement.
Dividends qualify for the dividends-received deduction if the stock has been owned for at least 30 days.
Dividends qualify for the dividends-received deduction only if the holding period is met for each dividend received.
Dividends qualify for the dividends-received deduction only if the corporation owning the stock files a special election with the IRS.
Dividends qualify for the dividends-received deduction only if the holding period is met for each dividend received.
Dividends qualify for the dividends-received deduction only if the 46-day (or 91-day) holding period is met for each dividend received. The holding period must be met within the 91-day period beginning 45 days before the ex-dividend date of the stock. If the stock is cumulative preferred stock with an arrearage of dividends, it must be held at least 91 days during the 181-day period beginning 90 days before the ex-dividend date.
Days when the corporation is protected from loss on the stock by put options do not count toward the holding period requirement. The holding period requirement must be met for each dividend viewed over time.
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4631 Determination of Taxable Income/Loss
In general, which of the following statements is correct with respect to a real estate mortgage
The mortgage must be signed by both the mortgagor (borrower) and mortgagee (lender).
The mortgagee may assign the mortgage to a third party without the mortgagor’s consent.
The mortgage must contain the actual amount of the underlying debt.
The mortgage may not be given to secure an antecedent debt.
The mortgagee may assign the mortgage to a third party without the mortgagor’s consent.
The mortgagee has the right to assign the mortgage (sell the mortgage) to their part without the mortgagor’s consent. Only the mortgagor must sign the mortgage. The mortgage has priority only over later recorded mortgages.
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4233 Secured Transactions
In the current year, Fitz, a single taxpayer, sustained a $48,000 loss on Section 1244 stock in JJJ Corp., a qualifying small business corporation, and a $20,000 loss on Section 1244 stock in MMM Corp., another qualifying small business corporation. What is the maximum amount of loss that Fitz can deduct for the current year
$50,000 capital loss
$68,000 capital loss
$18,000 ordinary loss and $50,000 capital loss
$50,000 ordinary loss and $18,000 capital loss
$50,000 ordinary loss and $18,000 capital loss
The taxpayer is allowed to deduct a maximum of $50,000 as an ordinary loss under IRC Section 1244. The balance of the loss would then be a capital loss (($48,000 + $20,000) - $50,000 = $18,000).
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4440 Taxable and Nontaxable Sales and Exchanges
Under the Securities Exchange Act of 1934, which of the following conditions generally will allow an issuer of securities to terminate the registration of a class of securities and suspend the duty to file periodic reports
I. The corporation has fewer than 300 shareholders
II. The securities are listed on a national securities exchange
Both I and II
I only
II only
Neither I nor II
I only
The Securities Exchange Act of 1934, Section 10, requires continuous disclosures only if the securities are traded on the securities exchanges, the company has assets in excess of $10 million, and if the company has 500 + shareholders. The first fact states that the company has less than 300 shareholders. This would mean that the company should be able to terminate the registration with the SEC. However, since the second fact says that the securities are listed on a national securities exchange, the company must continue registration and reporting under the Securities Exchange Act of 1934.
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4251 Federal Securities Regulation
An IRS agent has just completed an examination of a corporation and issued a “no change” report. Which of the following statements about that situation is correct
The taxpayer may not amend the tax return for that taxable year.
The IRS generally does not reopen the examination except in cases involving fraud or other similar misrepresentation.
The IRS may not reopen the examination.
The IRS may not examine any other tax return of the corporation for a period of one year.
The IRS generally does not reopen the examination except in cases involving fraud or other similar misrepresentation.
The IRS examines some federal tax returns to determine if income, expenses, and credits are being reported accurately. Once an examination is concluded and the taxpayer agrees, the case will generally not be reopened unless there has been fraud or misrepresentation of a material fact.
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4322 Internal Revenue Service (IRS) Audit and Appeals …
During 2014, Adams, a general contractor, Brinks, an architect, and Carson, an interior decorator, formed the Dex Home Improvement General Partnership by contributing the assets as follows:
Fair % of Partner Share
Adjusted Market in Capital
Asset Basis Value Profits and Losses
--------- -------- ------- ------------------
Adams Cash $40,000 $40,000 50%
Brinks Land $12,000 $21,000 20%
Carson Inventory $24,000 $24,000 30%
The land was a capital asset to Brinks, subject to a $5,000 mortgage, which was assumed by the partnership. Carson's initial basis in Dex is: $25,500. $24,000. $19,000. $5,000.
$25,500.
When a general partnership is formed and one of the partners contributes property to the partnership which is subject to a mortgage, the other partners increase their basis by the portion of the mortgage assumed. Carson’s initial basis is calculated as follows:
Carryover Basis of the Inventory $24,000
ADD: 30% x $5,000 Mortgage Assumed by the Partnership 1,500
——-
Carson’s Initial Basis $25,500
=======
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4652 Basis of Partner’s/Member’s Interest and Basis of …
Terrell has a 60% interest in the capital and profits of Bronco Partnership. He also owns a 65% interest in the capital and profits of STI Partnership. On March 2, 2014, Bronco Partnership sold land to STI for $35,000. At the time of the sale, the land had an adjusted basis to Bronco of $40,000. What is the amount of loss that Bronco can recognize in 2014 $6,500 $5,000 $3,250 $0
$0
Losses are not allowed from a sale or exchange of property (other than an interest in the partnership) directly or indirectly between a partnership and a person whose direct or indirect interest in the capital or profits of the partnership is more than 50%. Terrell owns more than 50% interest in both partnerships. His basis in the partnership will be reduced by the amount of loss. When the property is sold, any gain will not be recognized up to the amount of the loss not allowed. In other words, the subsequent gain is reduced by the previously disallowed loss. The basis in the partnership will be increased by any gain not recognized.
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4654 Transactions Between a Partner and the Partnership
To which of the following transactions does the common law statute of frauds not apply
Contracts for the sale of real estate
Agreements made in consideration of marriage
Promises to pay the debt of another
Contracts that can be performed within one year
Contracts that can be performed within one year
If it is possible to perform a contract within one year, then an oral contract is enforceable and is not required to be written. The statute of frauds does not apply when a contract can be completed in one year or less.
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4222 Performance
Baker is a partner in BDT with a partnership basis of $60,000. BDT made a liquidating distribution of land with an adjusted basis of $75,000 and a fair market value of $40,000 to Baker. What amount of gain or loss should Baker report $35,000 loss $20,000 loss $0 $15,000 gain
$0
Generally, no gain or loss is recognized by the partnership on a distribution of money or other property to a partner. A partner realizes a gain only if the cash received exceeds the basis of the partnership interest. Where the partner receives property other than cash, unrealized receivables, and inventory, no loss is recognized.
Since Baker did not receive cash, no gain is recognized. Since Baker received only land, no loss is recognized.
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4654 Transactions Between a Partner and the Partnership
4657 Ownership Changes, and Liquidation and Termination of …
Fern received $30,000 in cash and an automobile with an adjusted basis and market value of $20,000 in a proportionate liquidating distribution from EF Partnership. Fern's basis in the partnership interest was $60,000 before the distribution. What is Fern's basis in the automobile received in the liquidation $0 $10,000 $20,000 $30,000
$30,000
Fern started with a basis in EF Partnership of $60,000. The receipt of cash of $30,000 reduces the basis to $30,000. This basis is assigned to the automobile received as a distribution.
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4654 Transactions Between a Partner and the Partnership
4657 Ownership Changes, and Liquidation and Termination of …
On June 1, Year 3, Nord Corp. engaged Milo & Co., CPAs, to perform certain management advisory services for nine months for a $45,000 fee. The terms of their oral agreement required Milo to commence performance any time before October 1, Year 3. On June 30, Year 4, after Milo completed the work to Nord’s satisfaction, Nord paid Milo $30,000 by check. Nord conspicuously marked on the check that it constituted payment in full for all services rendered. Nord has refused to pay the remaining $15,000, arguing that although it believes the $45,000 fee is reasonable, it had received bids of $20,000 and $38,000 from other firms to perform the same services as Milo. Milo endorsed and deposited the check. If Milo commences an action against Nord for the remaining $15,000, Milo will be entitled to recover:
$0, because the statute of frauds has not been satisfied.
$0, because there has been an enforceable accord and satisfaction.
$8,000, because $38,000 was the highest other bid.
$15,000, because it is the balance due under the agreement.
$15,000, because it is the balance due under the agreement.
The contract was for $45,000. The notation on the check is not a valid modification of the contract. Milo should still be able to collect all amounts due to them.
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4221 Formation
4231 Sales Contracts
Green was adjudicated incompetent by a court having proper jurisdiction. Which of the following is correct regarding contracts subsequently entered into by Green All contracts are voidable. All contracts are valid. All contracts are void. All contracts are enforceable.
All contracts are void.
Incompetence questions generally revolve around when (if at all) the person was adjudicated incompetent. This adjudication of incompetence is critical in the determination of contractual validity.
Any contracts entered into by an adjudicated incompetent person are by matter of law invalid or void.
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4222 Performance
Gain on stock held for more than 12 months and sold on October 15, 2014, that would otherwise be taxed at a 15% rate if it were ordinary income is taxed at a rate of: 20%. 15%. 10%. 0%.
0%.
The following requirements must be met for the sale of property to be taxed at the 0% capital gains rate:
The property must be held for more than 12 months.
The taxpayer’s marginal rate may not be more than 15%.
The gain must be recognized after December 31, 2007.
Long-term capital gains are taxed at the following favorable tax rates for 2014:
General capital assets:
Marginal tax rate of 15% 0%
Marginal tax rate 25% through 35% 15%
Marginal tax rate of 39.6% 20%
Unrecaptured Section 1250 gain 25%
Collectibles 28%
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4550 Loss Limitations
The maximum deduction on interest paid during 2014 on a qualified education loan is: $2,500. $2,000. $1,000. 50% of the interest paid during 2014.
$2,500.
Since the repeal of deductions for personal interest by the Tax Reform Act of 1986, student loan interest, which generally is a personal expense, has not been deductible. In order to take a personal deduction on Schedule A for interest on debt proceeds used for educational expenses, the debt must be home equity debt.
Under TRA ‘97, however, individuals who pay interest after December 31, 1997, on qualified education loans generally may claim a deduction for the interest, subject to dollar limits and an AGI-based phaseout. The student loan interest deduction is allowed whether or not a taxpayer itemizes other deductions and is deducted before AGI. These provisions were made permanent by the Taxpayer Relief Act of 2012.
IRC Section 221
Under TRA ‘97, the maximum student loan interest deductions are:
-$1,000 in 1998,
-$1,500 in 1999,
-$2,000 in 2000, and
-$2,500 in 2001 and later years.
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4530 Adjustments and Deductions to Arrive at Taxable Income
Cobb, Inc., a partner in TLC Partnership, assigns its partnership interest to Bean, who is not made a partner. After the assignment, Bean asserts the rights to:
I. participate in the management of TLC.
II. Cobb’s share of TLC’s partnership profits.
Bean is correct as to which of these rights
II only
Neither I nor II
I and II
I only
II only
In the transfer of a partnership interest, the new partner obtains only the right to a share of the old partner’s profit. The new partner does not obtain the right to participate in management of the partnership.
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4264 Rights, Duties, Legal Obligations, and Authority of …
Brown transfers property to a trust. A local bank was named trustee. Brown retained no powers over the trust. The trust instrument provides that current income and $6,000 of principal must be distributed annually to the beneficiary. What type of trust was created Simple Grantor Complex Revocable
Complex
The trust is a complex trust. A complex trust is any trust that does not qualify as a simple trust.
- The trust is not a simple trust. One of the requirements of a simple trust is that the trust not distribute principal (corpus). This trust provides that current income and $6,000 of principal be distributed annually.
- The trust is not a grantor trust. A grantor trust is one in which the grantor retains beneficial enjoyment or substantial control over the trust property or income. The grantor (Brown) of this trust retains no powers over the trust and is not the trustee.
- The trust is not revocable. A revocable trust is one in which the grantor retains the power to revest all or part of the trust property. Brown retained no powers over the trust.
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4662 Income and Deductions
4663 Determination of Beneficiary’s Share of Taxable Income
All of the following statements are correct about an S corporation except:
an election automatically terminates under special situations.
an election to terminate requires the consent of all shareholders.
once an S corporation election is made, it stays in effect until it is terminated.
the revocation may specify a revocation date that is on or after the date the revocation is filed.
an election to terminate requires the consent of all shareholders.
If an S corporation election is revoked by the consent of shareholders, the revocation may specify a revocation date that is on or after the date the revocation is filed (IRS Form 1120S Instructions).
An election terminates automatically in certain situations as spelled out in the instructions for IRS Form 1120S.
All shareholders must give consent to be treated as an S corporation. To terminate the S corporation status requires a vote of 50% of shares plus one share.
The election to be treated as an S corporation will take effect on the date entered on line 8 of IRS Form 8832 (Entity Classification Election) or on the date filed if no date is entered. However, an election specifying an entity’s classification for federal tax purposes can take effect no more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date on which the election is filed.
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4350 Tax Return Elections, Including Federal Status …
Tom Lewis, a single taxpayer, had the following income and expense items for 2014:
Wages $55,000
Alimony paid to former spouse 5,000
Child support paid to former spouse 4,000
Deductible moving expenses 2,000
Mortgage interest on personal residence 6,000
Credit card interest 1,000
Tom’s personal exemption amount for 2014 3,950
Tom’s standard deduction amount for 2014 6,200
What is Tom's adjusted gross income for the year $55,000 $50,000 $48,000 $46,000
$48,000
The key points for this question are:
-alimony paid to former spouse is an adjustment to gross income.
-child support is not an adjustment to gross income (child support is not deductible on an individual tax return).
-moving expenses are an adjustment to gross income.
Thus, adjusted gross income for this question is calculated as follows:
Wages $55,000
Minus Alimony (5,000)
Minus Moving expenses (2,000)
--------
Adjusted gross income $48,000
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4530 Adjustments and Deductions to Arrive at Taxable Income
Which of the following transactions is subject to registration requirements of the Securities Act of 1933
The public sale by a corporation of its negotiable 10-year notes
The public sale by a charitable organization of 10-year bearer bonds
The sale across state lines of municipal bonds issued by a city
Issuance of stock by a publicly traded corporation to its shareholders because of a stock split
The public sale by a corporation of its negotiable 10-year notes
If a security is not exempt, it must be registered with the Securities Exchange Commission before it can be sold. Exempt securities include commercial paper; securities of the government; securities of banks; securities of nonprofit organizations; securities of savings and loan associations; securities of common carriers or contract carriers; insurance, annuity, and endowment policies; exchange securities issued in bankruptcy reorganizations; and securities exchanged with existing security holders.
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4251 Federal Securities Regulation
A distinction between a surety and a co-surety is that only a co-surety is entitled to: reimbursement (indemnification). subrogation. contribution. exoneration.
contribution.
A distinction between a surety and co-surety is that only a co-surety is entitled to “contribution.” Contribution is when the other co-sureties are obliged to contribute their share of the liability to the surety that had to make the full payment. Generally, each surety agrees to a maximum liability, and any amount that is paid that is less than the full debt results in each surety being liable for the percentage of their agreed liability to the total debt.
Reviewing the other terms:
Reimbursement is the right of the co-sureties to be paid by the principal debtor if they have to make good on their guarantee to the creditor. Both sureties and co-sureties have this right.
Subrogation gives the sureties and co-sureties the right to any assignments of property in the event that they have had to make payment to the creditor.
Exoneration gives both sureties and co-sureties the right to compel the principal debtor to make payment to the creditor if it possibly can.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
A common carrier bailee generally would avoid liability for loss of goods entrusted to its care if the goods are:
stolen by an unknown person.
negligently destroyed by an employee.
destroyed by the derailment of the train carrying them due to railroad employee negligence.
improperly packed by the party shipping them.
improperly packed by the party shipping them.
A common carrier has liability for loss of goods entrusted to its care in most instances. Although this liability is not “absolute” in the true sense, the liability of the carrier can rarely be avoided. One instance in which the carrier would not be considered liable would be where the goods were improperly packed by the party shipping them.
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4231 Sales Contracts
Within how many months after the date of a decedent's death is the federal estate tax return (Form 706) due if no extension of time for filing is granted 9 6 4-1/2 3-1/2
9
A federal estate tax return, if required, is due nine months after the date of the decedent’s death.
An executor may request and obtain from the IRS an extension of time for filing Form 706 (Federal Estate Tax Return) up to an additional six months.
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4473 Determination of Taxable Estate
Bern Corp., an S corporation, had an ordinary loss of $36,500 for the year ended December 31, Year 0. At January 1, Year 0, Meyer owned 50% of Bern’s stock. Meyer held the stock for 40 days in Year 0 before selling the entire 50% interest to an unrelated third party. Meyer’s basis for the stock was $10,000. Meyer was a full-time employee of Bern until the stock was sold. Meyer’s share of Bern’s Year 0 loss was: $10,000. $0. $2,000. $18,250.
$2,000.
Each shareholder of an S corporation will include in his taxable income his pro rata share of corporate items of income, deduction, loss, and credit in his tax year in which the corporation’s tax year ends.
Meyer owned 50% of Bern Corp for 40 days during Year 0. Therefore, Meyer will include in his Year 0 tax return a loss of $2,000 from Bern Corporation, as computed below:
-$36,500 × 0.50 × 40/365 = $2,000
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4643 Basis of Shareholder’s Interest
During 2014, Yeats transferred property worth $20,000 to a trust with the income to be paid to her 22-year-old niece Jane. After Jane reaches the age of 30, the remainder interest is to be distributed to Yeats' brother. The income interest is valued at $9,700 and the remainder interest at $10,300. The income interest: is a gift of present interest. is a gift of a future interest. is not a completed gift. is not a gift.
is a gift of present interest.
The income interest is a present interest because the beneficiary has immediate enjoyment of the income interest.
An unrestricted right to the immediate use of the income from property qualifies as a present interest. Only a present interest qualifies for the $14,000 annual exclusion from gift tax.
IRC Section 2503(b); Regulation Section 25.2503-3; Revenue Ruling 77-358
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4471 Transfers Subject to the Gift Tax
You are a new audit member of a medium sized CPA firm which has as a client a public company covered under the Sarbanes-Oxley Act (SOX). The audit firm has had the publicly traded SOX client for seven years. You are concerned since your firm has audited the client for that many years. Your concerns are:
unfounded since most of the team has new members.
unfounded since the review partner had rotated off after four years.
founded since seven years have gone by and an audit firm may only audit the same public firm five years.
unfounded since the lead audit partner and reviewing partner rotated off the audit two years ago.
unfounded since the lead audit partner and reviewing partner rotated off the audit two years ago.
While it is true SOX has restricted or modified many attributes of audit behavior, it does not require a public company to rotate to a new audit firm every five years at this time (Sarbanes-Oxley Act, Section 207). It does require the lead audit partner and the reviewing partner to rotate off of the audit at least every five years. Here, the lead audit partner and reviewing partner have rotated off before the five-year requirement (Section 203)
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4123 Requirements of Regulatory Agencies
4251 Federal Securities Regulation
A has a basis of $6,000 for a 1/3rd interest in ABC partnership. A sells his interest for $14,000. What should A report as a gain on the sale $0 $8,000 ordinary income $8,000 capital gain $6,000 capital gain
$8,000 capital gain
Gain is recognized if cash distributed is in excess of the partner’s basis in the partnership interest. The sale for $14,000 results in a gain of $8,000 and a tax-free return of capital of $6,000. An investment in a partnership is a capital asset that gives rise to a capital gain.
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4654 Transactions Between a Partner and the Partnership
At a confidential meeting, an audit client informed a CPA about the client’s illegal insider-trading actions. A year later, the CPA was subpoenaed to appear in federal court to testify in a criminal trial against the client. The CPA was asked to testify to the meeting between the CPA and the client. After receiving immunity, the CPA should do which of the following
Take the Fifth Amendment and not discuss the meeting.
Cite the privileged communications aspect of being a CPA.
Discuss the entire conversation, including the illegal acts.
Discuss only the items that have a direct connection to those items the CPA worked on for the client in the past.
Discuss the entire conversation, including the illegal acts.
Although the CPA has a confidential fiduciary relationship with the client, under common law there is no privilege that an accountant or client may invoke to prevent disclosures. Under a subpoena, the CPA would be required to disclose information regarding the conversation. Compliance with a court summons, a subpoena, laws, or government regulations would be an exception to the Confidential Client Information Rule (ET 301).
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4133 Privileged Communications, Confidentiality, and …
During 2014, Adler had the following cash receipts:
Wages $18,000
Interest income from investments in municipal bonds 400
Unemployment compensation 1,500
What is the total amount that must be included in gross income on Adler’s 2014 income tax return
$18,000
$18,400
$19,500
$19,900
$19,500
Interest income from municipal bonds is excluded from gross income. Wages are taxable; unemployment compensation is taxable in 2014.
The amount that must be included in gross income is $19,500 (Wage of $18,000 + Unemployment compensation of $1,500).
IRC Sections 61, 85, and 103
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4512 Characterization of Income
On March 23, 2014, Tom Lewis sold 50 shares of ABC Corp. stock at a $3,500 loss. He had purchased the stock three years earlier. He repurchased 50 shares of ABC Corp. on April 15, 2014. Tom had no other stock transactions for the year. Select the appropriate tax treatment for the capital loss.
Not deductible for 2014
$3,500 long-term capital loss deductible on 2014 return
$3,500 short-term capital loss deductible on 2014 return
$3,500 long-term capital loss, limited to $3,000 deductible on 2014 return
Not deductible for 2014
A loss sustained upon a sale or other disposition of stock or securities is not allowed if, within a period beginning 30 days before the date of the sale or disposition and ending 30 days after that date, the taxpayer has acquired, or has entered into a contract or option to acquire, substantially identical stock or securities. This is known as the “wash sale rules.”
