Regulation Flashcards

Question

An S corporation has 30,000 shares of voting common stock and 20,000 shares of nonvoting common stock issued and outstanding. The S election can be revoked voluntarily with the consent of the shareholders holding, on the day of the revocation, Shares of Shares of Voting Stock Nonvoting Stock A. 0 20,000 B. 7,500 5,000 C. 20,000 0 D. 10,000 16,000

Answer 1

D. 10,000 16,000 Answer (D) is correct. An S corporation election may be terminated by revocation. A revocation may be made only with the consent of shareholders who, at the time the revocation is made, hold more than one-half of the number of issued and outstanding shares of stock (including both voting and nonvoting stock) of the corporation.

Answer 2

C. $1,500 Answer (C) is correct. A shareholder’s pro rata share of passed-through losses in excess of basis in the S corporation is not deductible. After the distribution, Stone’s adjusted basis is Stock basis at the beginning of the year $5,000 Less: Distribution (3,500) Adjusted basis $1,500 Therefore, Stone can deduct $1,500 of the passed-through loss on his tax return. The excess $500 ($2,000 – $1,500) is suspended and carried forward indefinitely. It is deductible when the shareholder’s amount at risk has increased.

Answer 3

D. G-corp., established in 1985 as a C corporation, elected to be an S corporation on April 15, 2017. Answer (D) is correct. An S corporation that, upon conversion from C to S status after 1986, had net appreciation inherent in its assets is subject to tax of 35% on net gain recognized (up to the amount of built-in gain on conversion) during the recognition period. For conversions made after the 2010 tax year, the recognition period is the 5-year period beginning on the date the S election became effective. The tax liability is passed through, as a loss, pro rata to its shareholders.

Answer 4

B. $0 Answer (B) is correct. Passive investment income includes gross receipts from royalties, rents, dividends, interest, and annuities. If an S corporation has pre-S corporation E&P (from the period it was a C corporation) at the end of a tax year and its passive investment income is more than 25% of its gross receipts, the S corporation may be subject to a tax on excess net passive income. Here, the passive investment income of $72,000 ($60,000 rental income + $7,000 interest income + $5,000 royalties) is less than 25% of gross receipts ($75,000). Therefore, there is no tax on net passive income.

Answer 5

C. It is either a disproportionate distribution, or a distribution instead of money or other property. Answer (C) is correct. Usually, a shareholder does not include a distribution of stock or rights to acquire stock in gross income unless it is (1) a distribution in lieu of money, (2) a disproportionate distribution, (3) a distribution on preferred stock, (4) a distribution of convertible preferred stock, or (5) a distribution of common and preferred stock, resulting in receipt of preferred stock by some shareholders and common stock by other shareholders.

Answer 6

D. $30,000 Answer (D) is correct. If the requirements of Sec. 351(a) are met, no gain or loss is recognized when property is transferred to a corporation. There are three primary exceptions to Sec. 351(a). Gain can be recognized when Property other than stock (e.g., cash) is received [Sec. 351(b)], A liability is assumed by the corporation for tax avoidance or nonbusiness purposes [Sec. 351(b)], or A liability is assumed in excess of the adjusted basis of the property transferred [Sec. 357(c)]. Since the mortgage is assumed for a valid business reason and does not exceed the $150,000 adjusted basis, none of the mortgage that is assumed is treated as boot property [Sec. 357(a)]. The recognized gain is the lesser of the cash received by the transferor ($30,000) or the realized gain of $100,000 [($100,000 FMV of stock + $120,000 mortgage release + $30,000 cash) – $150,000 adjusted basis].

Answer 7

A. Any amounts paid to foreign persons. Answer (A) is correct. U.S. tax laws and regulations require the payer to withhold income taxes from payments and remit the withheld amounts to the IRS for foreign persons, including nonresident aliens, foreign corporations, foreign partnerships, and foreign partners in U.S. partnerships. Any amounts above the tax required to be paid, as determined by the annual income filing by the recipient, are refunded to the recipient.

Answer 8

D. $50,000 Answer (D) is correct. Gain realized on distributed property must be recognized by the corporation as if the property were sold to the distributee at its FMV. However, FMV is conclusively presumed to be no less than liabilities related to the property subject to which the shareholder assumes or takes the property, whether with recourse or not. Therefore, the corporation recognizes a gain on the land of $50,000 ($70,000 FMV – $20,000 basis).

Answer 9

D. $11,000 gain realized; $10,000 recognized. Answer (D) is correct. The gain realized on this transaction is $11,000 [($16,000 FMV of stock + $10,000 cash + $5,000 assumption of liability) – $20,000 adjusted basis of transferred property]. However, the transaction qualifies under Sec. 351 for nonrecognition. Transfer of mortgaged property to a controlled corporation does not require the recognition of gain unless the liabilities transferred or assumed are greater than the basis of all the property transferred. Accordingly, the only gain that must be recognized is the gain attributable to the amount of boot property received. The $10,000 cash received is boot property.

Answer 10

C. Assets transferred to the parent of the liquidating corporation generally have a carryover basis. Answer (C) is correct. Basis in property distributed to the parent is transferred to the parent.

Answer 11

A. $0 Answer (A) is correct. The exchange of stock for stock in obtaining control of a corporation qualifies as a reorganization. No gain or loss is recognized in a reorganization if stock or securities are exchanged solely for stock or securities in the same corporation or in another corporation that was a party to the reorganization. For Gow, since no boot was received, no gain is recognized.

Answer 12

D. $0 $75,000 Answer (D) is correct. A shareholder does not recognize any gain or loss in a reorganization on an exchange of stock or securities in a corporation solely for stock or securities in the same or another corporation that is a party to the reorganization. Since, pursuant to a reorganization, Eber exchanged shares of Faro stock solely for shares of Judd stock, Eber will recognize no gain. Since there is no recognition of gain or loss, Eber’s basis in the new stock will be the same as her basis in the stock exchanged.

Answer 13

B. $12,000 Answer (B) is correct. Section 336(a) provides that a corporation should treat a complete liquidation as a sale using the fair market value. However, Sec. 336(b) requires that the fair market value used should not be less than any liability accepted by the distributee. Since Len is transferring property with a liability of $38,000, which is higher than the $35,000 FMV, the $38,000 is used as the new FMV. Therefore, Len Corporation recognizes a $12,000 gain ($38,000 new FMV