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4550 Loss Limitations
A first-time homebuyer, for purposes of favorable IRA distribution treatment, is one who has not had a present ownership interest in another principal residence for what minimum period before a new principal residence is purchased One year Two years Three years Five years
Two years
IRA distributions qualify as made for first-time homebuyer expenses if:
-the homebuyer is the taxpayer, spouse, child or grandchild of either, or ancestor of either,
-the home is used as a principal residence by the homebuyer,
-the homebuyer (and if married, the homebuyer’s spouse) has not had a present ownership interest in another principal residence within the 2-year period ending on the date that the current principal residence is acquired, and
-the distribution is used within 120 days to pay for qualified acquisition expenses, such as buying, building or reconstructing the residence, as well as usual or reasonable settlement, financing, or other closing costs.
Only $10,000 of aggregate distributions received by an individual can be treated as made for qualified first-time homebuyer expenses. This is a lifetime limit.
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4560 Taxation of Retirement Plan Benefits
On May 25, Year 1, Smith contracted with Jackson to repair Smith’s cabin cruiser. The work was to begin on May 31, Year 1. On May 26, Year 1, the boat, while docked at Smith’s pier, was destroyed by arson. Which of the following statements is correct with regard to the contract
Smith would be liable to Jackson for the profit Jackson would have made under the contract.
Jackson would not be liable to Smith because performance by the parties would be impossible.
Smith would not be liable to Jackson because of mutual mistake.
Jackson would be liable to repair another boat owned by Smith.
Jackson would not be liable to Smith because performance by the parties would be impossible.
When performance of a contract becomes impossible, the contract is discharged.
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4224 Discharge, Breach, and Remedies
Lewis, Clark, and Beal entered into a written agreement to form a partnership. The agreement required that the partners make the following capital contributions: Lewis, $40,000; Clark, $30,000; and Beal, $10,000. It was also agreed that, in the event the partnership experienced losses in excess of available capital, Beal would contribute additional capital to the extent of the losses. The partnership agreement was otherwise silent about division of profits and losses. Which of the following statements is correct
Profits are to be divided among the partners in proportion to their relative capital contributions.
Profits are to be divided equally among the partners.
Losses will be allocated in a manner different from the allocation of profits because the partners contributed different amounts of capital.
Beal’s obligation to contribute to additional capital would have an effect on the allocation of profit or loss to Beal.
Profits are to be divided equally among the partners.
If a partnership agreement is silent on the subject of how profits will be shared, they will be shared equally among the partners. Interestingly, this example poses a situation where the partners defined how losses would be shared, but they did not write down their intended distribution of profits. Had they defined how profits were to be shared, but said nothing about losses, then their formula for sharing profits would define how losses would be shared. However, a formula for sharing losses will not be applied to sharing profits. The partners’ allocation of capital does not bear on how profits and losses will be shared if the issue is not defined in the partnership agreement.
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4264 Rights, Duties, Legal Obligations, and Authority of …
Which of the following disclosures must be contained in a securities registration statement filed under the Securities Act of 1933
A list of all existing stockholders
The principal purposes for which the offering proceeds will be used
A copy of the corporation’s latest proxy solicitation statement
The names of all prospective accredited investors
The principal purposes for which the offering proceeds will be used
The Securities Act of 1933 requires the disclosure of the principal purposes for which the offering proceeds will be used. The key to selecting the best answer is to remember the purpose of the Securities Act of 1933. This act is a disclosure act relating to the original sale of securities by an issuer. The most important disclosure for an investor is to learn what the company intends to do with the funds that it is seeking through the sales of securities.
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4251 Federal Securities Regulation
Taxpayers generally have 3 years to file an amended tax return. The 3-year period is measured from the date you filed your original return. If you filed your return before April 15, the 3-year period begins on April 15. If you requested an extension, the 3-year period runs from October 15. Therefore, you would count the 3 months and 15 days from January 1 to April 15, and then the 3 years from April 15.
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4327 Statute of Limitations
April 15
An individual has until the due date of their return, excluding extensions, to make a deductible IRA or Roth IRA contribution for the preceding year. A calendar-year taxpayer, therefore, has until April 15 of the following year to make an IRA contribution.
IRC Section 219(f)(3)
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4321 Due Dates and Related Extensions of Time
Which of the following statements is correct if a taxpayer agrees to changes made during an examination and he signs an agreement, but does not pay the taxes due
If the taxpayer does not pay the additional tax when he or she signs the agreement, the taxpayer will receive a bill that includes interest and an additional penalty.
If the taxpayer pays the amount due within 21 calendar days of the billing date and the amount is less than $100,000, the taxpayer will not have to pay more interest or penalties.
If the taxpayer pays when he or she signs the agreement, the interest is generally waived from the due date of the return to the date of the payment.
None of the answer choices are correct.
If the taxpayer pays the amount due within 21 calendar days of the billing date and the amount is less than $100,000, the taxpayer will not have to pay more interest or penalties.
IRS Publication 556 provides that a taxpayer’s return may be examined for a variety of reasons, and the examination may take place in any one of several ways. After the examination, if any changes to a taxpayer’s tax are proposed, either the taxpayer can agree with those changes and pay any additional tax owed, or the taxpayer can disagree with the changes and appeal the decision.
Publication 556 states, in part, that if a taxpayer agrees with the proposed changes after the examination, the taxpayer can sign an agreement form and pay any additional tax he or she may owe. A taxpayer must pay interest on any additional tax.
- If the taxpayer pays when he or she signs the agreement, the interest is generally figured from the due date of the return to the date of the payment.
- If the taxpayer does not pay the additional tax when he or she signs the agreement, the taxpayer will receive a bill that includes interest.
- If the taxpayer pays the amount due within 10 business days of the billing date, the taxpayer will not have to pay more interest or penalties. This period is extended to 21 calendar days if the amount due is less than $100,000.
Given the information above, if the taxpayer pays the amount due is within 21 calendar days of the billing date and the amount is less than $100,000, the taxpayer will not have to pay more interest or penalties.
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4364 Impact of Proposed Tax Audit Adjustments
Which of the following, if intentionally misstated by a seller to a buyer, would be considered a fraudulent inducement to make a contract Prediction Nonexpert opinion Appraised value Immaterial fact
Appraised value
A fraudulent inducement must be factual and material. Opinions and predictions are not facts. Immaterial facts cannot affect an inducement. An intentionally misstated appraised value is a material fact.
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4221 Formation
Which of the following statements is true about the IRS
The IRS promulgates the rules governing CPAs as they practice before the IRS.
The IRS follows the rules set forth by the individual state boards of accountancy.
The IRS uses the rules provided by the AICPA when determining professional rules surrounding CPAs.
None of the answer choices are true statements.
The IRS promulgates (promote) the rules governing CPAs as they practice before the IRS.
The IRS determines what rules CPAs that practice in front of them will follow. While it is true that numerous other regulatory agencies, including state boards of accountancy, provide insight and overview, when it comes to practicing in front of the IRS, the IRS has the final word.
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4111 Treasury Department Circular 230
The sole shareholder of an S corporation had a basis for her stock of $30,000 and a basis for a loan to the S corporation of $15,000. In 2014, the S corporation operated at a loss of $39,000. What is the shareholder's basis in the stock and loan on December 31, 2014 Stock: $0; Loan: $6,000 Stock: $6,000; Loan: $0 Stock: $3,000; Loan: $3,000 Stock: $4,000; Loan: $2,000
Stock: $0; Loan: $6,000
The loss reduces the shareholder’s stock basis first. The remaining loss ($39,000 - $30,000) of $9,000 is deducted from the loan basis.
Stock Loan Total
--------- --------- --------- Beg. Basis $30,000 $15,000 $45,000 Less: Loss ( 30,000) ( 9,000) ( 39,000)
--------- --------- --------- Ending Basis: $ 0 $ 6,000 $ 6,000
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4643 Basis of Shareholder’s Interest
Under the Secured Transactions Article of the U.C.C., which of the following statements is correct regarding the filing of a financing statement
I. A financing statement must be filed before attachment of the security interest can occur.
II. Once filed, a financing statement is effective for an indefinite period of time provided continuation statements are timely filed.
I only
II only
Both I and II
Neither I nor II
II only
The filing of a financing statement only gives public notice of the security interest. A financing statement is effective for five years, but can be continued with a continuation statement filing. Since a continuation statement can be filed indefinitely, this makes a financing statement effective indefinitely.
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4233 Secured Transactions
Which of the following statements is correct with respect to the reorganization provisions of Chapter 11 of the Federal Bankruptcy Code
A trustee must always be appointed.
The debtor must be insolvent if the bankruptcy petition was filed voluntarily.
A reorganization plan may be filed by a creditor any time after the petition date.
The commencement of a bankruptcy case may be voluntary or involuntary.
The commencement of a bankruptcy case may be voluntary or involuntary.
A Chapter 11 reorganization case may be commenced either voluntarily or involuntarily, but does not require the appointment of a trustee or the insolvency of the debtor if a voluntary case. The reorganization plan may be filed by a creditor or creditors’ committee only 120 days after the petition date if the debtor or trustee has not filed a plan.
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4242 Bankruptcy and Insolvency
Which of the following factors, by itself, requires a corporation to comply with the reporting requirements of the Securities Exchange Act of 1934
600 employees
Shares listed on a national securities exchange
Total assets of $2 million
400 holders of equity securities
Shares listed on a national securities exchange
The Securities Exchange Act of 1934 imposes reporting requirements on all corporations whose shares are listed on a national securities exchange. Even if not traded on a national exchange, the Act applies if the company has 500 shareholders and total gross assets of at least $10 million. (There is no minimum number of employees.)
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4251 Federal Securities Regulation
Acorn, Inc., had the following items of income and expense:
Sales $500,000
Cost of sales 250,000
Dividends received 25,000 The dividends were received from a corporation of which Acorn owns 30%. In Acorn's corporate income tax return, what amount should be reported as income before special deductions $525,000 $505,000 $275,000 $250,000
$275,000
Sales $500,000
- Cost of Sales (250,000)
---------
$250,000
\+ Dividends Received + 25,000
---------
Total Income before
Special Deductions $275,000
=========
The question asks for income before special deductions (dividends-received deduction), not after special deductions.
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4631 Determination of Taxable Income/Loss
Under the Secured Transactions Article of the U.C.C., which of the following items can usually be excluded from a filed original financing statement The name of the debtor The address of the debtor A description of the collateral The amount of the obligation secured
The amount of the obligation secured
A financing statement is filed to give public notice of the security interest. The statement must contain:
- the names and addresses of the debtor and the secured party.
- a description of the collateral.
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4233 Secured Transactions
When computing a corporation’s income tax expense for estimated income tax purposes, which of the following should be taken into account
Corporate tax credits
Alternative minimum tax
Both corporate tax credits and alternative minimum tax
Neither corporate tax credits nor alternative minimum tax
Both corporate tax credits and alternative minimum tax
When computing a corporation’s income tax expense for estimating income taxes, every item that affects the calculation should be taken into account. This means corporate tax credits and the alternative minimum tax should be considered.
The corporation’s tax for estimated purposes is calculated as:
-the sum of the regular income tax plus the alternative minimum tax plus any environmental tax and (for foreign corporations) the tax on gross transportation income,
-minus the sum of all tax credits.
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4365 Impact of Estimated Tax Payment Rules on Planning
4631 Determination of Taxable Income/Loss
Under the liquidation provisions of Chapter 7 of the Federal Bankruptcy Code, certain property acquired by the debtor after the filing of the petition becomes part of the bankruptcy estate. An example of such property is:
municipal bond interest received by the debtor within 180 days after the filing of the petition.
alimony received by the debtor within one year after the filing of the petition.
Social Security payments received by the debtor within 180 days after the filing of the petition.
gifts received by the debtor within one year after the filing of the petition.
municipal bond interest received by the debtor within 180 days after the filing of the petition.
Upon filing a Chapter 7 bankruptcy proceeding, certain property becomes part of the estate if it is received (or entitled to be received) within 180 days of the filing. This type of property includes gifts, inheritances, various forms of property settlements (including divorce property divisions but not alimony) and life insurance proceeds. Notice the answers included most all of the included items, but had a different time schedule for their receipt. Notice that the time line alone is not controlling.
Via statute, various exemptions exist (up to certain dollar amounts), including such items as limited interests in homeowners equity, motor vehicles, household goods, tools of the trade, health aids, personal injury claims, alimony, and certain pension benefits. Finally, the bankruptcy statute specifically excludes Social Security payments.
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4242 Bankruptcy and Insolvency
Destry, a single taxpayer, reported the following on his U.S. Individual Income Tax Return (Form 1040):
Income:
Wages $5,000
Interest on savings account 1,000
Net rental income 4,000
Deductions:
Personal exemption $ 3,950
Standard deduction 6,200
Net business loss 16,000
Net short-term capital loss 2,000
What is Destry's net operating loss that is available for carryback or carryforward $7,000 $9,000 $15,700 $16,000
$7,000
The interest income (nonbusiness income) is offset by nonbusiness expenses, up to the amount of nonbusiness income. The standard deduction is a nonbusiness expense for this purpose.
IRC Section 172(d)(4)
The net capital loss (nonbusiness) is only deductible to the extent it is offset by nonbusiness capital gains.
IRC Section 172(d)(2)
Personal exemptions and unused personal deductions are added back to taxable income in arriving at net operating losses so they do not increase the carryback or carry forward.
The net business loss must be offset by wages and rental income for this year.
IRC Section 172
Wages of $5,000 plus net rental income of $4,000 minus the loss of $16,000 equals a net operating loss carryback or carryforward of $7,000.
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4530 Adjustments and Deductions to Arrive at Taxable Income
Bond purchased a painting from Wool, who is not in the business of selling art. Wool tendered delivery of the painting after receiving payment in full from Bond. Bond informed Wool that Bond would be unable to take possession of the painting until later that day. Thieves stole the painting before Bond returned. The risk of loss:
passed to Bond at Wool’s tender of delivery.
passed to Bond at the time the contract was formed and payment was made.
remained with Wool, because the parties agreed on a later time of delivery.
remained with Wool, because Bond had not yet received the painting.
passed to Bond at Wool’s tender of delivery.
Wool is not a “merchant,” someone in the business of selling art. Under Article 2 of the U.C.C., risk of loss passes to the buyer upon tender of delivery to the buyer if the seller is a nonmerchant. The law considers a nonmerchant seller one who would not necessarily have insurance or safe storage capacity for the goods, so the buyer is obliged to take physical possession of the goods as tendered or very soon thereafter to avoid loss.
If the seller is a merchant, risk of loss passes to the buyer when the buyer actually receives the goods.
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4231 Sales Contracts
In January 2002, Brown sold land he had owned for many years on the installment basis. Installments are to be made semi-annually on the first day of March and September. $30,000 of each installment represents Brown's profit. Brown is in the 33% bracket for 2014. How much capital gains tax must Brown pay on the two installments he receives in 2014 $9,000 $12,000 $19,800 $21,000
$9,000
Since both of the installments were received after May 5, 2004, and the property sold was held more than 12 months, both installments are taxed at the 15% capital gains rate. Thus, the capital gains tax is $9,000 ($60,000 × 0.15).
The current capital gains rates apply to installment sale proceeds collected after the effective date of the current rates (after May 5, 2004), even if the installment sale occurred before the effective date of the current rates.
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4450 Amount and Character of Gains and Losses, and Netting …
Mintee Corp., an accrual-basis calendar-year C corporation, had no corporate shareholders when it liquidated in 2014. Mintee Corporation distributed land held as an investment to its shareholders. At the time of the distribution, the land had an adjusted basis to the corporation of $300,000 and a fair market value of $400,000. The land was subject to a liability of $425,000. What is Mintee's gain or loss on the distribution of the land $0 $100,000 gain $100,000 loss $125,000 gain
$125,000 gain
The general rule for a liquidating distribution by a corporation is that a corporation recognizes a gain or loss on the distribution of property in a complete liquidation. The property is treated as if it were sold at its fair market value. When a liability is held on the property, the amount realized (deemed fair market value) from the “as if” sale cannot be less than the amount of the liability.
In this case, the gain would be computed as follows:
Liquidating Distributions:
Deemed FMV $425,000
Adjusted basis of land (300,000)
---------
Realized gain $125,000
=========
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4550 Loss Limitations
4634 Entity/Owner Transactions, Including Contributions and …
Which of the following acts will always result in the total release of a compensated surety
The creditor changes the manner of the principal debtor’s payment.
The creditor extends the principal debtor’s time to pay.
The principal debtor’s obligation is partially released.
The principal debtor’s performance is tendered.
The principal debtor’s performance is tendered.
A compensated surety is always totally released if the debtor tenders performance. The other actions indicated in the problem would not totally release the surety in all instances. A changing of the manner of payment or an extension of the debtor’s time to pay would operate as a release only if these changes in the contract were deemed to be material. A partial release of the debtor will release the surety only to the extent of the amount of the debt released.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Hope is a tax-exempt religious organization. Which of the following activities is consistent with Hope’s tax-exempt status
I. Conducting weekend retreats for business organizations
II.Providing traditional burial services that maintain the religious beliefs of its members
I only
Neither I nor II
II only
Both I and II
II only
Providing traditional burial services that maintain the religious beliefs of its members is consistent with Hope’s tax-exempt status as a religious organization. However, providing services for business organizations is generally not a religious activity, and therefore holding weekend retreats for business organizations is inconsistent a religious organization’s tax-exempt status.
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4671 Types of Organizations
According to the ethical standards of the profession, which of the following acts generally is prohibited
Accepting a fee for tax matters, the amount of which is determined by judicial proceedings
Using information gained from one client’s return to prepare another client’s return
Accepting a contingent fee for representing a client in connection with obtaining a private letter ruling from the Internal Revenue Service
Retaining client records after the client has demanded their return
Retaining client records after the client has demanded their return
Retaining client records after the client has demanded their return is prohibited according to the ethical standards of the profession. A CPA may keep a copy of the records, but the original records must be returned to the client.
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4111 Treasury Department Circular 230
Under the Negotiable Instruments Article of the U.C.C., which of the following circumstances would prevent a person from becoming a holder in due course of an instrument
The person was notified that payment was refused.
The person was notified that one of the prior indorsers was discharged.
The note was collateral for a loan.
The note was purchased at a discount.
The person was notified that payment was refused.
Holder in due course status requires that the person holding the instrument have no knowledge of any defenses to payment, or that payment has previously been refused. The fact that payment has in fact been refused will not of itself prevent holder in due course status; the key aspect is that the person holding the instrument cannot be a holder in due course if he or she is aware of the refusal to pay.
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4232 Negotiable Instruments
Park and Graham entered into a written partnership agreement to operate a retail store. Their agreement was silent as to the duration of the partnership. Park wishes to dissolve the partnership. Which of the following statements is correct
Park may dissolve the partnership at any time.
Unless Graham consents to a dissolution, Park must apply to a court and obtain a decree ordering the dissolution.
Park may not dissolve the partnership unless Graham consents.
Park may dissolve the partnership only after notice of the proposed dissolution is given to all partnership creditors.
Park may dissolve the partnership at any time.
A partnership which is for no specific term may be terminated by any partner at any time. This is done merely by the partner indicating his or her intent to withdraw. The other partners need not consent to this action.
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4262 Formation, Operation, and Termination
Which of the following statements is correct regarding the declaration of a stock dividend by a corporation having only one class of par value stock
A stock dividend has the same legal and practical significance as a stock split.
A stock dividend increases a stockholder’s proportionate share of corporate ownership.
A stock dividend causes a decrease in the assets of the corporation.
A stock dividend is a corporation’s ratable distribution of additional shares of stock to its stockholders.
A stock dividend is a corporation’s ratable distribution of additional shares of stock to its stockholders.
Stock dividends are dividends that are paid out in the form of additional stock shares of the company, as opposed to cash. The shares are distributed to the current shareholders in proportion to the shares owned. For example, if a shareholder holds 100 shares when a 3% stock dividend is paid out, then that shareholder will receive 3 additional shares (100 shares × .03 = 3 shares).
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4264 Rights, Duties, Legal Obligations, and Authority of …
4512 Characterization of Income
On January 2, Year 1, the Philips paid $50,000 cash and obtained a $200,000 mortgage to purchase a home. In Year 3, they borrowed $15,000 secured by their home, and used the cash to add a new room to their residence. That same year they took out a $5,000 auto loan. The following information pertains to interest paid in Year 7:
Mortgage interest $17,000
Interest on room construction loan 1,500
Auto loan interest 500
For Year 7, how much interest is deductible, prior to any itemized deduction limitations $19,000 $17,500 $18,500 $17,000
$18,500
The Philips can deduct the mortgage interest on the first mortgage of $17,000 and the second mortgage of $1,500, as both of these loans are secured by their main home, for a total of $18,500. Consumer loan interest is not an allowed deduction; therefore, the auto loan interest of $500 is not deductible.
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4233 Secured Transactions
Which of the following securities is exempt from registration under the Securities Act of 1933
Municipal bonds
Securities sold by a discount broker
Pre-incorporation stock subscriptions
One-year notes issued to raise working capital
Municipal bonds
The following securities are exempt from the registration requirements of the Securities Act of 1933:
- Commercial paper
- Securities of the government
- Securities of banks
- Securities of nonprofit organizations
- Securities of savings and loan associations
- Securities of common carriers or contract carriers
- Insurance, annuity, and endowment policies
- Exchange securities issued in bankruptcy reorganizations
- Securities exchanged with existing security holders
- Municipal bonds are government securities. The other choices may be subject to the registration requirements of the Act.
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4123 Requirements of Regulatory Agencies
Which of the following statements best describes the effect of the assignment of an interest in a general partnership
The assignee becomes a partner.
The assignee is responsible for a proportionate share of past and future partnership debts.
The assignment automatically dissolves the partnership.
The assignment transfers the assignor’s interest in partnership profits and surplus.
The assignment transfers the assignor’s interest in partnership profits and surplus.
A partner may transfer his or her partnership interest to a third person. Such an assignment will have the effect of transferring the assignor’s interest in partnership profits and surplus. The assignment will not result in the assignee being treated as a general partner.
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4264 Rights, Duties, Legal Obligations, and Authority of …
Owners of at least 10% of a residential rental unit who actively participate in the rental can deduct losses up to $25,000 a year. However, a phaseout of the deduction begins at $100,000 of adjusted gross income. The deduction of the rental loss is completely phased out at what level $125,000 $150,000 $175,000 $200,000
$150,000
For every $2 of adjusted gross income (AGI) over the $100,000 level, one dollar of that real estate loss is phased out, so that at $150,000 in AGI, the full deduction is phased out.
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4540 Passive Activity Losses
Sandy is the sole shareholder of Swallow, an S corporation. Sandy’s adjusted basis in Swallow stock is $60,000 at the beginning of the year. During the year, Swallow reports the following income items:
Ordinary income $30,000
Tax-exempt income 5,000
Capital gains 10,000
In addition, Swallow makes a nontaxable distribution to Sandy of $20,000 during the year. What is Sandy's adjusted basis in the Swallow stock at the end of the year $60,000 $70,000 $80,000 $85,000
$85,000
All of the activity affects the adjusted basis of Sandy’s Swallow stock.
Adjusted basis: Jan. 1 $ 60,000
Swallow income items:
Ordinary income 30,000
Tax-exempt income 5,000
Capital gains 10,000
---------
$105,000
Nontaxable distribution (20,000)
---------
Adjusted basis $ 85,000
=========
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4643 Basis of Shareholder’s Interest
A principal will not be liable to a third party for a tort committed by an agent:
unless the principal instructed the agent to commit the tort.
unless the tort was committed within the scope of the agency relationship.
if the agency agreement limits the principal’s liability for the agent’s tort.
if the tort is also regarded as a criminal act.
unless the tort was committed within the scope of the agency relationship.
A principal will not be liable to a third party for a tort committed by an agent unless the tort was committed within the scope of the agency relationship. For example, if you pay an agent to perform a task and he or she injures an innocent bystander while attempting to complete your project, the injured party could hold you, the principal, liable.
A principal may be held liable even though the principal did not order the agent to commit a tort. And, an agreement between a principal and agent cannot limit the rights of an injured third party to hold the principal liable for torts committed while in the scope of the agency relationship. The fact that a tort is also a criminal act does not relieve the principal of liability.
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4213 Duties and Liabilities of Agents and Principals
If a tax-exempt organization is a trust, and its unrelated business income is taxed, what tax rates are used Tax rates for C corporations Tax rates for S corporations Tax rates for trusts Tax rates for single individuals
Tax rates for trusts
Unrelated business income is net income from the regular operation of business activity and from debt-financed property.
A tax-exempt organization’s unrelated business income is taxed using the tax rates for a trust.
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4673 Unrelated Business Income
Under the Sales Article of the U.C.C., which of the following statements is correct regarding risk of loss and title to the goods under a sale or return contract
Title and risk of loss are shared equally between the buyer and the seller.
Title remains with the seller until the buyer approves or accepts the goods, but risk of loss passes to the buyer immediately following delivery of the goods to the buyer.
Title and risk of loss remain with the seller until the buyer pays for the goods.
Title and risk of loss rest with the buyer until the goods are returned to the seller.
Title and risk of loss rest with the buyer until the goods are returned to the seller.
Under Article 2 of the Uniform Commercial Code (U.C.C.), a sale or return contract is a conditional sale where title, possession, and risk of loss pass from the seller to the buyer; however, the buyer retains the option to return some or all of the goods, at the buyer’s expense and risk of loss, during the specified period even though the goods conform to the contract. The other answer choices do not precisely conform to this definition and thus are incorrect. There is no equal sharing of risk, there is no requirement of approval of the goods, and there is no issue about payment terms.
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4231 Sales Contracts
Dart, Inc., a closely held corporation, was petitioned involuntarily into bankruptcy under the liquidation provisions of Chapter 7 of the Federal Bankruptcy Code. Dart contested the petition.
Dart has not been paying its business debts as they became due, has defaulted on its mortgage loan payments, and owes back taxes to the IRS. The total cash value of Dart’s bankruptcy estate after the sale of all assets and payment of administration expenses is $100,000.
Dart has the following creditors:
- Fracon Bank is owed $75,000 principal and accrued interest on a mortgage loan secured by Dart’s real property. The property was valued at and sold, in bankruptcy, for $70,000.
- The IRS has a $12,000 recorded judgment for unpaid corporate income tax.
- JOG Office Supplies has an unsecured claim of $3,000, which was timely filed.
- Nanstar Electric Co. has an unsecured claim of $1,200, which was not timely filed.
- Decoy Publications has a claim of $18,000, of which $2,000 is secured by Dart’s inventory, which was valued and sold, in bankruptcy, for $2,000. The claim was timely filed.
What dollar amount would the IRS receive $0 $8,000 $10,000 $12,000
$12,000
The IRS, even though only an unsecured creditor, is given a priority status in the distribution of payouts to creditors in bankruptcy. In the problem given, the only other priority creditors would be those in the category of “administration expenses,” and these were paid in full. Since there are sufficient funds to pay priority creditors, the IRS is paid in full, even though this results in a reduced payout to nonpriority creditors.
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4242 Bankruptcy and Insolvency
Hunt has in his possession a negotiable instrument that was originally payable to the order of Carr. It was transferred to Hunt by a mere delivery by Drake, who took it from Carr in good faith in satisfaction of an antecedent debt. The back of the instrument read as follows: “Pay to the order of Drake in satisfaction of my prior purchase of a new video calculator, signed Carr.” Which of the following is correct
Hunt has the right to assert Drake’s rights, including his standing as a holder in due course, and also has the right to obtain Drake’s signature.
Hunt is a holder in due course.
Drake’s taking the instrument for an antecedent debt prevents him from qualifying as a holder in due course.
Carr’s endorsement was a special endorsement; thus, Drake’s signature was not required in order to negotiate it.
Hunt has the right to assert Drake’s rights, including his standing as a holder in due course, and also has the right to obtain Drake’s signature.
A holder in due course has accepted a negotiable instrument for value, in good faith, and without notice that the instrument is overdue or dishonored, has irregularities, or that any person has a defense against paying it. Drake was a holder in due course because the instrument was acquired for an existing debt. Hunt is a holder in due course because the instrument was acquired for a purchase. A holder after a holder in due course has all the rights of the first holder in due course. Consequently, Hunt has the right to assert Drake’s rights.
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4232 Negotiable Instruments
George and Suzanne have been married for 40 years. Suzanne inherited $1,000,000 from her mother. Assume that the annual gift tax exclusion is $14,000. What amount of the $1,000,000 can Suzanne give to George without incurring a gift tax liability $14,000 $26,000 $500,000 $1,000,000
$1,000,000
The gift tax provision for gifts from one spouse to another allows for a marital deduction; an unlimited deduction is available for all property given to a spouse.
Therefore, a gift of $1,000,000 from Suzanne to George would not be subject to the federal gift tax.
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4474 Marital Deduction
Which of the following requires consideration to be binding on the parties
Ratification of a contract by a person after reaching the age of majority
Material modification of a sale of goods contract under the U.C.C.
A written promise signed by a merchant to keep an offer to sell goods open for 10 days
Material modification of a contract involving the sale of real estate
Material modification of a contract involving the sale of real estate
Common law generally requires consideration to modify a contract. However, U.C.C. 2-209 allows modifying a contract for sale of goods to be enforceable without any consideration. There is no exception for real estate. Under U.C.C. 2-205, a written offer signed by a merchant for a stated time period does not require consideration to be irrevocable. No consideration is required for a minor to ratify a contract after reaching majority.
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4222 Performance
4231 Sales Contracts
Which of the following increases the accumulated adjustments account of an S corporation?
Distribution to shareholders
Capital contributions by the shareholders
Charitable contributions
Interest and dividends
Interest and dividends
Generally income items such as interest and dividends will increase the AAA account of an S-Corporation. Capital contributions and distributions have no effect on the AAA account, and charitable contributions would decrease the AAA account.
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4634 Entity/Owner Transactions, Including Contributions and …
Kane created a $100,000 trust that provided her nephew with the income interest until he reached 45 years of age. When the trust was created, Kane's nephew was 25. The income distribution is to start when Kane's nephew is 29. After Kane's nephew reaches the age of 45, the remainder interest is to go to Kane's niece. The income interest: is a gift of present interest. is a gift of a future interest. is not a completed gift. is eligible for the annual exclusion.
is a gift of a future interest.
The income interest is a gift of a future interest because the beneficiary will not benefit from the gift until a future time, when he is age 29.
To be a gift of a present interest, the recipient must have an unrestricted right to immediate possession, use or enjoyment of the property or income from the property. Only gifts of present interests are eligible for the $14,000 annual exclusion. Gifts of future interests are, however, subject to gift tax when made.
IRC Section 2503(b); Regulation Section 25.2503-3
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4471 Transfers Subject to the Gift Tax
Which of the following must take place for a corporation to be voluntarily dissolved
Passage by the board of directors of a resolution to dissolve
Approval by the officers of a resolution to dissolve
Amendment of the certificate of incorporation
Unanimous vote of the stockholders
Passage by the board of directors of a resolution to dissolve
Voluntary dissolution of a corporation occurs when the board of directors passes a dissolution resolution. The officers do not have the authority to dissolve a corporation—only the board of directors does. Amending a certificate of incorporation will not result in the dissolution of the corporation. The stockholders may vote on dissolution, but unanimous consent is not required.
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4262 Formation, Operation, and Termination
Randolph is a single individual who always claims the standard deduction. Randolph received the following in the current year:
Wages $22,000
Unemployment compensation 6,000
Pension distribution (100% taxable) 4,000
A state tax refund from the previous year 425
What is Randolph's adjusted gross income $22,000 $28,425 $32,000 $32,425
$32,000
Items included in AGI: $22,000 wages + $6,000 unemployment compensation + $4,000 pension distribution = $32,000 AGI.
State tax refunds are not taxable to an individual who does not itemize deductions as no prior tax benefit was received. All other income items have no exemption to be exempt from being included in income from whatever source derived. Unemployment compensation is explicitly included in income under IRC Section 85.
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4512 Characterization of Income
Which of the following statements is correct regarding the division of profits in a general partnership when the written partnership agreement only provides that losses be divided equally among the partners Profits are to be divided:
based on the partners’ ratio of contribution to the partnership.
based on the partners’ participation in day-to-day management.
equally among the partners.
proportionately among the partners.
equally among the partners.
The Uniform Partnership Act presumes that profits and losses are distributed equally among the partners unless the partnership agreement provides to the contrary. In this case, the partnership agreement does not provide to the contrary, so the rule of equal distribution of profits would apply.
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4264 Rights, Duties, Legal Obligations, and Authority of …
A routine review of a received return by the IRS looks for all of the following except:
failure to report a 1099.
failure to calculate the math correctly.
failure of the taxpayer to sign the return.
failure to submit a tax return.
failure to submit a tax return.
A routine review cannot be performed on a tax return if one has not been submitted to the IRS. Therefore, the IRS looks to make sure the tax return has been signed, all items have been reported, and there are no mathematical or clerical errors.
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4322 Internal Revenue Service (IRS) Audit and Appeals …
Taylor, an unmarried taxpayer, had $90,000 in adjusted gross income for 2014. During 2014, Taylor donated land to a church and made no other contributions. Taylor purchased the land in 1991 as an investment for $14,000. The land's fair market value was $25,000 on the day of the donation. What is the maximum amount of charitable contribution that Taylor may deduct as an itemized deduction for the land donation for 2014 $25,000 $14,000 $11,000 $0
$25,000
Land purchased in 1991 and held as an investment is a long-term capital asset. The deduction for the donation of appreciated capital assets is fair market value (FMV) and is limited to 30% of adjusted gross income on contributions to religious organizations. Exceptions to the FMV rule exist for (1) donations to private nonoperating foundations and (2) donations of tangible personal property that is put to an unrelated use by the charity. Neither of the exceptions applies in this question. If the taxpayer limits the deduction to cost, the adjusted gross income limitation is increased to 50%.
IRC Section 170(b)(1)(C)
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4530 Adjustments and Deductions to Arrive at Taxable Income
For a cash-basis taxpayer, gain or loss on a year-end sale of listed stock arises on the: trade date. settlement date. date of receipt of cash proceeds. date of delivery of stock certificate.
trade date.
Taxpayers who sell stock or securities traded on an established securities market (called “Listed Stock”) must recognize gains or losses on the trade date, not on the settlement date. Because of the delay between the day of sale and the day payment is received, the transaction is considered an installment sale. IRC Section 453(k) specifically excludes sales of stock and securities traded on an established market from the installment method.
Note
This rule applies to all taxpayers, whether on the cash or accrual method of accounting.
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4344 Installment Sales
Baker Corp., a calendar-year C corporation, realized taxable income of $36,000 from its regular business operations during the year. In addition, Baker had the following capital gains and losses in the same year: Short-term capital gain $8,500 Short-term capital loss (4,000) Long-term capital gain 1,500 Long-term capital loss (3,500) Baker did not realize any other capital gains or losses since it began operations. What is Baker's total taxable income $46,000 $42,000 $40,500 $38,500
$38,500
Short-term capital gain $ 8,500
Short-term capital loss (4,000)
Long-term capital gain 1,500
Long-term capital loss (3,500)
——–
Net gain $ 2,500
+ Taxable business income $36,000
——–
Taxable income $38,500
========
Note
A C corporation adds all its gains and losses together. If there is a net capital loss, the loss is carried back three years and forward five years, and it is always a short-term capital loss when it is carried back or forward. Current-year gains and losses are offset against each other. A net capital gain is taxable in the current year.
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4550 Loss Limitations
4631 Determination of Taxable Income/Loss
Under the Securities Act of 1933, which of the following statements is (are) correct regarding the purpose of registration
I. The purpose of registration is to allow for the detection of management fraud and prevent a public offering of securities when management fraud is suspected.
II. The purpose of registration is to adequately and accurately disclose financial and other information upon which investors may determine the merits of securities.
I only
II only
Both I and II
Neither I nor II
II only
The purpose of the Securities Act of 1933 is to protect the unsophisticated investing public by requiring registration of securities prior to issuance. Registration involves full disclosure of financial information.
While the purpose of the Act is not to allow for the detection of management fraud, it does have antifraud provisions. Fraudulent securities transactions are prohibited even if the securities are not required to be registered (they are exempt from registration). The Act provides consequences for any untrue statement of a material fact or omission of a material fact involving the sale of securities in interstate commerce or through the mail.
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4251 Federal Securities Regulation
Gary Berg, a farmer, exchanges a tractor with a basis of $40,000 and a value of $50,000 for a tractor with a value of $44,000 plus $6,000 cash. The basis of the tractor acquired by Gary is: $40,000. $44,000. $46,000. $50,000.
$40,000.
In a like-kind exchange, the basis of property received is the basis of the property given up plus any gain recognized, plus boot (cash or property not of a like kind) paid, less any loss recognized, less boot received. The basis of the tractor received is $40,000 ($40,000 + $6,000 gain - $6,000 boot received). The gain of $6,000 is the lesser of the realized gain of $10,000 or boot received of $6,000.
IRC Section 1031
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4440 Taxable and Nontaxable Sales and Exchanges
Unless otherwise provided in a general partnership agreement, which of the following statements is correct when a partner dies
The deceased partner’s executor would automatically become a partner, the deceased partner’s estate would be free from any partnership liabilities, and the partnership would be dissolved automatically.
The deceased partner’s executor would automatically become a partner.
The deceased partner’s estate would be free from any partnership liabilities.
The partnership would be dissolved automatically.
The partnership would be dissolved automatically.
The death of any partner automatically dissolves the partnership, unless there is an agreement to the contrary in the partnership contract. Upon such death, the estate would be entitled to the deceased partner’s interest in (portion of) the partnership, subject to any outstanding partnership liabilities. The executor or any other representative of the deceased partner does not automatically become a partner.
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4262 Formation, Operation, and Termination
A tax communication should include all of the following except:
one complete conclusion for all of the issues.
a brief summary of the facts.
a reasoning for the tax conclusion reached.
each tax issue listed.
one complete conclusion for all of the issues.
A tax communication should include:
-a brief statement of the facts,
-each tax issue listed,
-a separate conclusion for each tax issue, and
where the conclusions came from, e.g., the authority.
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4382 Communications with or on Behalf of Clients
For which of the following is a partnership recognized as a separate legal entity
In respect to contributions and advances made by partners to the partnership
The recognition of net operating losses
The status of the partnership as an employer for workers’ compensation purposes
The liability for and payment of taxes on partnership gains from the sale of capital assets
The status of the partnership as an employer for workers’ compensation purposes
In general, a partnership is a voluntary legal relationship to carry on business. It is not a separate legal entity. However, it is a legal entity for workers’ compensation purposes.
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4261 Advantages, Disadvantages, Implications, and …
Under the U.C.C. Secured Transaction Article (Article 9), what is the effect of perfecting a security interest by filing a financing statement
The secured party can enforce its security interest against the debtor.
The secured party has permanent priority in the collateral even if the collateral is removed to another state.
The debtor is protected against all other parties who acquire an interest in the collateral after the filing.
The secured party has priority in the collateral over most creditors who acquire a security interest in the same collateral after the filing.
The secured party has priority in the collateral over most creditors who acquire a security interest in the same collateral after the filing.
Under the Uniform Commercial Code (U.C.C.) Secured Transaction Article (Article 9), the effect of perfecting a security interest by filing a financing statement is that the secured party has priority in the collateral over most creditors who acquire a security interest in the same collateral after the filing. (See U.C.C. 9-203, “When Filing is Required to Perfect Security Interest.”)
To gain the right to retrieve collateral, all the creditor needs is a security agreement, or attachment. The purpose of filing a financing statement is to give notice to potential creditors that there is already a security interest in the goods. Creditors must file financing statements in the jurisdictions where the property is located. Due to the rules relating to priorities among conflicting security interests in the same collateral, it is incorrect to assert that the result of filing or perfecting a security interest is to protect the debtor against all other parties who acquire an interest in the collateral after the filing. (See U.C.C. 9-312 for details.) In addition, a bona fide purchaser may buy the collateral (like inventory) from the debtor and the perfected security party would have no right to repossess the collateral.
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4233 Secured Transactions
Lyon, a cash-basis taxpayer, died on January 15, 2014. In 2014, 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 2014:
2014 Estate Income
—————————————
$20,000 Taxable interest
10,000 Net long-term capital gains
allocable to *corpus
$5,000 Administrative expenses
attributable to taxable income
For the 2014 calendar year, what was the estate's distributable net income (DNI) $15,000 $20,000 $25,000 $30,000
*corpus - The corpus of a trust is the sum of money or property that is set aside to produce income for a named beneficiary. In the law of estates, the corpus of an estate is the amount of property left when an individual dies.
$15,000
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.
Note
The net long-term capital gains of $10,000 allocable to corpus are not part of “DNI.”
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4662 Income and Deductions
Pine, an employee of Global Messenger Co., was hired to deliver highly secret corporate documents for Global’s clients throughout the world. Unknown to Global, Pine carried a concealed pistol. While Pine was making a delivery, he suspected an attempt was being made to steal the package, drew his gun and shot Kent, an innocent passerby. Kent will not recover damages from Global if:
Global discovered that Pine carried a weapon and did nothing about it.
Global instructed its messengers not to carry weapons.
Pine was correct and an attempt was being made to steal the package.
Pine’s weapon was unlicensed and illegal.
Pine’s weapon was unlicensed and illegal.
Kent will not recover damages from Global if Pine’s weapon was unlicensed and illegal. This question tests your knowledge of respondeat superior—a legal theory whereby an employer is liable to third parties for the acts of an employee. Pine is an employee of Global Messenger Service. In the course of delivering corporate documents, he shot an innocent third party. While this act was done in the scope of employment, if the weapon was unlicensed and illegal, Kent (the injured party) would not be able to recover from Pine’s employer. The reason is that doing an illegal act would not be considered acting within the scope of his employment. The other alternatives would not prevent Kent from recovering damages from Global.
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4213 Duties and Liabilities of Agents and Principals
Tom Lewis, an individual taxpayer who is a CPA, performs volunteer accounting work for the local Red Cross throughout the year of 2014. Tom’s adjusted gross income for the year is $80,000. He incurs the following expenses for the year:
Transportation expenses to and from the Red Cross $ 200
Estimated value of accounting services performed 3,000
How much of these expenses may Tom deduct as a charitable donation on his Schedule A (itemized deduction) form for 2014 (assuming that he can fully itemize and deduct all such expenses) $0 $200 $3,000 $3,200
$200
Transportation expenses to and from an event in which an individual performs charitable services is deductible as a charitable contribution. The fair market value of services performed for a charitable organization is not deductible as a charitable contribution.
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4530 Adjustments and Deductions to Arrive at Taxable Income
The owners of a limited liability company are known as which of the following Partners Members Stockholders Shareholders
Members
A limited liability company (LLC) is a business structure that is governed by state statute. This business structure has become popular due to the fact that the owners have limited liability and these owners can be individuals, corporations, other LLCs, or foreign entities. The owners are called “members.”
Revised Uniform Limited Liability Company Act, Section 101
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4261 Advantages, Disadvantages, Implications, and …
On June 15, Peters orally offered to sell a used lawn mower to Mason for $125. Peters specified that Mason had until June 20 to accept the offer. On June 16, Peters received an offer to purchase the lawn mower for $150 from Bronson, Mason’s neighbor. Peters accepted Bronson’s offer. On June 17, Mason saw Bronson using the lawn mower and was told the mower had been sold to Bronson. Mason immediately wrote to Peters to accept the June 15 offer. Which of the following statements is correct
Mason’s acceptance would be effective when received by Peters.
Mason’s acceptance would be effective when mailed.
Peters was obligated to keep the June 15 offer open until June 20.
Peters’s offer had been revoked and Mason’s acceptance was ineffective.
Peters’s offer had been revoked and Mason’s acceptance was ineffective.
To create a contract, the offer must be accepted before a termination of the contract. A sale of the property to another entity would be a termination. An indirect revocation by the offerer, such as Mason being told by Bronson that Bronson bought the mower, is a valid termination.
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4221 Formation
Alice bought a home in May 2009 and lived there with her husband Jeff until Alice moved out in May 2010. They divorced in July 2011. Jeff continued to reside in the home under the terms of the divorce decree until Alice sold it in July 2014 for a $200,000 gain. How much of this gain may Alice exclude from her income $0 $100,000 $150,000 $200,000
$200,000
Alice qualifies for the full exclusion because she can tack on the period Jeff lived in the home. Alice needs to have owned and used the residence for two of the last five years. She meets the ownership requirement because she has owned it continuously from May 2009 to July 2014. She can meet the use test by using the special tacking provisions. She used it personally from May 2009 to May 2010, so she has one year of use. Her former husband used it under a divorce decree from July 2011 to July 2014. Alice is able to tack these years of use onto her own so she has the required two years of use.
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4550 Loss Limitations
Vee Corp. retained Water, CPA, to prepare its 20X4 income tax return. During the engagement, Water discovered that Vee had failed to file its 20X0 income tax return. What is Water’s professional responsibility regarding Vee’s unfiled 20X0 income tax return
Prepare Vee’s 20X0 income tax return and submit it to the IRS.
Advise Vee that the 20X0 income tax return has not been filed and recommend that Vee ignore filing its 20X0 return since the statute of limitations has passed.
Advise the IRS that Vee’s 20X0 income tax return has not been filed.
Consider withdrawing from preparation of Vee’s 20X4 income tax return until the error is corrected.
Consider withdrawing from preparation of Vee’s 20X4 income tax return until the error is corrected.
A submission of a client’s tax return cannot ethically be done without the client’s permission.
Advise Vee that the tax return has not been filed, but do not ignore filing it now.
Advising the IRS that the tax return has not been filed is an unethical act without the client’s permission.
If Vee refuses to file the return (which is illegal), Water should consider withdrawing from the 20X4 tax preparation assignment.
Under SSTS 6, the CPA should recommend that the tax return be filed, but can only withdraw from the assignment, not report the lack of reporting.
Circular 230, Section 10.21
Statement of Standards for Tax Services 6
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4112 AICPA Statements on Standards for Tax Services
In Year 6, an IRS agent completed an examination of a corporation’s Year 5 tax return and proposed an adjustment that will result in an increase in taxable income for each of Years 1 through 5. All returns were filed on the original due date. The proposed adjustment relates to the disallowance of corporate jet usage for personal reasons. The agent does not find the error to be fraudulent or substantial in nature. Which of the following statements regarding this adjustment is correct
The adjustment is improper because an agent may only propose adjustments to the year under examination.
The adjustment is proper because there is no statute of limitations for improperly claiming personal expenses as business expenses.
The adjustment is proper because it relates to a change in accounting method, which can be made retroactively irrespective of the statute of limitations.
The adjustment is improper because the statute of limitations has expired for several years of the adjustment.
The adjustment is improper because the statute of limitations has expired for several years of the adjustment.
Generally, the statute of limitations for the period to question tax returns is three years after the date the return is filed or the due date, whichever is later. In the case described, only Year 5 and Year 4 are clearly at risk, and Year 3 may be depending on the date the audit is completed. The time may be extended if the return is fraudulent or if unreported income is greater than 25% of the gross income reported. Neither of these conditions is present.
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4327 Statute of Limitations
Natalie inherited land from her Uncle Josh, who died January 3, 2014. The basis to Josh was $1,000,000 and the value on January 3, 2014, was $7,200,000. On July 3, 2014, the value was $7,600,000. When the land was distributed to Natalie on June 3, 2014, the value was $7,400,000. This land was Josh's entire estate. Natalie's basis for the estate is: $1,000,000. $7,200,000. $7,400,000. $7,600,000.
$7,200,000.
An estate tax return must be filed for the estate of Uncle Josh since its value is over $5,340,000 in 2014. In order to select the alternate valuation date of July 3, the valuation must be lower, resulting in reduced estate tax liability. Since the market value has risen, the value at time of death ($7,200,000) must be selected.
IRC Section 2032(a)
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4420 Basis and Holding Periods of Assets
Which Senate committee considers new tax legislation Budget Finance Appropriations Rules and Administration
Finance
The Senate Committee on Finance reviews all tax bills that are approved by the U.S. House of Representatives and forwarded to the Senate for action.
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4310 Federal Tax Legislative Process
4381 Authoritative Hierarchy
Which of the following should be included when determining adjusted gross income Alimony received Compensation for injuries or sickness Rental value of parsonages Tuition scholarship
Alimony received
The Internal Revenue Code (IRC) explicitly includes alimony received in gross income and explicitly excludes the other items listed (compensation for injuries or sickness, rental value of parsonages, and tuition scholarship).
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4512 Characterization of Income
4530 Adjustments and Deductions to Arrive at Taxable Income
Tom Lewis, an individual taxpayer, was assessed $250 in the current year for the construction of street lights in his neighborhood. It is thought that the street lights will reduce crime in the neighborhood. Tom's neighborhood is the only area of the city that is assessed the charges. Before the end of the year, Tom is assessed another $100 for repairing the street lights damaged in a storm. How much of the $350 paid by Tom is deductible as an itemized deduction in the current year $0 $100 $250 $350
$100
Taxes assessed against local improvements are not deductible if they are of a nature that tends to increase the value of the property being assessed. Maintenance, repair, or interest charges related to such assessments are deductible. Thus, only the $100 for repairing the street lights is deductible.
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4530 Adjustments and Deductions to Arrive at Taxable Income
Kent Corp. is a calendar-year, accrual-basis, C corporation. In 2014, Kent made a nonliquidating distribution of property with an adjusted basis of $150,000 and a fair market value of $200,000 to Reed, its sole shareholder. The following information pertains to Kent:
Reed’s basis in Kent stock at January 1, 2014 $500,000
Accumulated earnings and profits at
January 1, 2014 125,000
Current earnings and profits for 2014
including the effects of this distribution 60,000
What was taxable as dividend income to Reed for 2014 $60,000 $150,000 $185,000 $200,000
$185,000
When a corporation makes a nonliquidating distribution of property to a sole shareholder, it is considered a dividend.
Accumulated earnings and profits at Jan 1, 2014 $125,000
plus the current earnings and profits 60,000
——–
Total earnings and profits and maximum taxable dividend $185,000
========
The taxable dividend income to Reed for 2014 is $185,000, which is 100% of the earnings and profits of the corporation.
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4634 Entity/Owner Transactions, Including Contributions and …
4635 Earnings and Profits
In a general partnership, a partner’s interest in specific partnership property is:
transferable to a partner’s individual creditors.
subject to a partner’s liability for alimony.
transferable to a partner’s estate upon death.
subject to a surviving partner’s right of survivorship.
subject to a surviving partner’s right of survivorship.
In a general partnership, a partner’s interest in specific partnership property is subject to a surviving partner’s right of survivorship. In the event a partner dies, his partnership interest becomes part of his estate. However, the deceased partner’s interest in specific partnership property does not result in his estate having a claim on that property. The property stays in the partnership.
A partner’s interest in specific partnership property is not transferable to a partner’s individual creditors. For example, if a partner incurs what is personal debt (not a debt made in the course of furthering partnership business), the creditor may obtain a court judgment giving him a claim against the partner’s interest in the partnership (a right to receive profits from the partnership until the debt is paid off). A court will not, however, grant a creditor a claim against specific partnership property to satisfy a personal debt of the partner. In the event a partner dies, the partner’s interest in the partnership business is transferred to his estate, but not his interest in specific partnership property.
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4263 Financial Structure, Capitalization, Profit and Loss …
Which of the following concepts affects the amount of monetary damages recoverable by the nonbreaching party when a contract is breached
Foreseeability of damages
Mitigation of damages
Both foreseeability and mitigation of damages
Neither foreseeability nor mitigation of damages
Both foreseeability and mitigation of damages
The concept of foreseeability of damages generally requires that compensation for damages is given only in those situations where the breaching party could reasonably have foreseen the probable result of their breach. In other words, this means the “normal or natural result” of damages resulting from a breach of contract (i.e., those damages that are fairly and reasonably considered according to the usual course of things in a similar circumstance). Alternatively, the concept of foreseeability may be defined as the damages resulting from the circumstances and risk that may have been reasonably supposed to have been in contemplation of both parties at the time they made the contract. This consideration of risk also includes the communicating of special facts of the situation to either party during the contract negotiation.
Mitigation of damages is a concept that imposes a duty upon the innocent injured party to reduce (mitigate) their damages resulting from a breach of contract. The classic example of mitigation of damages is where a tenant has moved out of an apartment before their lease is up, and as such continues to owe on the lease. It would be appropriate for the landlord to attempt to find a new tenant and accordingly mitigate the final damages against the tenant who has breached the lease.
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4212 Authority of Agents and Principals
4224 Discharge, Breach, and Remedies
Which of the following corporate shareholder rights is enforceable by means of a derivative suit
Protecting preemptive rights
Compelling payment of properly declared dividends
Enforcing access to corporate records
Recovering damages from a third party
Recovering damages from a third party
If a corporation is harmed by someone, the directors of the corporation have the authority to bring an action on behalf of the corporation. When the corporation fails to bring such a suit, the shareholders have the right to sue on behalf of the corporation. This is called a derivative suit.
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4264 Rights, Duties, Legal Obligations, and Authority of …
Pix Corp. is making a $6 million stock offering. Pix wants the offering exempt from registration under the Securities Act of 1933.
Which of the following provisions of the act would Pix have to comply with for the offering to be exempt
Regulation A
Regulation D, Rule 504
Regulation D, Rule 505
Regulation D, Rule 506
Regulation D, Rule 506
Rule 506 of Regulation D allows an exemption from registration under the Securities Act of 1933 for an offering of an unlimited amount of stock to an unlimited number of accredited investors and up to 35 other “sophisticated” buyers. The sale must be a private placement with no general public offering, and the shares are restricted as to resale by the investor.
Rule 504 has a $1 million limit and Rule 505 has a $5 million limit. Regulation A limits its exemption to $1.5 million for a 12-month period offered by all selling security holders and a limit of $5 million offered by the corporation and shareholders. The $5 million includes all cash and other consideration received.
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4251 Federal Securities Regulation
Which of the following circumstances may permit the piercing of the corporate veil of a closely held corporation and thus may cause its shareholders to be held personally liable
I. The corporation is thinly capitalized.
II. The corporation borrows money from a shareholder without giving the shareholder a security interest in corporate assets.
I only
II only
Both I and II
Neither I nor II
I only
A corporation is a separate, legal entity that is separate from its shareholders, directors, officers, and employees. Thus, owners have liability for the organization limited to their investment in the organization.
Piercing the corporate veil means that a shareholder, director, or officer can be held personally liable for corporate obligations. In order for the “lifting” of the corporate veil to occur, two elements must be present:
A shareholder, director, or officer must have controlled the corporation for his or her own benefit in an attempt to protect himself or herself from legal liability.
A shareholder, director, or officer must have used the corporation in an improper manner, doing such things as perpetuating fraud, not capitalizing the organization adequately, or looting the corporation of assets.
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4262 Formation, Operation, and Termination
Betty Sue is an unincorporated grain farmer in Mississippi with a calendar year-end. She does not live or farm in a declared disaster area. Betty computed her estimated tax liability of $20,000 for 2014. To avoid the penalty for failure to pay the estimated tax, she should:
pay all of her 2014 estimated taxes by the due date of her return.
pay all her 2014 estimated taxes by February 14, 2015, and file her tax return by April 15, 2015.
make her first 2014 estimated tax payment by March 1, 2015.
include any alternative minimum tax she expects to owe in her calculations.
include any alternative minimum tax she expects to owe in her calculations.
IRS Publication 225 provides that a qualified farmer is a taxpayer whose gross income for 2014 was at least two-thirds from farming. The qualified farmer can choose either of the following options for her 2014 tax and not be penalized for failure to pay estimated tax:
- Make the required annual payment by January 15, 2015
- File Form 1040 by March 1, 2015, and pay all of the tax due
With respect to the required annual payment in the first option, the required annual payment is the smaller of:
- 66.67% (.6667) of the total tax for 2014 or
- 100% of the total tax shown on the taxpayer’s 2013 return (the return must cover all 12 months).
In addition, the taxpayer must include any expected alternative minimum tax (AMT) when figuring the taxpayer’s estimated tax. Thus, estimated taxes are used to pay not only income tax, but self-employment tax and alternative minimum tax as well (IRS Publication 505).
For this problem, Betty Sue can avoid any filing of estimated tax penalty by including any AMT that she expects to owe in her calculation.
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4365 Impact of Estimated Tax Payment Rules on Planning
*VIDEO EXPLANATION 12/08
The Rites are married, file a joint income tax return, and qualify to itemize their deductions in the current year. Their adjusted gross income for the year was $55,000, and during the year they paid the following taxes:
Real estate tax on personal residence $2,000
Ad valorem tax on personal automobile 500
Current-year state and city income
taxes withheld from paycheck 1,000
What total amount of the expense should the Rites claim as an itemized deduction as a result of their tax payments on their current-year joint income tax return $1,000 $2,500 $3,000 $3,500
$3,500
All of these types of taxes are deductible as part of your itemized deductions. The Rites’ filing status and adjusted gross income are not relevant in determining which taxes are deductible.
The amount of the expense the Rites should claim on their current-year tax return is $3,500, computed as follows:
Real estate tax on personal residence $2,000
Ad valorem tax on personal automobile 500
Current-year state and city income
taxes withheld from paycheck 1,000
——
Total $3,500
======
IRC Section 164
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4530 Adjustments and Deductions to Arrive at Taxable Income
In preparing a client’s current-year individual income tax return, a tax practitioner discovers an error in the prior year’s return. Under the rules of practice prescribed in Treasury Circular 230, the tax practitioner:
is barred from preparing the current year’s return until the prior-year error is rectified.
must advise the client of the error.
is required to notify the IRS of the error.
must file an amended return to correct the error.
must advise the client of the error.
Treasury Circular 230 requires tax practitioners to promptly inform a taxpayer of any error or omission or other noncompliance that the tax practitioner becomes aware of. The practitioner must also inform that taxpayer of the consequences of such error or omission or other noncompliance.
In addition, under SSTS 6, the CPA should consider withdrawing from the engagement, but cannot disclose the error to the IRS.
Treasury Circular 230, Section 10.21
Statement of Standards for Tax Services 6
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4112 AICPA Statements on Standards for Tax Services
A member would be in violation of the Standards for Tax Services if the member recommends a return position under which of the following circumstances
It meets the realistic possibility standard, is not frivolous, and is disclosed on the return.
It might result in penalties and the member advises the taxpayer and discusses avoiding such penalties through disclosing the position.
It does not meet the realistic possibility standard but the member feels the return has a minimal likelihood for examination by the IRS.
It meets the realistic possibility standard based on the well-reasoned opinion of the taxpayer’s attorney.
It does not meet the realistic possibility standard but the member feels the return has a minimal likelihood for examination by the IRS.
Statement on Standards for Tax Services (SSTS) 1, Section 5(a), states that a member should have a good-faith belief that the tax return position being recommended has a realistic possibility of being sustained administratively or judicially on its merits, if challenged. A member must not use the low possibility of audit to justify a position on a return.
Statement on Standards for Tax Services (SSTS) 1, Section 5(a)
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4112 AICPA Statements on Standards for Tax Services
A CPA who prepares clients’ federal income tax returns for a fee must:
file certain required notices and powers of attorney with the IRS before preparing any returns.
keep a completed copy of each return for a specified period of time.
receive client documentation supporting all travel and entertainment expenses deducted on the return.
indicate the CPA’s federal identification number on a tax return only if the return reflects tax due from the taxpayer.
keep a completed copy of each return for a specified period of time.
A CPA who prepares clients’ federal income tax returns for a fee must keep a completed copy of each return for a specific period of time.
A CPA is not required to maintain the client’s documentation, or to file certain powers of attorney, etc., with the IRS before preparing any returns. Tax preparers have to indicate their federal identification number on the tax return regardless of whether a tax is due or not.
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4113 Internal Revenue Code of 1986, as Amended, and …
In Year 1, a taxpayer sold real property for $200,000, receiving $100,000 at closing and $100,000 plus accrued interest at the prime rate in the next year. The buyer also assumed a $50,000 mortgage on the property. The taxpayer's adjusted basis was $75,000, and the taxpayer incurred $10,000 of selling expenses. If this transaction qualifies for installment sale treatment, what is the gross profit on the sale $115,000 $125,000 $165,000 $175,000
$165,000
The installment method allows for a taxpayer to spread the recognition of gain over the years of receipt of payment. The gross profit is determined by total payments received ($200,000 payments received and $50,000 mortgage assumed by the buyer) less the taxpayers basis ($75,000) and selling expenses incurred ($10,000):
$200,000 + $50,000 - $75,000 - $10,000 = $165,000
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4344 Installment Sales
Tom Lewis, a single taxpayer, had the following income and expense items for 2015:
Wages $55,000
Alimony paid to former spouse 5,000
Child support paid to former spouse 4,000
Deductible Moving Expenses 2,000
Mortgage interest on personal residence 6,000
Credit card interest 1,000
Tom’s personal exemption amount for 2014 3,950
Tom’s standard deduction amount for 2014 6,200
What is Tom's total deductible itemized deduction amount for 2015? $6,000 $7,000 $8,000 $9,000
$6,000
The key points here are:
- credit card interest is considered personal interest and is not deductible on an individual’s tax return.
- moving expenses are considered an adjustment to gross income in arriving at adjusted gross income and are not an itemized deduction.
Thus, the only itemized deduction is the mortgage interest on the personal residence of $6,000.
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4530 Adjustments and Deductions to Arrive at Taxable Income
Unless prohibited by the organization documents, a stockholder in a publicly held corporation and the owner of a limited partnership interest both have the right to: ownership of the business' assets. control management of the business. assign their interest in the business. an investment that has perpetual life.
assign their interest in the business.
Unless prohibited by the organization documents, a stockholder in a publicly held corporation and the owner of a limited partnership interest both have the right to assign their interest in the business.
Neither shareholder nor limited partner has ownership of the business assets. They also do not control management of the business. In a corporation, the board of directors hires and supervises management with shareholders electing board members. Limited partners have no control over the general partnership under partnership law. By definition, a limited partnership has a definite life.
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4264 Rights, Duties, Legal Obligations, and Authority of …
Under the Securities and Exchange Act of 1934, which of the following types of instruments is excluded from the definition of “securities” Investment contracts Convertible debentures Nonconvertible debentures Certificates of deposit
Certificates of deposit
Certificates of deposit are not considered “securities” under the Securities and Exchange Act of 1934 because they do not constitute an investment in a common enterprise with the expectation of profit as do investment contracts and both convertible and nonconvertible debentures.
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4251 Federal Securities Regulation
In the current year, Drake, a disabled taxpayer, made the following home improvements:
Cost
-------- Pool installation, which qualified as a medical expense and increased the value of the home by $25,000 $100,000 Widening doorways to accommodate Drake's wheelchair (The improvement did not increase the value of his home.) 10,000 For regular income tax purposes and without regard to the adjusted gross income percentage threshold limitation, what maximum amount would be allowable as a medical expense deduction in the current year $110,000 $85,000 $75,000 $10,000
$85,000
Permanent capital improvements made primarily for medical reasons are deductible as medical expenses subject to certain limitations. If the capital improvement increases the value of the residence, only the excess of the cost over the increase in value is deductible as a medical expense.
Drake installed a pool for medical reasons at a cost of $100,000, which increased the value of his residence by $25,000, so the medical deduction is limited to $75,000 ($100,000 - $25,000 = $75,000).
Drake also widened doorways to accommodate his wheelchair at a cost of $10,000. Since this did not increase the value of his residence, it is deductible in full as a medical expense.
Drake’s medical deduction is computed as follows:
Pool $75,000
Doorways 10,000
-------
Total $85,000
=======
IRC Section 213
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4530 Adjustments and Deductions to Arrive at Taxable Income
Jane took her watch to the jeweler in order to have it repaired. The jeweler did not agree to do the repair on credit and expected to be paid in cash when Jane returned to pick up her watch. If Jane refuses to pay for the watch:
the jeweler must still return the watch to Jane and then file suit for the amount due for the repairs.
the jeweler can recover based on his mechanic’s lien.
the jeweler will have an artisan’s lien on the watch whether or not he returns the watch to Jane.
the jeweler could sell the watch to satisfy the outstanding amount due for the repair.
the jeweler could sell the watch to satisfy the outstanding amount due for the repair.
An artisan’s lien is a common law security device whereby a creditor can recover for work done on personal property of the debtor. If the debtor fails to pay for the work performed, the creditor can retain possession of the property and sell it in satisfaction of the lien.
An artisan’s lien is a possessory lien. If the lien holder voluntarily returns possession of the property to the debtor, the lien no longer exists.
Finally, a mechanic’s lien arises from the making of improvements to real property.
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4233 Secured Transactions
On January 1, Fast, Inc., entered into a covenant not to compete with Swift, Inc., for a period of 5 years, with an option by Swift to extend it to 7 years. What is the amortization period of the covenant for tax purposes 5 years 7 years 15 years 17 years
15 years
A covenant not to compete that is acquired with the purchase of a business is considered to be a Section 197 intangible eligible for 15-year amortization.
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4430 Cost Recovery (Depreciation, Depletion, and …
Professional rules and ethics for CPA tax practitioners that are merely advisory, rather than having formal administrative authority, include which of the following sources
AICPA Code of Professional Conduct
AICPA Statements on Responsibilities in Tax Practice
Internal Revenue Code
Treasury Department Practice Rules (Circular 230)
AICPA Statements on Responsibilities in Tax Practice
The AICPA Statements on Responsibilities in Tax Practice (SRTP) were issued from 1964 to 1977. On October 31, 2000, the AICPA replaced the SRTP with Statements on Standards for Tax Services (SSTS). Since the SSTS are now the enforceable tax practice standards, the SRTP are merely advisory.
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4112 AICPA Statements on Standards for Tax Services
West Corp. received a check that was originally made payable to the order of one of its customers, Ted Burns. The following indorsement was written on the back of the check:
Ted Burns, without recourse, for collection only
Which of the following describes the indorsement
Special
Restrictive
Both special and restrictive
Neither special nor restrictive
Restrictive
The indorsement that reads “Ted Burns, without recourse, for collection only” is a restrictive indorsement. This problem tests your understanding of the two different types of indorsements. A special indorsement identifies the person to whose order the instrument is further payable. A restrictive indorsement is one that in some way limits the rights of the next holder. In this case, West Corp. is limited to collecting payment and may not transfer or further indorse the instrument because of the phrase “for collection only.” The phrase “without recourse” makes the indorsement a “qualified” indorsement. A person who indorses using the phrase “without recourse,” in this case Ted Burns, is in effect saying that if the primary party does not pay on the instrument tough luck—the holder cannot seek payment from Ted.
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4232 Negotiable Instruments
Fuller was the owner and beneficiary of a $200,000 life insurance policy on a parent. Fuller sold the policy to Decker, for $25,000. Decker paid a total of $40,000 in premiums. Upon the death of the parent, what amount must Decker include in gross income $0 $135,000 $160,000 $200,000
$135,000
Although life insurance death proceeds are generally not taxable to the recipient, there are special rules if the policy is transferred for value. In that case the death proceeds are taxable, except to the extent of basis.
Basis in such a policy consists of:
-consideration paid for the policy,
-premiums paid under the policy, and
-interest expense on debt incurred to finance the policy which would not have been allowed as a deduction previously.
The transfer for value rule does not apply:
-when basis is determined by reference to the basis in the hands of the transferor,
-to transfers to the insured, or
-to transfers to a partner of the insured, transfers to a partnership in which the insured is a partner, or transfers to a corporation in which the insured is a shareholder or officer.
In this case, Fuller’s taxable amount from the death proceeds is computed as follows:
Death proceeds $200,000
Less basis in policy:
Consideration paid for policy - 25,000
Premiums paid - 40,000
Interest disallowed 0
——–
Taxable amount $135,000
IRC Section 101(a)(2)
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4512 Characterization of Income
Under the U.C.C. Secured Transactions Article, which of the following actions will best perfect a security interest in a negotiable instrument against any other party
Filing a security agreement
Taking possession of the instrument
Perfecting by attachment
Obtaining a duly executed financing statement
Taking possession of the instrument
Under the Uniform Commercial Code (U.C.C.) Secured Transactions Article, perfection of a security interest in a negotiable instrument is achieved only by the creditor taking possession of the instrument.
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4233 Secured Transactions
Roland and Wanda Czewick have one child who is 14 years old. The Czewicks are divorced and, under the divorce agreement, Wanda claims the child as her dependent in the current year. Wanda's adjusted gross income for the current year is $80,000. Wanda files as head of household. What is the child tax credit amount Wanda can claim in the current year $750 $600 $350 $0
$750
A married couple filing a joint return loses some or all of the child credit if the couple has modified adjusted gross income (AGI) in excess of $110,000. The credit is reduced by $50 for each $1,000 of modified AGI (or fraction thereof) in excess of the $110,000 threshold. Modified AGI is AGI determined without regard to foreign, possession, or Puerto Rico income exclusions.
Single filers and heads of household lose $50 of the credit for each $1,000 of modified AGI (or fraction thereof) in excess of $75,000.
Married taxpayers filing separate returns lose $50 of the credit for each $1,000 of modified AGI (or fraction thereof) in excess of $55,000.
- ($80,000 - $75,000) ÷ $1,000 × $50 = $250
- $1,000 - $250 = $750
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4580 Tax Computations and Credits
Perle, a dentist, billed Wood $600 for dental services. Wood paid Perle $200 cash and built a bookcase for Perle's office in full settlement of the bill. Wood sells comparable bookcases for $350. What amount should Perle include in taxable income as a result of this transaction $0 $200 $550 $600
$550
Cash $200
Fair Market Value of the bookcases 350
----
Amount Perle should include in taxable income $550
==== When Wood built the bookcase for the dentist (Perle) rather than paying cash, this is called a “bartered service.” Barter, or the swapping of goods and services, must be included in gross income to the extent of the fair market value (FMV) of the good or service received.
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4420 Basis and Holding Periods of Assets
In a common law action against an accountant, lack of privity is a viable defense in most jurisdictions if the plaintiff:
is the client’s creditor who sues the accountant for negligence.
can prove the presence of gross negligence that amounts to a reckless disregard for the truth.
is the accountant’s client.
bases the action upon fraud.
is the client’s creditor who sues the accountant for negligence.
Privity of contract is the existence of a contractual relationship between the accountant and the client. Therefore, there is no lack of privity defense in an action brought by the client. In most cases privity is a required element of any lawsuit by an aggrieved party against the accountant. However, privity is not required if the accountant has been guilty of fraud or gross negligence.
A client’s creditor (a third party) suing for mere negligence does not have privity with the accountant and does not fall within either of the mentioned exceptions, and therefore lack of privity of contract is a viable defense against such a lawsuit (under the Ultramares doctrine).
However, recently, many jurisdictions apply the Foreseeable Third-Party Beneficiary Rule, which holds the auditor liable for simple negligence to all third parties who can reasonably be foreseen to rely on the audited financial statements. In such circumstances, the client’s creditor could be a foreseeable third-party beneficiary and lack of privity would not be a valid defense against suit for negligence.
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4131 Common Law Duties and Liability to Clients and Third …
A taxpayer sold for $200,000 equipment that had an adjusted basis of $180,000. Through the date of the sale, the taxpayer had deducted $30,000 of depreciation. Of this amount, $17,000 was in excess of straight-line depreciation. What amount of gain would be recaptured under Section 1245 (“Gain from Dispositions of Certain Depreciable Property”) $13,000 $17,000 $20,000 $30,000
$20,000
Because the taxpayer sold equipment for $200,000 that had an adjusted basis of $180,000, the taxpayer has a capital gain of $20,000.
The taxpayer had taken $30,000 in depreciation on the equipment. IRC Section 1245 requires that a gain on the sale of equipment will be treated as ordinary income to the extent of all depreciation. Although a maximum of $30,000 could have been recaptured, the total gain in the sale was $20,000, limiting the depreciation recapture to $20,000.
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4430 Cost Recovery (Depreciation, Depletion, and …
In what order are the following obligations paid after a secured creditor rightfully sells the debtor’s collateral after repossession
I. Debt owed to any junior security holder
II. Secured party’s reasonable sale expenses
III. Debt owed to the secured party
I, II, III
II, I, III
II, III, I
III, II, I
II, III, I
Under Article 9-504 of the Uniform Commercial Code (U.C.C.), obligations are paid in the following order when a secured creditor repossesses and sells the debtor’s collateral (when the debtor is in default) in a commercially reasonable manner:
- first to pay expenses incurred in selling the collateral,
- then toward the debt owed to the secured party, and
- next to any junior or inferior secured parties with rights in the collateral.
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4233 Secured Transactions
Deet, an unmarried taxpayer, qualified to itemize deductions in 2014. Deet's 2014 adjusted gross income was $40,000 and he made a $1,500 substantiated cash donation directly to a needy family. Deet also donated art, valued at $11,000, to a local art museum. Deet had purchased the art work two years earlier for $2,000. What was the maximum amount of the charitable contribution allowable as an itemized deduction on Deet's 2014 income tax return $12,500 $11,000 $3,500 $2,000
$11,000
Donations to qualifying organizations are deductible subject to certain limitations depending on the type of property donated and on the type of organization to which the donation is given. Donations to individuals are not deductible, even if the individuals are needy. Therefore, the $1,500 given to the family is not deductible.
Donations of tangible personal property that would generate long-term capital gains if sold are eligible to be deducted at their fair market value if the donated property is related to the organization’s exempt purpose. Art donated to an art museum would be a donation of long-term capital gain property that would qualify and the deduction would be valued at its fair market value.
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4530 Adjustments and Deductions to Arrive at Taxable Income
Under the Sales Article of the U.C.C., in an FOB place of shipment contract, the risk of loss passes to the buyer when the goods: are identified to the contract. are placed on the seller's loading dock. are delivered to the carrier. reach the buyer's loading dock.
are delivered to the carrier.
The Uniform Commercial Code (U.C.C.) provides that when the terms of the contract are “FOB place of shipment,” the seller must “bear the expense and risk of putting them into the possession of the carrier.” When the carrier takes custody, the risk of loss passes to the buyer.
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4231 Sales Contracts
A CPA firm auditing a public company has been asked by the CFO to also prepare the company’s tax return. The tax engagement is estimated to be approximately 6% of the billings of the audit engagement due to extraordinarily complicated factors this year. The CPA firm may:
take the tax return engagement as long as a note is placed into the financial statements noting such activity.
not take the tax return engagement since such activity would conflict with the audit.
take the return engagement if the activity is approved by the audit committee of the board of directors and disclosed to investors.
take the tax return engagement if the activity is approved by the board of directors of the company.
take the return engagement if the activity is approved by the audit committee of the board of directors and disclosed to investors.
The Sarbanes-Oxley Act (SOX) specifically allows tax services (and certain other nonaudit services) if they are pre-approved by the audit committee of the company and reported to investors. Nonaudit items of less than 5% of total amount paid by the client would not necessarily require pre-approval by the audit committee. However, here the situation exceeds the 5% threshold (SOX 201).
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4123 Requirements of Regulatory Agencies
While conducting an audit, Larson Associates, CPAs, failed to detect material misstatements included in its client’s financial statements. Larson’s unqualified opinion was included with the financial statements in a registration statement and prospectus for a public offering of securities made by the client. Larson knew that its opinion and the financial statements would be used for this purpose.
Which of the following statements is correct with regard to a suit against Larson and the client by a purchaser of the securities under Section 11 of the Securities Act of 1933
The purchaser must prove that Larson was negligent in conducting the audit.
The purchaser must prove that Larson knew of the material misstatements.
Larson will not be liable if it had reasonable grounds to believe the financial statements were accurate.
Larson will be liable unless the purchaser did not rely on the financial statements.
Larson will not be liable if it had reasonable grounds to believe the financial statements were accurate.
The best defense against a suit under Section 11 is due care. If Larson can demonstrate due care (that is, that it had reasonable grounds to believe its client’s financial statements were accurate), Larson may escape liability to a purchaser under Section 11 of the Securities Act of 1933.
Proof that the purchaser relied on the financial statements or that Larson was negligent or knew of the misstatements (scienter) are not required to create liability. Liability under Section 11 is based on misstatement or omission rather than negligence.
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4132 Federal Statutory Liability
Who regulates the licensing of CPAs The national board of accountancy State boards of accountancy The AICPA The IRS
State boards of accountancy
State boards are in place to monitor and address all licensing issues as they pertain to individuals practicing within their jurisdictions. Federal agencies have rules that must be adhered to if an individual is practicing in front of them, but generally speaking, the state handles all licensing issues outside of any other agency control.
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4122 Role of State Boards of Accountancy
Golden Enterprises, Inc., entered into a contract with Hidalgo Corporation for the sale of its mineral holdings. The transaction proved to be ultra vires. Which of the following parties, for the reason stated, may properly assert the ultra vires doctrine
Golden Enterprises to avoid performance
Hidalgo Corporation to avoid performance
A shareholder of Golden Enterprises to enjoin the sale
Golden Enterprises to rescind the consummated sale
A shareholder of Golden Enterprises to enjoin the sale
Ultra vires can be used by a shareholder against a corporation to prohibit the corporation from performing a totally executory contract. The proposed transaction is an executory contract. The other answer choices are not allowed under ultra vires.
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4261 Advantages, Disadvantages, Implications, and …
Which of the following rights does one co-surety generally have against another co-surety Exoneration Subrogation Reimbursement Contribution
Contribution
When two or more sureties exist, a surety who has paid more than his or her agreed share is entitled to reimbursement from the co-surety in accordance with the surety contract. This right to receive payment from co-sureties is known as “contribution.”
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Uniform capitalization rules apply to: real property produced by the taxpayer. tangible personal property produced by the taxpayer. I only II only Both I and II Neither I nor II
Both I and II
Uniform capitalization (UNICAP) rules apply to all real and tangible personal property produced by the taxpayer for use in a trade or business or in an activity engaged in for profit, such as property produced for sale to customers. Regulation Section 263(a)-1(b)
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4342 Inventory Valuation Methods, Including Uniform …
Prin Corp., the parent corporation, and Strel Corp., both accrual-basis, calendar-year C corporations, file a consolidated return. During the current year, Strel made dividend distributions to Prin as follows:
Adjusted Tax Basis Fair Market Value
------------------ ----------------- Cash $4,000 $4,000 Land 2,000 9,000
What amount of dividend income should be reported on Prin and Strel's consolidated income tax return for the current year $13,000 $11,000 $6,000 $0
$0
Since Prin Corp. and Strel Corp. filed a consolidated tax return, dividend income received by one member from other members of the consolidated group is eliminated. This is one of the advantages of filing a consolidated return.
If a consolidated return is not filed, a dividend received deduction of 100% is allowed for dividends from members of the affiliated group. However, there are limits on the total amount of the dividends-received deduction that may be allowed in a given year.
Under the general corporate distribution rules of IRC Section 311, a corporation that distributes appreciated property to a shareholder recognizes gain as if the asset had been sold for its fair market value. However, since these corporations file a consolidated return, such inter-company gain would also be eliminated.
IRC Sections 243 and 1504; Regulation Section 1.1502-13(f)
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4636 Consolidated Returns
Under the Revised Model Business Corporation Act, a merger of two public corporations usually requires all of the following, except:
a formal plan of merger.
an affirmative vote by the holders of a majority of each corporation’s voting shares.
receipt of voting stock by all stockholders of the original corporations.
approval by the board of directors of each corporation.
receipt of voting stock by all stockholders of the original corporations.
A merger of two corporations requires a formal plan of merger that is approved by both the board of directors and the shareholders of both corporations. There is no requirement that stockholders of the original (surviving) corporation receive voting stock from the other corporation.
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4262 Formation, Operation, and Termination
Which of the following provisions must be included to have an enforceable written residential lease
I. A description of the leased premises
II. A due date for the payment of rent
Both I and II
I only
II only
Neither I nor II
I only
A residential lease is not required to be in writing in most cases, but when a writing is included the document should at least contain a basic description of the leased premises. The document need not include a statement as to the due date for the payment of rent. The common law will presume that rent is due at the end of the term or period of tenancy unless otherwise agreed.
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4234 Documents of Title and Title Transfer
Jackson owns two residences. The second residence, which has never been used for rental purposes, is the only residence that is subject to a mortgage. The following expenses were incurred for the second residence in 2015:
Mortgage interest $5,000 Utilities 1,200 Insurance 6,000
For regular income tax purposes, what is the maximum amount allowable as a deduction for Jackson’s second residence in 2015
$6,200 in determining adjusted gross income
$11,000 in determining adjusted gross income
$5,000 as an itemized deduction
$12,200 as an itemized deduction
$5,000 as an itemized deduction
Home mortgage interest is deductible for two personal residences subject to certain limits. However, utilities and insurance on a personal residence are not deductible.
If the second residence had been rented part of the year, the utilities and insurance may have been deductible, subject to the vacation home rules.
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4512 Characterization of Income
4530 Adjustments and Deductions to Arrive at Taxable Income
Which of the following describes a testamentary trust
A trust created by a grantor who is still alive at the time the trust is created
A trust that may be amended, altered, or revoked by its grantor at any time, provided the grantor is not mentally incapacitated
A trust created by an individual’s will at or following the date of the grantor’s death
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
A trust created by an individual’s will at or following the date of the grantor’s death
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.
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4661 Types of Trusts
ABC Corporation distributes land with a fair market value (FMV) of $100,000 (adjusted basis of $75,000) to Anna when the corporation's E&P is $350,000. Anna is the sole shareholder. What basis does Anna take in the land and what amount of gain does ABC Corporation recognize, respectively, as a result of this nonliquidating property distribution $75,000; $0 $100,000; $0 $25,000; $25,000 $100,000; $25,000
$100,000; $25,000
The shareholder’s basis in property received as a result of a nonliquidating property dividend is the fair market value (FMV) on the date of the distribution. The corporation will recognize a gain for the difference between the FMV on the date of the distribution and the adjusted basis of the property at the date of the distribution. Corporations will not recognize a loss on a nonliquidating property dividend.
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4613 Distributions
A 33-year-old taxpayer withdrew $30,000 (pretax) from a traditional IRA. The taxpayer has a 33% effective tax rate and a 35% marginal tax rate. What is the total tax liability associated with the withdrawal $10,000 $10,500 $13,000 $13,500
$13,500
When the 33-year-old taxpayer withdraws $30,000 from an IRA, a penalty of 10% is imposed (0.10 × $30,000 = $3,000). The $30,000 is added to taxable income and will be taxed not at the effective rate but at the marginal rate of 35% (0.35 × $30,000 = $10,500). The total tax liability as a result of the withdrawal is $13,500 ($3,000 + $10,500).
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4560 Taxation of Retirement Plan Benefits
Hart's adjusted basis in Best Partnership was $9,000 at the time he received the following nonliquidating distributions of partnership property: Cash $5,000 Land Adjusted basis 7,000 Fair market value 10,000
What was the amount of Hart's basis in the land $0 $4,000 $7,000 $10,000
$4,000
Hart’s adjusted basis in Best Partnership $9,000
He received the following:
Cash - 5,000
——
Remaining basis allocated to the land $4,000
======
General Rule
The basis of property received in a distribution, other than in liquidation of a partner’s interest, will ordinarily be the same as the basis in the hands of the partnership immediately prior to distribution.
Limitations
In no case may the basis of property in the hands of the distributee exceed the basis of his partnership interest reduced by the amount of money distributed to him in the same transaction.
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4652 Basis of Partner’s/Member’s Interest and Basis of …
Under the federal Clean Air Act, which of the following statements is correct
Power plants are required to eliminate all air polluting emissions.
Factories that emit toxic air pollutants are required to reduce emissions by installing the best available emission control technology.
Automobile manufacturers are required to have emission control equipment installed on previously manufactured vehicles.
Homeowners are required to remove all pollutants from their residences.
Factories that emit toxic air pollutants are required to reduce emissions by installing the best available emission control technology.
The federal Clean Air Act requires that factories use the best available emission control technology to reduce the release of pollutants. The Act does not require the removal of all air and residential pollution, nor does it require that emission control equipment be installed after the sale of an automobile. Removing all pollutants is impossible and retrofitting vehicles after their sale is not required.
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4252 Other Federal Laws and Regulations (Antitrust, …
A check has the following indorsements on the back:
Paul Folk
without recourse
George Hopkins
payment guaranteed
Ann Quarry
collection guaranteed
Rachel Ott
Which of the following conditions occurring subsequent to the indorsements would discharge all of the indorsers
Lack of notice of dishonor
Late presentment
Insolvency of the maker
Certification of the check
Certification of the check
All indorsers would be discharged from liability if the check was certified subsequent to the indorsements. Under the Uniform Commercial Code, “Certification of a check is acceptance. Where a holder procures certification the drawer and all prior indorsers are discharged.”
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4232 Negotiable Instruments
Mell Corp. engaged Davis & Co., CPAs, to audit Mell’s financial statements. Mell’s management informed Davis it suspected that the accounts receivable were materially overstated. Although the financial statements did include a materially overstated accounts receivable balance, Davis issued an unqualified opinion. Mell relied on the financial statements in deciding to obtain a loan from County Bank to expand its operations. County relied on the financial statements in making the loan to Mell. As a result of the overstated accounts receivable balance, Mell has defaulted on the loan and has incurred a substantial loss.
If County sues Davis for fraud, must Davis furnish County with the audit working papers
Yes, if the working papers are lawfully subpoenaed into court
Yes, provided that Mell does not object
No, because of the privileged communication rule, which is recognized in a majority of jurisdictions
No, because County was not in privity of contract with Davis
Yes, if the working papers are lawfully subpoenaed into court
If County sues Davis for fraud, they will likely subpoena the audit working papers as evidence that Davis knew accounts receivable were materially overstated.
Audit working papers may be subpoenaed and are not protected as privileged communication.
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4133 Privileged Communications, Confidentiality, and …
During an audit of Trent Realty Corp.’s financial statements, Clark, CPA, reviewed the following instrument:
FRONT OF INSTRUMENT BACK OF INSTRUMENT
To: Pure Bank M. West
Upton, VT
Pay to C. Larr
April 5, 20X1 T. Keetin
Pay to the order of M. West $1,500.00
One Thousand Five Hundred and 00/100 Dollars C. Larr
on May 1, 20X1. Without recourse
(SIGNED) W. Fields
West's indorsement makes the instrument: bearer paper. order paper. negotiable. nonnegotiable.
bearer paper.
The signature of the payee (in this case, West) on the back of an instrument without any additional wording (called a blank indorsement) results in an instrument becoming bearer paper. No additional indorsement will be needed to negotiate the instrument. (The instrument was and continues to be negotiable because all requirements for negotiability appear on the face/front of the instrument; the blank indorsement has no effect on the negotiability of the instrument.)
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4232 Negotiable Instruments
Tom Lewis, an individual taxpayer, bought a personal residence for $2,000,000 in 2015. He assumed a mortgage on the full amount of this acquisition cost. On how much of this $2,000,000 loan amount may Tom deduct interest charges for on his 2015 tax return (assuming that he can fully itemize and deduct all such charges) $100,000 $1,000,000 $1,100,000 $2,000,000
$1,000,000
The amount of qualified acquisition indebtedness that an interest deduction is allowed for is limited to $1,000,000 ($500,000 for a married individual filing a separate return). Qualified acquisition indebtedness incurred prior to October 13, 1987, is not subject to any limitation (this is referred to as grandfathered debt). However, the aggregate amount of pre-October 13, 1987, indebtedness reduces the $1,000,000 limitation available for new acquisitions indebtedness incurred after October 13, 1987.
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4530 Adjustments and Deductions to Arrive at Taxable Income
What business entity can be voluntarily dissolved and terminated without filing a dissolution document with the state of organization
A corporation
A general partnership
A limited liability limited
A general partnership
A general partnership can be dissolved when:
-the agreed time limit of the partnership ends,
-the purpose for the partnership ends (e.g., a project),
a partner quits the partnership,
-all partners agree upon the termination, or
-the continuation of the partnership becomes illegal.
In order to legally dissolve a partnership, one must:
-notify the state and federal tax authorities (this does not include filing a dissolution document),
-notify all creditors, and
-notify suppliers, customers, clients, and anyone else who does business with the partnership of the dissolution.
Revised Uniform Partnership Act, Section 801
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4262 Formation, Operation, and Termination
Under the Secured Transactions Article of the U.C.C., which of the following statements is correct regarding the filing of a financing statement
A financing statement must be filed before attachment of the security interest can occur.
Once filed, a financing statement is effective for an indefinite period of time provided continuation statements are timely filed.
I only
II only
Both I and II
Neither I nor II
II only
The filing of a financing statement only gives public notice of the security interest. A financing statement is effective for five years, but can be continued with a continuation statement filing. Since a continuation statement can be filed indefinitely, this makes a financing statement effective indefinitely.
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4233 Secured Transactions
Which of the following statements is generally correct regarding the liability of a CPA who negligently gives an opinion on an audit of a client’s financial statements
The CPA is only liable to those third parties who are in privity of contract with the CPA.
The CPA is only liable to the client.
The CPA is liable to anyone in a class of third parties who the CPA knows will rely on the opinion.
The CPA is liable to all possible foreseeable users of the CPA’s opinion.
The CPA is liable to anyone in a class of third parties who the CPA knows will rely on the opinion.
A CPA has duties towards his client due to their privity of contract, and since no such privity exists between the CPA and third persons there is no duty of care owing to them, with one major exception. When the CPA has reason to believe his accounting services will be made available to third persons, then a legal duty of care is imposed on the CPA. When the services are primarily for the benefit of a third party, the third party is in effect a party to the contract between the CPA and the client (i.e., a third-party beneficiary).
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4121 Liability Generally
4131 Common Law Duties and Liability to Clients and Third …
Sky Corp. was a wholly owned subsidiary of Jet Corp. Both corporations were domestic C corporations. Jet received a liquidating distribution of property in cancellation of its Sky stock when Jet's tax basis in Sky stock was $100,000. The distributed property had an adjusted basis of $135,000 and a fair market value of $250,000. What amount of taxable gain did Jet, the parent corporation, recognize on the receipt of the property $250,000 $150,000 $35,000 $0
$0
Under IRC Section 332, an 80% or greater parent does not generally recognize a gain or loss on the liquidation of a subsidiary corporation. When the parent already owns 100% of the stock, then liquidating the subsidiary and passing the assets of the subsidiary to the parent does not change the economic position of the parent.
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4634 Entity/Owner Transactions, Including Contributions and …
Under Title VII of the 1964 Civil Rights Act, which of the following forms of discrimination is not prohibited Sex Age Race Religion
Age
The 1964 Civil Rights Act prohibits discrimination against employees on the basis of race, color, religion, sex, or national origin. Age discrimination is prohibited by the Age Discrimination Act (1967), but only if the individual claiming discrimination has reached the age of 40.
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4252 Other Federal Laws and Regulations (Antitrust, …
Which of the following is not considered personal property for purposes of local taxes Land Jewelry Boats Shed
Land
Since land cannot be moved, it is not considered personal property. Land is real property and would be taxed as real property.
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4370 Impact of Multijurisdictional Tax Issues on Federal …
Apex, Inc., is a small calendar-year corporation with annual gross receipts as follows: 2009 ($4 million), 2010 ($5 million), 2011 ($6 million), and 2012 ($7 million). Its 3-year average annual gross receipts are $5 million in 2011 and $6 million for 2012. Therefore, it is exempt from alternative minimum tax for 2013. What happens if Apex has annual gross receipts of $8 million for 2013
It loses its small corporation exemption and is subject to AMT for 2014.
It permanently loses its small corporation exemption.
It remains exempt from AMT for 2014.
It loses its small corporation exemption and must pay AMT for all the years it was exempt.
It remains exempt from AMT for 2014.
A small corporation loses the AMT exemption only if its average annual gross receipts for three consecutive years exceed $7.5 million. Although Apex gross receipts for 2013 exceeded $7.5 million, its 3-year average gross receipts for 2011 through 2013 were only $7 million. Therefore, it retains its status as a small corporation that is exempt from AMT.
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4632 Tax Computations and Credits, Including Alternative …
Dart, Inc., a closely held corporation, was petitioned involuntarily into bankruptcy under the liquidation provisions of Chapter 7 of the Federal Bankruptcy Code. Dart contested the petition.
Dart has not been paying its business debts as they became due, has defaulted on its mortgage loan payments, and owes back taxes to the IRS. The total cash value of Dart’s bankruptcy estate after the sale of all assets and payment of administration expenses is $100,000.
Dart has the following creditors:
- Fracon Bank is owed $75,000 principal and accrued interest on a mortgage loan secured by Dart’s real property. The property was valued at and sold, in bankruptcy, for $70,000.
- The IRS has a $12,000 recorded judgment for unpaid corporate income tax.
- JOG Office Supplies has an unsecured claim of $3,000, which was timely filed.
- Nanstar Electric Co. has an unsecured claim of $1,200, which was not timely filed.
- Decoy Publications has a claim of $18,000, of which $2,000 is secured by Dart’s inventory, which was valued and sold, in bankruptcy, for $2,000. The claim was timely filed.
What total dollar amount would Fracon Bank receive on its secured and unsecured claims $70,000 $72,000 $73,335 $75,000
$73,335
Fracon Bank is a secured creditor who is owed $75,000 by the debtor. Fracon Bank has first claim on all funds generated from the sale of the collateral. Unfortunately for Fracon, the sale of the collateral generated only $70,000. Fracon Bank becomes a general unsecured creditor for the remaining $5,000. As such, Fracon’s $5,000 claim will be subservient to the claims of priority creditors. The total amount available to pay general unsecured creditors is calculated as follows:
Total value of estate after sale of assets
and payment of administrative expenses: $100,000
Less: payment of Fracon Bank as secured creditor: (70,000)
payment to Decoy Publications as secured creditor: (2,000)
payment to IRS as priority creditor (12,000)
———
Total available for general unsecured creditors: $ 16,000
The total amount of general unsecured claims is calculated as follows:
Fracon: $ 5,000
JOG Office Supp.: 3,000
Decoy Pub.: 16,000
-------
Total unsecured: $24,000
With $16,000 available to pay $24,000 of general unsecured claims, all general unsecured creditors will be paid 16,000 ÷ 24,000, or 66.7%, of the balance due. Thus, Fracon Bank will receive $4,000 on the unsecured portion of its claim ($5,000 × 66.7% = $3,335). The total payout to Fracon Bank will be $70,000 + $3,335 = $73,335.
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4242 Bankruptcy and Insolvency
Which of the following statements best describes an advantage of the corporate form of doing business
Day-to-day management is strictly the responsibility of the directors.
Ownership is contractually restricted and is not transferable.
The operation of the business may continue indefinitely.
The business is free from state regulation.
The operation of the business may continue indefinitely.
One of the advantages of the corporate form of doing business is “perpetual life.” This means that the corporation may continue to do business indefinitely. Since the shareholders have a legal existence separate and distinct from the corporation itself, death of one or more shareholders does not affect the life of the corporation.
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4262 Formation, Operation, and Termination
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 $22,000 $26,000 $28,000 $34,000
*corpus - The corpus of a trust is the sum of money or property that is set aside to produce income for a named beneficiary. In the law of estates, the corpus of an estate is the amount of property left when an individual dies.
$26,000
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
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4663 Determination of Beneficiary’s Share of Taxable Income
Smith filed his individual income tax return on April 15, 20X1. What is the time limit for filing a claim for a refund
Three years
Later of three years after filing or two years after payment of tax
Six years
No time limit
Later of three years after filing or two years after payment of tax
A taxpayer may file a claim for a refund until the later of three years after filing a return or two years after paying the tax, whichever is later. If no return was filed, the claim must be made within two years of payment of the tax.
IRC Section 6511(a)
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4327 Statute of Limitations
Summer, a single individual, had a net operating loss of $20,000 three years ago. A Section 1244 stock loss made up 3/4ths of that loss. Summer had no taxable income from that year until the current year. In the current year, Summer has gross income of $80,000 and sustains another loss of $50,000 on Section 1244 stock. Assuming that Summer can carry the entire $20,000 net operating loss to the current year, what is the amount and character of the Section 1244 loss that Summer can deduct for the current year $35,000 ordinary loss $35,000 capital loss $50,000 ordinary loss $50,000 capital loss
$50,000 ordinary loss
The total loss for the current year equals $70,000, which is the $20,000 loss carryover plus the current-year loss of $50,000. However, Section 1244 has a limit of $50,000 per year. Therefore, of the total loss of $70,000, $50,000 will be allowed Section 1244 status and will be treated as an ordinary loss.
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4440 Taxable and Nontaxable Sales and Exchanges
Internal Revenue Code Section 651 defines a simple trust as one that meets three conditions during the year. Which of the following is not one of those conditions Distributes all income currently Does not distribute from trust corpus Does not deduct charitable contributions Does not have tax-exempt income
Does not have tax-exempt income
Simple trusts may have tax-exempt income, but the other three conditions listed must be met for the current year for a trust to be considered simple and not complex.
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4662 Income and Deductions
Generally, a disclosed principal will be liable to third parties for its agent’s unauthorized misrepresentations if the agent is:
an employee.
an independent contractor.
either an employee or an independent contractor.
None of the answer choices are correct.
an employee.
A disclosed principal is one known to a third party dealing with an agent. The third party may hold the principal liable for unauthorized misstatements of the agent when said agent is an employee because the principal/employer exercises control over an employee.
An independent contractor acts under little or no control by the principal and is generally personally responsible for his mistakes or misrepresentations; the principal (the person he contracted with) is not liable.
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4213 Duties and Liabilities of Agents and Principals
Which of the following is an advantage of forming a limited liability company (LLC) as opposed to a partnership
The entity may avoid taxation.
The entity may have any number of owners.
The owner may participate in management while limiting personal liability.
The entity may make disproportionate allocations and distributions to members.
The owner may participate in management while limiting personal liability.
An LLC with two or more members is taxed as a partnership in the absence of an election otherwise. As such, both LLCs and partnerships are pass-through entities (conduit entities) and avoid taxation. Both LLCs and partnerships allow for an unlimited number of owners. Both LLCs and partnerships allow for disproportionate allocations and distributions to members. An LLC does allow an owner to participate in management while limiting personal liability, while even a limited partnership requires managing partners to retain general liability.
Regulation Section 301.7701-2(c)(1)
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4261 Advantages, Disadvantages, Implications, and …
4611 Formation
Packer Corp., an accrual-basis, calendar-year S corporation, has been an S corporation since its inception. Starr was a 50% shareholder in Packer throughout the current year and had a $10,000 tax basis in Packer stock on January 1. During the current year, Packer had a $1,000 net business loss and made an $8,000 cash distribution to each shareholder. What amount of the distribution was includible in Starr's gross income $8,000 $7,500 $4,000 $0
$0
Since Packer Corp. has been an S corporation since its inception, it has no accumulated E&P. Distributions by S corporations with no accumulated E&P are tax-free up to the adjusted basis of the stock with any excess taxable as capital gains. In this case, the $8,000 distribution did not exceed Starr’s basis and, therefore, was not taxable.
Basis on January 1 $10,000
Pro rata share of current loss
(50% x $1,000) (500)
Distribution (8,000)
--------
Basis on December 31 $1,500 IRC Section 1368(b)
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4643 Basis of Shareholder’s Interest
4644 Entity/Owner Transactions, Including Contributions and …
Under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), also known as Superfund, a responsible party can avoid liability by use of the Third-Party Defense. Under the Third-Party Defense, the responsible party must show which of the following
I. A third party was solely responsible for the hazardous condition.
II. The third party was not the responsible person’s employee.
III. No contractual relationship exists with the third party.
I and II
I and III
II and III
I, II, and III
I, II, and III
One of the defenses available to a responsible party under CERCLA is that the occurrence was the result of an act or omission of a Third Party (Third-Party Defense). To make use of the Third-Party Defense, the responsible party must show that the third party was solely responsible for the hazardous condition, the third party was not their employee, and no contractual relationship exists with the third party.
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4252 Other Federal Laws and Regulations (Antitrust, …
Jay and Co., CPAs, audited the financial statements of Maco Corp. Jay intentionally gave an unqualified opinion on the financial statements even though material misstatements were discovered. The financial statements and Jay’s unqualified opinion were included in a registration statement and prospectus for an original public offering of Maco stock.
Which of the following statements is correct regarding Jay’s liability to a purchaser of the offering under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934
Jay will be liable if the purchaser relied on Jay’s unqualified opinion on the financial statements.
Jay will be liable if Jay was negligent in conducting the audit.
Jay will not be liable if the purchaser’s loss was under $500.
Jay will not be liable if the misstatement resulted from an omission of a material fact by Jay.
Jay will be liable if the purchaser relied on Jay’s unqualified opinion on the financial statements.
Under Section 10(b) and Rule Sections/Rules 10b-5 of the Securities Exchange Act of 1934, the professional’s intentional material misstatement coupled with reasonable reliance by the purchaser results in liability. Jay’s liability under these sections/rules requires more than mere negligence (carelessness) and a misstatement or omission of material fact. Furthermore, the amount of the loss is irrelevant.
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4132 Federal Statutory Liability
A couple filed a joint return in prior tax years. During the current tax year, one spouse died. The couple has no dependent children. What is the filing status available to the surviving spouse for the first subsequent tax year Surviving spouse Married filing separately Single Head of household
Single
The status of surviving spouse or head of household is available to the widow or widower only if he or she has a dependent child living with him or her. Since the spouse has died, the surviving spouse cannot claim married filing separately in subsequent years.
Single is the only status available to this surviving spouse.
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4530 Adjustments and Deductions to Arrive at Taxable Income
Deft, CPA, is an unsecured creditor of Golf Co. for $16,000. Golf has a total of 10 creditors, all of whom are unsecured. Golf has not paid any of the creditors for three months. Under Chapter 11 of the Federal Bankruptcy Code, which of the following statements is correct
Golf may not be petitioned involuntarily into bankruptcy because there are less than 12 unsecured creditors.
Golf may not be petitioned involuntarily into bankruptcy under the provisions of Chapter 11.
Three unsecured creditors must join in the involuntary petition in bankruptcy.
Deft may file an involuntary petition in bankruptcy against Golf.
Deft may file an involuntary petition in bankruptcy against Golf.
Chapter 11 of the Bankruptcy Code calls for the reorganization or restructuring of the debt so that the debtor can continue to operate. Bankruptcy under Chapter 11 may result from either a voluntary petition filed by the debtor or an involuntary petition filed by one or more creditors. If there are fewer than 12 creditors, any one creditor who is owed at least $15,325 (unsecured) may file petition. If there are 12 or more creditors, at least three creditors (owed collectively at least $15,325) must join in the petition. These are indexed amounts and are adjusted every three years.
In this case, since there are fewer than 12 creditors, Deft, who is owed $16,000, may file the complaint individually.
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4242 Bankruptcy and Insolvency
Curry's adjusted basis in Vantage Partnership was $5,000 at the time he received a nonliquidating distribution of land. The land had an adjusted basis of $6,000 and a fair market value of $9,000 to Vantage. What was the amount of Curry's basis in the land $9,000 $6,000 $5,000 $1,000
$5,000
Curry’s basis in the land is $5,000.
Any time a partner receives a noncash, nonliquidating distribution (in this case it is land), there is no gain or loss recognized by the partnership or the partner. The basis Curry has in the partnership interest is assigned to the land up to his total basis. So $5,000 is assigned as the basis of the land, leaving Curry’s basis in the partnership at zero.
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4652 Basis of Partner’s/Member’s Interest and Basis of …
Boles Corp., an accrual-basis, calendar-year S corporation, has been an S corporation since its inception and is not subject to the uniform capitalization rules. In the current year, Boles recorded the following:
Gross receipts $50,000
Dividend income from investments 5,000
Supplies expense 2,000
Utilities expense 1,500
What amount of net business income should Boles report on its 2014 Form 1120S, U.S. Income Tax Return for an S Corporation, Schedule K $53,500 $53,000 $48,000 $46,500
$46,500
An S corporation passes its income through to its shareholders. Each type of income that could have a different tax treatment or an effect on other items of income or expense must be passed through to the shareholders separately.
Net business income is computed as follows:
Gross receipts $50,000
Less supplies expense (2,000)
Less utilities expense (1,500)
--------
Net business income $46,500
========
Dividend income is not part of net business income.
IRC Section 1366
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4642 Determination of Ordinary Income/Loss and Separately …
Drain Corp. has two classes of stock—100,000 shares of authorized, issued, and outstanding voting common stock and 10,000 shares of authorized, issued, and outstanding nonvoting 5% cumulative, nonparticipating preferred stock with a face value of $100 per share. In 20X1, Drain’s officers and directors intentionally allowed pollutants to be discharged by Drain’s processing plant. These actions resulted in Drain having to pay penalties. Solely as a result of the penalties, no dividends were declared for the years ended December 31, 20X1, and December 31, 20X2. The total amount Drain paid in penalties was $1,000,000. In 20X2, Drain was able to recover the full amount of the penalties from an insurance company that had issued Drain a business liability policy. Drain’s directors refused to use this money to declare a dividend and decided to hold the $1,000,000 in a special fund to pay future bonuses to officers and directors.
Please choose the best answer to complete the following statement.
A stockholder’s derivative suit, if successful, probably would result in the officers and directors being:
immune from liability.
liable for abuse of discretion.
liable to the corporation for $1,000,000.
liable to the corporation for $1,000,000 and liable for abuse of discretion.
liable for abuse of discretion.
The board of directors has a fiduciary relationship to the corporation. To have violated their responsibility by knowingly allowing pollution, restricting dividends because of the fines and penalties, recovering the loss from insurance, then setting aside the money for bonuses to themselves would certainly be an abuse of discretion. They may not be liable financially because of the insurance recovery. They would not be immune to liability recovery if their actions were illegal or a breach of fiduciary duty.
To eliminate the payment of dividends and use the dollars to pay bonuses to themselves should be considered self-serving and a conflict of interest.
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4264 Rights, Duties, Legal Obligations, and Authority of …
An agent will usually be liable under a contract made with a third party when the agent is acting on behalf of:
a disclosed principal.
an undisclosed principal.
either a disclosed or an undisclosed principal.
neither a disclosed nor undisclosed principal.
an undisclosed principal.
If an agent fails to make a full disclosure of the existence and identity of the principal at the time the contract is made (i.e., the principal is undisclosed), the agent has potential contractual liability to the third person. There is no such contractual liability on the agent’s part in the event of a full disclosure of the agency relationship.
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4213 Duties and Liabilities of Agents and Principals
Grill deals in the repair and sale of new and used clocks. West brought a clock to Grill to be repaired. One of Grill’s clerks mistakenly sold West’s clock to Hone, another customer. Under the Sales Article of the U.C.C., will West win a suit against Hone for the return of the clock
No, because the clerk was not aware that the clock belonged to West
No, because Grill is a merchant to whom goods had been entrusted
Yes, because Grill could not convey good title to the clock
Yes, because the clerk was negligent in selling the clock
No, because Grill is a merchant to whom goods had been entrusted
West can claim damages against Grill but cannot bring any actions against Hone. Hone is unaware of the understanding between Grill and West and therefore has no responsibility to Grill.
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4231 Sales Contracts
Carson agreed orally to repair Ives' rare book for $450. Before the work was started, Ives asked Carson to perform additional repairs to the book and agreed to increase the contract price to $650. After Carson completed the work, Ives refused to pay and Carson sued. Ives' defense was based on the statute of frauds. What total amount will Carson recover $0 $200 $450 $650
$650
Carson will recover $650. First, let’s review the statute of frauds. This statute defines situations when a contract must be in writing to be enforced. The contract between these two parties is an oral one. There is no indication that it cannot be performed within one year. Therefore, the contract does not have to be in writing to be enforced. In addition, the Uniform Commercial Code (U.C.C.) Statute of Frauds does not apply to personal service contracts, even those for more than $500.
The other legal principle potentially related to this problem is the Parol Evidence Rule. The Parol Evidence Rule states the conditions under which oral testimony will be permitted to explain a written agreement. Since there is no written contract between the two parties, the Parol Evidence Rule does not apply! While the original discussion was for a contract of $450, the parties later discussed some refinements for a total price of $650. The contract was performed, and the party is entitled to full payment.
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4222 Performance
When dealing with small corporations, how much stock must a shareholder own for them (shareholder and corporation) to be considered related parties More than 5% More than 25% More than 45% More than 50%
More than 50%
A corporation and a shareholder are related parties if the shareholder owns more than 50% by value of the outstanding stock of the corporation.
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4460 Related Party Transactions
In 2014, 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: $0. $3,000. $4,000. $3,700.
$3,700.
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) x $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
=======
Authoritative Terms
Simple Trust
All of the net income from a simple trust must be distributed on an annual basis. The exemption amount is $300.
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4662 Income and Deductions
When parties intend to create a partnership that will be recognized under the Uniform Partnership Act, they must agree to:
conduct a business for profit.
share gross receipts from a business.
both conduct a business for profit and share gross receipts from a business.
neither conduct a business for profit nor share gross receipts from a business.
conduct a business for profit.
Section 6(1) of the Uniform Partnership Act defines a partnership as “an association of two or more persons to carry on as co-owners a business for profit.” Accordingly, by definition the partnership, to be recognized under the Uniform Partnership Act, must be conducted for a profit. Whether or not the partnership eventually achieves a profit is not determinative, rather it is the intention to make a profit that is a critical element. Section 7(3) establishes that, as part of the rules for determining the existence of a partnership, “the sharing of gross returns does not of itself establish a partnership, whether or not the persons sharing them have a joint or common right or interest in any property from which the returns are derived.” Thus, while it might be expected that the sharing of gross returns is a natural part of creating a partnership, under the Act it is not an explicit requirement.
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4261 Advantages, Disadvantages, Implications, and …
Chris, age 5, has $3,000 of interest income and no earned income this year. Assuming that the current applicable standard deduction is $1,000, how much of Chris's income will be taxed at Chris's parents' maximum tax rate for 2013 $0 $1,000 $2,200 $3,000
$1,000
Chris has interest income of $3,000. Subtracting the $1,000 standard deduction for dependents, $2,000 of income is taxable. The limit for children is $2,000, to be taxed at their own rate.
1. Gross income (all unearned income) $3,000
2. Less Standard deduction (minimum for
taxpayer claimed as a dependent) (1,000)
——-
3. Taxable income $2,000
- Gross unearned income $3,000
- Child must have net unearned income
of more than $2,000 (2,000)
——- - Gross unearned income (line 4 – line 5) $1,000
- Net unearned income (lesser of line 5
or line 6 taxed at parent’s rate) $1,000
The remaining $1,000 of taxable income is taxed at the child’s rate.
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4530 Adjustments and Deductions to Arrive at Taxable Income
Both the Rehabilitation Act of 1973 and the Americans with Disabilities Act of 1990 prohibit employment practices that discriminate on the basis of disability. Which of the following are specifically excluded as a disability
Individuals with alcohol abuse problems
Individuals with Acquired Immune Deficiency Syndrome (AIDS)
Individuals who are currently using illegal drugs
All of the answer choices are correct.
Individuals who are currently using illegal drugs
Current illegal drug use is specifically excluded as a disability. Persons with AIDS or who have an alcohol abuse problem are protected against discriminatory employment practices.
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4252 Other Federal Laws and Regulations (Antitrust, …
Under the liability provisions of Section 18 of the Securities Exchange Act of 1934, for which of the following actions would an accountant generally be liable
Negligently approving a reporting corporation’s incorrect internal financial forecasts
Negligently filing a reporting corporation’s tax return with the IRS
Intentionally preparing and filing with the SEC a reporting corporation’s incorrect quarterly report
Intentionally failing to notify a reporting corporation’s audit committee of defects in the verification of accounts receivable
Intentionally preparing and filing with the SEC a reporting corporation’s incorrect quarterly report
The Securities Exchange Act of 1934 provides for liability in the case of an intentional misrepresentation or omission of a material fact in connection with the purchase or sale of any security. Therefore, the only answer which is associated with reporting to the SEC and does not involve negligence is intentionally preparing and filing with the SEC a reporting corporation’s incorrect quarterly report.
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4132 Federal Statutory Liability
The National Association of State Boards of Accountancy (NASBA) is in place to establish standards for providers of continuing professional education (CPE) units throughout the country. The organization also works to:
establish uniform rules of accountancy for all 54 U.S. Boards.
require CPE program sponsors to provide program-level content.
provide background checks on candidates.
promulgate rules surrounding continuing education.
require CPE program sponsors to provide program-level content.
State boards dictate the rules and expectations of licensure within their individual jurisdictions, so the NASBA is tasked with monitoring CPE programs for accuracy and content. Keep in mind that not every jurisdiction has the same education requirements, so it is essential to check with each locale in order to determine what is necessary and what is not.
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4122 Role of State Boards of Accountancy
Drain Corp. has two classes of stock—100,000 shares of authorized, issued, and outstanding voting common stock and 10,000 shares of authorized, issued, and outstanding nonvoting 5% cumulative, nonparticipating preferred stock with a face value of $100 per share. In 20X1, Drain’s officers and directors intentionally allowed pollutants to be discharged by Drain’s processing plant. These actions resulted in Drain having to pay penalties. Solely as a result of the penalties, no dividends were declared for the years ended December 31, 20X1, and December 31, 20X2. The total amount Drain paid in penalties was $1,000,000. In 20X2, Drain was able to recover the full amount of the penalties from an insurance company that had issued Drain a business liability policy. Drain’s directors refused to use this money to declare a dividend and decided to hold the $1,000,000 in a special fund to pay future bonuses to officers and directors.
Please choose the correct answer to complete the following statement.
If the $1,000,000 was distributed in 20X2, each share of 5% cumulative preferred stock would receive: $5.00. $9.00. $10.00. $18.00.
$10.00.
The preferred stock is stated to be:
- nonvoting,
- 5% cumulative,
- nonparticipating, and
- face value of $100.
The face value of $100 and the 5% rate establish an annual dividend of $5 per share ($100 × .05 = $5). The nonparticipating feature indicates that no dividends beyond the $5 will be paid no matter what the company earnings are. However, the cumulative feature indicates that previously unpaid dividends must be paid to the preferred shareholders before any payment to the common shareholders. The dividends due for both 20X1 and 20X2 must be paid due to the cumulative feature.
20X1 Dividend $ 5.00/Share
20X2 Dividend $ 5.00/Share
-----------
Total Dividends $10.00/Share
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4264 Rights, Duties, Legal Obligations, and Authority of …
In the U.S. Congress, what members form the Joint Conference Committee Senate members only House of Representatives members only State Society CPAs Both House and Senate members
Both House and Senate members
The U.S. Joint Conference Committee consists of both House and Senate members. This committee solves issues between the House and Senate committees in bill approval. Since the committee consists of both House and Senate members, the differences in the bill approvals will be resolved with both involved.
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4310 Federal Tax Legislative Process
If a bill is passed by the U.S. Senate Finance Committee, where does it go from there The full Senate The House Ways and Means Committee The Joint Conference Committee The House of Representatives
The full Senate
The process of a bill in the U.S. Congress is as follows:
- The House Ways and Means Committee starts the federal bill.
- The House of Representatives approves the bill (with changes).
- The Senate Finance Committee approves the bill (with more changes).
- The full Senate then votes on the bill.
- Since there were changes to the bill, it then goes to a Joint Conference Committee.
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4310 Federal Tax Legislative Process
Which of the following parties is liable to repay an illegal distribution to a corporation
A director not breaching his or her duty in approving the distribution and the corporation is solvent.
A director not breaching his or her duty in approving the distribution and the corporation is insolvent.
A shareholder not knowing of the illegality of the distribution and the corporation is solvent.
A shareholder not knowing of the illegality of the distribution and the corporation is *insolvent.
*insolvent - unable to pay debts owed.
A shareholder not knowing of the illegality of the distribution and the corporation is insolvent.
A director is individually liable if the director engages in illegal conduct or conduct that is a breach of fiduciary duty to the corporation. If a director has not breached his or her duty, then he or she is not liable to repay the illegal distribution.
A shareholder does not normally have a fiduciary duty to the corporation. However, if a shareholder furthers his or her own interests (by accepting the distribution) to the detriment of the corporation (the corporation is insolvent), then a fiduciary duty exists. Breaching that fiduciary duty can have consequences such as the liability to repay the illegal distribution.
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4264 Rights, Duties, Legal Obligations, and Authority of …
On August 1, Neptune Fisheries contracted in writing with West Markets to deliver to West 3,000 pounds of lobsters at $4.00 a pound. Delivery of the lobsters was due October 1 with payments due November 1. On August 4, Neptune entered into a contract with Deep Sea Lobster Farms that provided as follows: “Neptune Fisheries assigns all the rights under the contract with West Markets dated August 1 to Deep Sea Lobster Farms.” The best interpretation of the August 4 contract would be that it was:
only a delegation of duties by Neptune.
an unenforceable third-party beneficiary contract.
only an assignment of rights by Neptune.
an assignment of rights and a delegation of duties by Neptune.
an assignment of rights and a delegation of duties by Neptune.
An assignment of a contract is generally interpreted as both an assignment of right and a delegation of duties.
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4222 Performance
Under the Secured Transactions Article of the U.C.C., which of the following statements is correct regarding a security interest that has not attached
It is effective against the debtor, but not against third parties.
It is effective against both the debtor and third parties.
It is effective against third parties with unsecured claims.
It is not effective against either the debtor or third parties.
It is not effective against either the debtor or third parties.
A security interest is an interest in personal property or fixtures that secures payment or performance of an obligation. Attachment is the creation and coming into existence of a security interest. Attachment requires a security agreement between the debtor and the secured party; the secured party must give value and have rights in the collateral. If these things do not occur, then no attachment has been completed and it is not effective against either the debtor or third parties.
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4233 Secured Transactions
Sand orally promised Frost a $10,000 bonus, in addition to a monthly salary, if Frost would work two years for Sand. If Frost works for the two years, will the statute of frauds prevent Frost from collecting the bonus
No, because the contract did not involve an interest in real estate
No, because Frost fully performed
Yes, because the monthly salary was the consideration of the contract
Yes, because the contract could not be performed within one year
No, because Frost fully performed
The statute of frauds applies only to contracts for the sale of goods, a transfer of interest in land, promises to pay for the debts of another, or contracts that cannot be performed within one year. Consequently, the statute of frauds will not be considered in the performance of this contract.
Frost did fully perform and therefore a contract has been created. A contract contains an offer, acceptance of the offer, and valid consideration. Sand offered Frost a bonus, Frost agrees to work the two years (acceptance), and the $10,000 is the motivation or consideration for the contract.
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4222 Performance
Which of the following is allowed in the calculation of the taxable income of a simple trust
Exemption
Standard deduction
Brokerage commission for purchase of tax-exempt bonds
Charitable contribution
Exemption
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.
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4662 Income and Deductions
Which of the following courts listens to an appeal from a taxpayer or the government when there is a disagreement with the trial court's decision U.S. Court of Federal Claims U.S. Tax Court U.S. District Court U.S. Federal Court of Appeals
U.S. Federal Court of Appeals
The U.S. Federal Court of Appeals hears the appeals from taxpayers or the government if they disagree with the trial court’s decision. The appropriate procedures must be followed in order for the process to begin. The Court of Appeals hears both tax and nontax cases.
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4323 Judicial Process
Which of the following facts must be proven for a plaintiff to prevail in a common-law negligent misrepresentation action
The misrepresentations concerned opinion.
The plaintiff justifiably relied on the misrepresentations.
The defendant made the misrepresentations with a reckless disregard for the truth.
The misrepresentations were in writing.
The plaintiff justifiably relied on the misrepresentations.
In the Ultramares case, a third party who proves gross negligence will be able to prove that the CPA is guilty of fraud. Gross negligence is a deceit that involves a misrepresentation of a material fact, with lack of reasonable ground for belief, relied upon by another, which causes damage to that party.
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4131 Common Law Duties and Liability to Clients and Third …
Browne, a self-employed taxpayer, had 2015 business net income of $260,000 prior to any expense deduction for equipment purchases. In 2015, Browne purchased and placed into service, for business use, office machinery costing $120,000. This was Browne's only 2015 capital expenditure. Browne's business establishment was not in an economically distressed area. Browne made a proper and timely expense election to deduct the maximum amount. Browne was not a member of any pass-through entity. What is Browne's deduction under the election $15,000 $120,000 $108,000 $25,000
$120,000
Browne is allowed to expense up to $500,000 in 2015. Therefore, since Browne’s purchase only cost $120,000, he can deduct the entire amount. If the taxpayer purchases, in 2015, qualified tangible personal property in excess of $2,000,000, the $500,000 is reduced dollar for dollar.
IRC Section 179
Note
Taxpayers (except trusts, estates, and certain noncorporate lessors) can elect (on Form 4562) to expense up to $500,000 of the cost of personal property purchased and used in the active conduct of a trade or business. The amount of the deduction cannot exceed net income before the Section 179 deduction. Excess amounts carry over to future years.
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4430 Cost Recovery (Depreciation, Depletion, and …
The following note was executed by Elizabeth Quinton on April 17, Year 9 and delivered to Ian Wolf:
(face)
_________________________________
| April 17, Year 9
|
| On demand, the undersigned promises to pay to the order of Ian Wolf
|
| Seven Thousand and 00/100 Dollars |
|
| Elizabeth Quinton
| Elizabeth Quinton
(back)
Ian Wolf | Ian Wolf | | Pay: George Vernon | Samuel Thorn | Samuel Thorn | | Pay: Alan Yule | George Vernon | George Vernon | | Alan Yule | Alan Yule
In sequence, beginning with Wolf’s receipt of the note, this note is properly characterized as what type of negotiable instruments Order, order, bearer, order, bearer Order, bearer, order, order, bearer Bearer, order, order, order, bearer Bearer, bearer, order, order, order
Order, bearer, order, order, bearer
Order paper is made payable to a named party and can be negotiated only by delivery with the necessary endorsement of the named party. Bearer paper is made payable to bearer, it may be negotiated by delivery alone without any endorsement, and it may also be negotiated by delivery with endorsement.
- The document was originally made payable to Ian Wolf: Order
- Then endorsed by Ian Wolf with no “payable to”: Bearer
- Then endorsed by Samuel Thorn payable to George Vernon: Order
- Then endorsed by George Vernon payable to Allen Yule: Order
- Then endorsed by Allen Yule with no “payable to”: Bearer
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4232 Negotiable Instruments
If the executor of a decedent's estate elects the alternate valuation date and none of the property included in the gross estate has been sold or distributed, the estate assets must be valued as of how many months after the decedent's death 12 9 6 3
6
Normally, the value included in the gross estate is the fair market value of the property at the date of the decedent’s death. However, the executor can make an irrevocable election (on Form 706) to use an “alternate valuation date” which is generally six months after death (or if the property is disposed, distributed, or sold, during that “6-month period” that value must be used). In order to elect the “alternative valuation date,”both the value of the gross estate and the estate tax liability must be less than those amounts would be at the date of death.
In this question, since none of the property was sold or distributed during the 6-month period, all of his or her property will be valued for estate tax purposes six months after the decedent’s death. The use of the alternate valuation date must result in a lower valuation and lower tax.
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4473 Determination of Taxable Estate
An individual entered into several exchanges during the current tax year. Which of the following exchanges is classified as a like-kind exchange
Partnership interest for partnership interest
Common stock for common stock
Apartment building for unimproved land
Manufacturing equipment for factory building
Apartment building for unimproved land
For a tax-free exchange with the objective of postponing a gain or loss, property held for use in a trade or business, or for investment, must be exchanged for property of like kind, which will then be held for business or investment purposes.
Required swaps are: real estate for real estate and personal property for personal property. The following may only be exchanged for similar items: Office furniture Computers Airplanes Automobiles Buses Light trucks Heavy trucks
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4440 Taxable and Nontaxable Sales and Exchanges
To establish a cause of action based on strict liability in tort for personal injuries resulting from using a defective product, one of the elements the plaintiff must prove is that the seller (defendant):
failed to exercise due care.
was in privity of contract with the plaintiff.
defectively designed the product.
was engaged in the business of selling the product.
was engaged in the business of selling the product.
Strict liability means that no matter how careful the seller/manufacturer was in the design, manufacture, and/or distribution of the product, any injury to the user caused by a defective product will result in liability irrespective of fault or of privity. The injured plaintiff in such a case must prove that the seller (defendant) was in the business of selling the product and not merely a casual or next-door-neighbor seller.
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4231 Sales Contracts
On May 2, Handy hardware sent Ram Industries a signed purchase order that stated, in part, as follows:
“Ship for May 8 delivery 300 Model A-X socket sets at current dealer price. Terms 2/10/net30.”
Ram received Handy’s purchase order on May 4. On May 5, Ram discovered that it had only 200 Model A-X socket sets and 100 Model W-Z socket sets in stock. Ram shipped the Model A-X and Model W-Z sets to Handy without any explanation concerning the shipment. The socket sets were received by Handy on May 8.
Which of the following statements concerning the shipment is correct
Ram’s shipment is an acceptance of Handy’s offer.
Handy’s order must be accepted by Ram in writing before Ram ships the socket sets.
Ram’s shipment is a counteroffer.
Handy’s order can only be accepted by Ram shipping conforming goods.
Ram’s shipment is an acceptance of Handy’s offer.
Ram’s shipment is an acceptance of Handy’s offer. The fact that Ram shipped out the order (whether it had the A-X sockets or the W-Z sockets was irrelevant) was acceptance enough for Handy’s offer to pay in 2/10/net30.
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4231 Sales Contracts
Which of the following defenses by a surety will be effective to avoid liability
Incompetency of the debtor to make the contract in question
Insolvency in the bankruptcy sense by the debtor
Lack of consideration to support the surety undertaking
Fraudulent statements by the principal debtor that induced the surety to assume the obligation and that were unknown to the creditor
Lack of consideration to support the surety undertaking
One of the defenses to the surety to avoid liability to the creditor is anything that will hurt the surety’s chance of coming out whole. Consequently, “lack of consideration to support the surety undertaking” is correct. The other three answer choices are not included in the list of defenses.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Under the Sales Article of the U.C.C., and unless otherwise agreed to, the seller’s obligation to the buyer is to:
deliver all goods called for in the contract to a common carrier.
set aside conforming goods for inspection by the buyer before delivery.
hold conforming goods and give the buyer whatever notification is reasonably necessary to enable the buyer to take delivery.
deliver the goods to the buyer’s place of business.
hold conforming goods and give the buyer whatever notification is reasonably necessary to enable the buyer to take delivery.
Under the UCC sellers are obligated to transfer and deliver conforming goods. The seller must tender delivery of conforming goods. The tender must be at a reasonable time and place. The seller’s obligation is described in option (B). The seller has the goods as agreed (the tender) and stands ready to deliver the goods as agreed.
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4231 Sales Contracts
Your firm has the enviable task of auditing the Azzon/Doble Oil and Gas Company, a rather large player in the oil and gas arena. You are asked to attend the meetings with the audit partner. Which of the following scenarios should be the proper result
The audit partner discusses matters of significance with management and provides recommended solutions and ramifications of alternative disclosure and accounting treatments. He also reports on all of these matters, and more, to the full board of directors.
The audit partner reports all significant and critical accounting methods to the full board of directors, and discloses the preferred method of handling accounting issues of the company to the full board at that time.
The audit partner reports all significant matters and discusses its concerns with management. Management promises to report your findings, and particularly your recommendations of ways to handle the matters, to the audit committee.
The audit partner discusses matters of significance with management and provides recommended solutions and ramifications of alternative disclosure and accounting treatments. He also reports on all of these matters, and more, to the audit committee of the board of directors. He also reports the same to the full board.
The audit partner discusses matters of significance with management and provides recommended solutions and ramifications of alternative disclosure and accounting treatments. He also reports on all of these matters, and more, to the audit committee of the board of directors. He also reports the same to the full board.
As per Section 204 of the Sarbanes-Oxley Act (SOX), the accounting firm must report to the audit committee all critical accounting issues and alternative treatments. There is no prohibition from discussing these items with management and/or the full board. In the other answers, the audit committee was not involved. Worse, no discussion had occurred with the board or the audit committee.
It could be argued that reporting to the full board alone (which is composed of members of the audit committee) would seem to be sufficient. However, SOX requires the audit committee, which is not composed of members of management and of members familiar with accounting, to hear and consider these technical discussions, and to assure possible disclosure of internal affairs known “only” to management (aka prevent management from hiding things from the Board).
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4123 Requirements of Regulatory Agencies
Under the Negotiable Instruments Article of the U.C.C. (Article 3), which of the following provisions satisfies the requirement that an instrument, to be negotiable, must be payable at a definite time
The instrument is dated and payable “15 days after sight.”
The instrument is dated and payable “in six months but the payor may extend this period indefinitely.”
The instrument is undated and payable “30 days after date.”
The instrument is undated and payable “when the payee dies.”
The instrument is dated and payable “15 days after sight.”
The key to the answer here is the definition of “Payment at a Definite Time”: an instrument is payable at a definite time if it states that it is payable (i) on a specified date, (ii) within a definite period of time, or (iii) on a date or at a time readily ascertainable at the time the promise or order is made. Based on this definition, only this answer provides such a definite time at the time the instrument was made.
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4232 Negotiable Instruments
Under the U.C.C. Secured Transactions Article, what is the order of priority for the following security interests in store equipment
I. Security interest perfected by filing on April 15, Year 4
II. Security interest attached on April 1, Year 4
III. Purchase money security interest attached April 11, Year 4, and perfected by filing on April 20, Year 4
II, I, III
I, III, II
III, II, I
III, I, II
III, I, II
Item III, a purchase money security interest, has priority over nonpurchase money securities when perfected within 20 days of attachment. Item I has priority over item II because it was perfected. Item II was not perfected.
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4233 Secured Transactions
Gray Corp. had taxable income of $100,000 before capital gains for 2014. Here is a history of the corporate capital gain transactions:
2009 $ 10,000 2012 $ 8,000 2010 $ 3,000 2013 $(40,000) 2011 $ 0 2014 $ 20,000
What is Gray Corp.’s 2014 taxable income including capital gains and what M-1 adjustment, if any, will Gray Corp. report on its corporate income tax return
Taxable income: $80,000; M-1 adjustment: $40,000
Taxable income: $100,000; M-1 adjustment: $20,000
Taxable income: $101,000; M-1 adjustment: $19,000
Taxable income: $120,000; M-1 adjustment: $0
Taxable income: $100,000; M-1 adjustment: $20,000
Corporations are not allowed a deduction for capital losses. They can only be used to offset capital gains. Corporations can carry capital losses back three years and forward five years. In this case, Gray Corp. incurred a capital loss in 2013, which was carried back to offset all available capital gains in 2010, 2011, and 2012, and the excess is carried forward to 2014 as follows:
2013 loss $40,000
Carry back to
2010 ( 3,000)
2011 0
2012 ( 8,000)
--------
Available to carryforward $29,000
Used 2014 20,000
--------
Available for 2015 through 2019 $ 9,000
========
So the total taxable income is $100,000 computed as follows:
Income before capital gain $100,000
Capital gain 20,000
Less capital loss carryforward (20,000)
---------
Income after capital items $100,000
========= The $20,000 of capital loss carryforward used in 2014 is also entered as a Schedule M-1 adjustment.
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4621 Reconciliation of Book Income to Taxable Income
Under the Negotiable Instruments Article of the U.C.C. (Article 3), a holder in due course in a nonconsumer transaction takes a negotiable instrument free from which of the following defenses that may be asserted by a party with whom the holder in due course had not dealt
Fraud in the execution
Discharge in an insolvency proceeding
Breach of contract
Infancy, to the extent that it is a simple contract defense
Breach of contract
A holder in due course takes an instrument for value, in good faith, and without notice. Simple breach of contract defenses are considered “personal defenses” and cannot be used against holders in due course.
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4232 Negotiable Instruments
A shareholder's basis in the stock of an S corporation is increased by the shareholder's pro rata share of income from: tax-exempt interest. taxable interest. both tax-exempt and taxable interest. neither tax-exempt nor taxable interest.
both tax-exempt and taxable interest.
A shareholder’s basis in the stock of an S corporation is increased by the shareholders pro rata share of income from both tax-exempt interest and taxable interest.
In fact, the basis is increased by all taxable income and tax-exempt income and is decreased by all deductible losses/expenses and nondeductible losses/expenses.
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4643 Basis of Shareholder’s Interest
Which of the following payments is deducted from an employee’s salary
Unemployment compensation insurance
Workers’ compensation insurance
Both unemployment compensation insurance and workers’ compensation insurance
Neither unemployment compensation insurance nor workers’ compensation insurance
Neither unemployment compensation insurance nor workers’ compensation insurance
Unemployment compensation insurance and workers’ compensation insurance constitute part of the payroll tax expense of the employer. Neither can be deducted from the employee’s salary.
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4252 Other Federal Laws and Regulations (Antitrust, …
Under the “Ultramares” rule, to which of the following parties will an accountant be liable for negligence
Parties in privity of contract
Foreseen parties
Both parties in privity and foreseen parties
Neither parties in privity nor foreseen parties
Parties in privity of contract
The Ultramares rule derives from the case of Ultramares Corporation v. Touche (N.Y. 1931). In that case, the court held that a CPA’s liability for negligent acts extended only to those parties with whom the CPA was in privity of contract, unless the victim could prove gross negligence or fraud. While some states have expanded the liability of the CPA to include “foreseeable” parties (parties who the accountant knew would use the work product), this is not the holding of the Ultramares case.
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4131 Common Law Duties and Liability to Clients and Third …
Are start-up expenses incurred in January 2014 amortized over 60 months for sole proprietorships and partnerships
Sole proprietorships: Yes; Partnerships: Yes
Sole proprietorships: Yes; Partnerships: No
Sole proprietorships: No; Partnerships: No
Sole proprietorships: No; Partnerships: Yes
Sole proprietorships: No; Partnerships: No
For start-up expenses incurred after August 16, 2011, taxpayers may deduct up to $5,000 in the taxable year in which the business begins. The $5,000 amount is reduced by the amount by which the cumulative cost of start-up expenditures exceeds $50,000. Any remaining start-up expenditures not deducted are amortized over a 15-year period (180 months).
IRC Section 195
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4611 Formation
Under the provisions of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, which of the following activities must be proven by a stock purchaser in a suit against a CPA
I. Intentional conduct by the CPA designed to deceive investors
II. Negligence by the CPA
I only
II only
Both I and II
Neither I nor II
I only
Under the Securities Exchange Act of 1934, the CPA can be held liable to investors in certain circumstances. The United States Supreme Court, in Hochfelder (1976), ruled that such liability will attach only if scienter can be proven. Scienter is a deliberate act intended to deceive, manipulate, or defraud. Thus, simple negligence is not sufficient to impose liability on the CPA under this interpretation of the statute.
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4132 Federal Statutory Liability
Under which of the following circumstances may a CPA charge fees that are contingent upon finding a specific result
For preparation of an amended tax return
For preparation of an original tax return
If fixed by courts, other public authorities, or in tax matters if based on the results of judicial proceedings
For preparation of a claim for tax refund
If fixed by courts, other public authorities, or in tax matters if based on the results of judicial proceedings
Under Treasury Circular 230, Section 10.27(b)(1), a CPA may not charge a contingent fee for “services rendered in connection with any matter before the Internal Revenue Service.” This would include an original tax return, amended tax return, or claim for a tax refund. Under Circular 230, Section 10.27(b)(4), a CPA can charge a contingent fee “in connection with any judicial proceeding arising under the Internal Revenue Code.”
ET Rule 203 (“Contingent fees”) of the AICPA Professional Standards uses the wording “if fixed by courts or other public authorities, or, in tax matters, if determined based on the results of judicial proceedings” to describe contingent fees that a CPA may charge.
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4111 Treasury Department Circular 230
How is a domestic LLC with at least two members classified for federal tax purposes (The domestic LLC has not filed IRS Form 8832.) S corporation LLC C corporation Partnership
Partnership
If the entity does not file IRS Form 8832 and is a domestic LLC with at least two members, the entity will be classified as a partnership.
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4350 Tax Return Elections, Including Federal Status …
Generally, which of the following statements concerning workers’ compensation laws is correct
The amount of damages recoverable is based on comparative negligence.
Employers are strictly liable without regard to whether or not they are at fault.
Workers’ compensation benefits are not available if the employee is negligent.
Workers’ compensation awards are payable for life.
Employers are strictly liable without regard to whether or not they are at fault.
Workers’ compensation is a system which imposes liability on employers for on the job injuries regardless of fault. The mere fact that the employee is negligent would not eliminate this coverage, since the system operates regardless of fault. In return, the worker accepts a scheduled level of payments under the statute, instead of filing suit against the employer.
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4252 Other Federal Laws and Regulations (Antitrust, …
Ivor and Associates, CPAs, audited the financial statements of Jaymo Corp. As a result of Ivor’s negligence in conducting the audit, the financial statements included material misstatements. Ivor was unaware of this fact. The financial statements and Ivor’s unqualified opinion were included in a registration statement and prospectus for an original public offering of stock by Jaymo. Thorp purchased shares in the offering. Thorp received a copy of the prospectus prior to the purchase but did not read it. The shares declined in value as a result of the misstatements in Jaymo’s financial statements becoming known. Under which of the following Acts is Thorp most likely to prevail in a lawsuit against Ivor
Securities Act of 1933 (Section 11)
Securities Exchange Act of 1934 (Section 10(b), Rule 10b-5)
Both the Securities Act of 1933 (Section 11) and the Securities Exchange Act of 1934 (Section 109(b), Rule 10b-5)
Neither the Securities Act of 1933 nor the Securities Exchange Act of 1934
Securities Act of 1933 (Section 11)
Under Section 11 of the Securities Act of 1933, the plaintiff need only show that misstated material information was contained in the prospectus prior to the public offering. Section 10(b)/Rule 10b-5 requires reliance by the purchaser and knowledge of the falsity (scienter) on the part of the CPA.
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4132 Federal Statutory Liability
The Federal Fair Debt Collection Practices Act prohibits a debt collector from engaging in unfair practices. Under the Act, a debt collector generally can be prevented from:
contacting a third party to ascertain a debtor’s location.
continuing to collect a debt.
communicating with a debtor who is represented by an attorney.
commencing a lawsuit to collect a debt.
communicating with a debtor who is represented by an attorney.
The Fair Debt Collection Practices Act regulates the collection of consumer (noncommercial) debt. Some of the FDCPA provisions are that:
-debtors may not be contacted at inconvenient times,
-debtors cannot be contacted at their place of employment,
-creditors cannot continue to contact a debtor who has expressed in writing that he wants no more contact (they must use other methods to continue to collect),
-if notified of the fact that the debtor has retained an attorney, the creditor must contact the attorney only,
creditors may not harass or abuse debtors, and
-collectors may not misrepresent their affiliations or any actions they may take.
Creditors may commence a lawsuit to collect a debt, contact third parties to ascertain the location of the debtor, and continue to collect the debt by communicating using methods allowed by the FDCPA. They may not communicate with a debtor who is represented by an attorney.
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4241 Rights, Duties, and Liabilities of Debtors, Creditors, …
Under the Sales Article of the U.C.C., and unless otherwise agreed to, the seller’s obligation to the buyer is to:
deliver the goods to the buyer’s place of business.
hold conforming goods and give the buyer whatever notification is reasonably necessary to enable the buyer to take delivery.
deliver all goods called for in the contract to a common carrier.
set aside conforming goods for inspection by the buyer before delivery.
hold conforming goods and give the buyer whatever notification is reasonably necessary to enable the buyer to take delivery.
The manner of the seller’s tender of delivery is provided for in Uniform Commercial Code (U.C.C.) Section 2-503. The U.C.C. stipulates that a seller is under an obligation to “put and hold conforming goods at the buyer’s disposition and give the buyer any notification reasonably necessary to enable him to take delivery.”
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4231 Sales Contracts
Under the Internal Revenue Code sections pertaining to partnerships, guaranteed payments are payments to partners for:
payments of principal on secured notes honored at maturity.
timely payments of periodic interest on bona fide loans that are not treated as partners’ capital.
services or the use of capital without regard to partnership income.
sales of partners’ assets to the partnership at guaranteed amounts regardless of market values.
services or the use of capital without regard to partnership income.
Guaranteed payments are payments to partners for services or the use of capital without regard to partnership income.
Note
Guaranteed payments for a partner’s services or capital are treated like salary payments to an employee or interest payments to a creditor rather than partnership distributions.
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4651 Determination of Ordinary Income/Loss and Separately …
To which of the following parties may a CPA partnership provide its working papers without either the client's consent or a lawful subpoena The IRS: Yes; The FASB: Yes The IRS: Yes; The FASB: No The IRS: No; The FASB: Yes The IRS: No; The FASB: No
The IRS: No; The FASB: No
Generally, clients must be asked whether their materials can be released to other parties. Here, however, the question’s proper answer hinges on other matters.
Though the FASB is a governing board for accounting standards, it has neither the inherent ability nor the power to require CPAs to provide copies of working papers to the board. It is not a licensing (or regulatory) board, such as a state board of public accountancy.
The IRS has tremendous and broad administrative powers, particularly in criminal matters, yet it must still follow the law and follow due process procedures. The key to understanding this part of the question is the lack of a lawful subpoena being noted as having been issued. Once a subpoena has been issued, compliance will be necessary. Notice, however, that a third party, the judiciary, has independently reviewed the IRS’s materials and determined that probable cause or other appropriate justification is present to issue the subpoena. Unlike an attorney, a CPA does not have absolute privilege, although tax workpapers have some limited privilege. It is not clear here whether such requested records are tax or other working papers.
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4133 Privileged Communications, Confidentiality, and …
In negotiations with Andrews for the lease of Kemp’s warehouse, Kemp orally agreed to pay one-half of the cost of the utilities. The written lease, later prepared by Kemp’s attorney, provided that Andrews pay all of the utilities, Andrews refused, claiming that the lease did not accurately reflect the oral agreement. Andrews also learned that Kemp intentionally misrepresented the condition of the structure of the warehouse during the negotiations between the parties. Andrews sued to rescind the lease and intends to introduce evidence of the parties’ oral agreement about sharing the utilities and the fraudulent statements made by Kemp. The parol evidence rule will prevent the admission of evidence concerning the:
I. oral agreement regarding who pays the utilities.
II. fraudulent statements by Kemp.
Both 1 and 2
Only 2
Only 1
Neither 1 or 2
Only 1
Generally, the parol evidence rule will not allow oral evidence to alter the terms of a written contract. The parol evidence rule will only allow the admission of evidence that is not in the written contract in limited circumstances. Since there was evidently no fraud in the case, the oral evidence will not be admitted.
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4222 Performance
Simmons gives her child a gift of publicly traded stock with a basis of $40,000 and a fair market value of $30,000. No gift tax is paid. The child subsequently sells the stock for $36,000. What is the child's recognized gain or loss, if any $4,000 loss No gain or loss $6,000 gain $36,000 gain
No gain or loss
Because of the special situation in this gift, neither a gain nor a loss can be computed on the sale of this stock received as a gift. In this situation, the selling price is less than the basis for gain and more than the basis for loss.
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4420 Basis and Holding Periods of Assets
What is an example of property that can be considered either personal property or real property Air rights Mineral rights Harvested crops Growing crops
Growing crops
Growing crops are normally considered part of the land and are thus considered realty. However, if the land were sold, the sales contract could exclude such crops, and as such the crops would not go with the land and would be considered personalty.
Air rights are considered real property rights. For example, early cases held it to be trespass to the land if high-tension electrical lines run over a piece of property even if the wire doesn’t touch the property.
Mineral rights are part of the real property bundle of rights. Mineral rights are commonly associated with subsurface rights, such as oil and gas, but there are mineral surface rights as well, such as granite. Mineral rights are divisible from the surface estate.
Harvested crops are considered personal property; they no longer are a part of the land. Consider a sale of timber; growing timber is part of the land and as such is realty, but the harvested timber is considered personalty as it has been severed from the land. Further, harvested crops are considered goods and as such sales are controlled by the U.C.C.
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4231 Sales Contracts
4410 Types of Assets
John Larken is a single taxpayer. He sells the home he has owned and lived in for the past 31 years for a gain of $200,000 on October 5, 2014. How much of this gain may he exclude $200,000 $125,000 $63,333 $12,500
$200,000
Up to $250,000 of gain ($500,000 for married persons filing jointly) is excluded on home sales after May 6, 1997. The new exclusion replaces the two methods of avoiding home sale gain under prior law:
A home seller qualifies for the full $250,000 exclusion if the following requirements are met:
-the seller owned and used the home as a principal residence (a main home) for at least two years of the 5-year period ending on the sale date, and
-the seller did not previously use the home sale exclusion during the 2-year period ending on the date that the current home sale takes place, disregarding any sale prior to May 7, 1997.
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4550 Loss Limitations
Carr Corp. declared a 7% stock dividend on its common stock. The dividend:
must be registered with the SEC pursuant to the Securities Act of 1933.
is includable in the gross income of the recipient taxpayers in the year of receipt.
has no effect on Carr’s earnings and profits for federal income tax purposes.
requires a vote of Carr’s stockholders.
has no effect on Carr’s earnings and profits for federal income tax purposes.
A “stock dividend” is the issuance by the company of additional shares of stock to current shareholders. The issuance has no effect on the company’s earnings and profits for income tax purposes.
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4264 Rights, Duties, Legal Obligations, and Authority of …
4512 Characterization of Income
A CPA will be liable to a tax client for damages resulting from all of the following actions, except:
failing to timely file a client’s return.
failing to advise a client of certain tax elections.
refusing to sign a client’s request for a filing extension.
neglecting to evaluate the option of preparing joint or separate returns that would have resulted in a substantial tax savings for a married client.
refusing to sign a client’s request for a filing extension.
A CPA will be liable to a tax client for damages from:
- failing to timely file a client’s return,
- failing to advise a client of certain tax deductions, and
- neglecting to evaluate the option of preparing joint or separate returns that would have resulted in substantial tax savings for a married client.
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4131 Common Law Duties and Liability to Clients and Third …
Under the Revised Model Business Corporation Act, which of the following statements is correct regarding corporate officers of a public corporation
An officer may not simultaneously serve as a director.
A corporation may be authorized to indemnify its officers for liability incurred in a suit of stockholders.
Stockholders always have the right to elect a corporation’s officers.
An officer of a corporation is required to own at least one share of the corporation’s stock.
A corporation may be authorized to indemnify its officers for liability incurred in a suit of stockholders.
Officers of a corporation can be held liable to the corporation for failure to carry out their duties in a non-negligent fashion. The liability is enforced by means of a “derivative action lawsuit,” in which the corporation (plaintiff) sues the officers for damages. However, the Model Business Corporation Act permits the corporation to indemnify the officers for any liability incurred in such a lawsuit (except for acts which constitute a deliberate breach of the fiduciary duty of good faith).
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4262 Formation, Operation, and Termination
The following endorsements appear on the back of a negotiable promissory note payable to Lake Corp.:
Pay to John Smith only
Frank Parker, President of Lake Corp
John Smith
Pay to the order of Sharp, Inc., without recourse,but only if Sharp delivers computers purchased by Mary Harris by March 15, Year 2
Mary Harris
Sarah Sharp, President of Sharp, Inc.
Which of the following statements is correct
The note became nonnegotiable as a result of Parker’s endorsement.
Smith’s endorsement effectively prevented further negotiation of the note.
Harris’s endorsement was a conditional promise to pay and caused the note to be nonnegotiable.
Harris’s signature was not required to effectively negotiate the note to Sharp.
Harris’s signature was not required to effectively negotiate the note to Sharp.
The endorsement by Harris is a conditional endorsement. Under the Uniform Commercial Code (U.C.C.), anyone taking the instrument for value can disregard the condition.
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4232 Negotiable Instruments
Which of the following actions may a corporation take without its stockholders’ consent
Consolidate with one or more corporations.
Merge with one or more corporations.
Dissolve voluntarily.
Purchase 55% of another corporation’s stock.
Purchase 55% of another corporation’s stock.
A corporation may purchase 55% of another corporation’s stock without its stockholders’ consent. Recall the definition of consolidation—when two corporations agree to trade their shares in for stock of a new corporation. That, in effect, causes the dissolution of the original corporation.
Dissolution requires shareholder approval as does a merger. However, acquiring stock of a “target” corporation does not require shareholder approval.
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4262 Formation, Operation, and Termination
Income of a trust that is taxed to the trust is taxed at the rate applicable to: single individuals. corporations. estates and trusts. unified transfers.
estates and trusts.
Income of an estate or trust that is taxed to that entity uses a separate tax rate for estates and trusts. The tax rate accelerates quickly.
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4662 Income and Deductions
Allen owns 100 shares of Prime Corp., a publicly traded company, which Allen purchased on January 1, 2009, for $10,000. On January 1, 2014, Prime declared a 2-for-1 stock split when the fair market value (FMV) of the stock was $120 per share. Immediately following the split, the FMV of Prime stock was $62 per share. On February 1, 2014, Allen had his broker specifically sell the 100 shares of Prime stock received in the split when the FMV of the stock was $65 per share.
What amount should Allen recognize as long-term capital gain income on his Form 1040, U.S. Individual Income Tax Return, for 2014 $300 $750 $1,500 $2,000
$1,500
The basis in the original stock must be allocated between the original shares and the new shares received in a stock split. The new shares have the same holding period as the original shares.
Allen purchased 100 shares of Prime Corp for $10,000. When Prime Corp had a 2-for-1 stock split, the basis must be allocated to 200 shares (100 original shares and 100 new shares). So, the original 100 shares have a basis of $5,000 and the new 100 shares have a basis of $5,000.
The long-term capital gain that Allen must report on his income tax return is $1,500, computed as follows:
Sales price $65 x 100 shares $6,500
Basis in new 100 shares 5,000
------
Long-term capital gain $1,500
======
IRC Section 305
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4512 Characterization of Income
Pulse Corp. maintained a warehouse where it stored its manufactured goods. Pulse received an order from Star. Shortly after Pulse identified the goods to be shipped to Star, but before moving them to the loading dock, a fire destroyed the warehouse and its contents. With respect to the goods, which of the following statements is correct
Pulse has title and an insurable interest.
Star has title and an insurable interest.
Star has title but no insurable interest.
Pulse has title but no insurable interest.
Pulse has title and an insurable interest.
Title passes from the seller to the buyer only if the goods are identified in the sales contract. A buyer has an insurable interest from the time the goods are identified in the contract.
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4231 Sales Contracts
Allen owns 100 shares of Prime Corp., a publicly traded company, which Allen purchased on January 1, 2009, for $10,000. On January 1, 2014, Prime declared a 2-for-1 stock split when the fair market value (FMV) of the stock was $120 per share. Immediately following the split, the FMV of Prime stock was $62 per share. On February 1, 2014, Allen had his broker specifically sell the 100 shares of Prime stock received in the split when the FMV of the stock was $65 per share. What amount should Allen recognize as long-term capital gain income on his Form 1040, U.S. Individual Income Tax Return, for 2014 $300 $750 $1,500 $2,000
$1,500
The basis in the original stock must be allocated between the original shares and the new shares received in a stock split. The new shares have the same holding period as the original shares.
Allen purchased 100 shares of Prime Corp for $10,000. When Prime Corp had a 2-for-1 stock split, the basis must be allocated to 200 shares (100 original shares and 100 new shares). So, the original 100 shares have a basis of $5,000 and the new 100 shares have a basis of $5,000.
The long-term capital gain that Allen must report on his income tax return is $1,500, computed as follows:
Sales price $65 x 100 shares $6,500
Basis in new 100 shares 5,000
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Long-term capital gain $1,500
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IRC Section 305
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4512 Characterization of Income
Which of the following statements about qualifying shareholders of an S corporation is correct
A general partnership may be a shareholder.
Only individuals may be shareholders.
Individuals, estates, and certain trusts may be shareholders.
Nonresident aliens may be shareholders.
Individuals, estates, and certain trusts may be shareholders.
S corporations are limited to 100 shareholders and only one class of stock can be issued and outstanding. The eligible shareholders can only be individuals, estates, charitable organizations, and certain trusts. It is logical that partnerships cannot be shareholders because, like S corporations, most items of income and expense flow through to the shareholders, and if you look past the partnership to the partners, it would be very easy to go beyond 100 shareholders for S corporation status. Also, nonresident aliens may not be shareholders.
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4641 Eligibility and Election
Which of the following statements best states the purpose of cumulative voting
To assure the continuance of incumbent directors
To allow minority shareholders to gain representation on the board of directors
To allow for the election of one-third of the board of directors each year
To assure that a majority of shares voted elects the entire board of directors
To allow minority shareholders to gain representation on the board of directors
The board of directors of a company is elected by the shareholders. The number of votes each shareholder receives is the number of shares held times the number of directors being elected.
Cumulative voting allows a particular shareholder to cast all of his/her votes held for a single individual; thus, minority shareholders are provided a greater voice in electing directors who will represent their interests.
Model Business Corporation Act, Section 7.28
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4264 Rights, Duties, Legal Obligations, and Authority of …
According to the standards of the profession, which of the following sources of information should a CPA consider before signing a client’s tax return
I. Information actually known to the CPA from the tax return of another client
II. Information provided by the client that appears to be correct based on the client’s returns from prior years
I only
II only
Both I and II
Neither I nor II
Both I and II
Before signing a client’s tax return, a CPA may rely in good faith without verification upon information provided by the client. However, the CPA should not ignore the implications of other information which has come to his or her attention. This would include information known to the CPA from the tax return of another client. The consideration of this information does not violate any rules regarding confidentiality.
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4112 AICPA Statements on Standards for Tax Services
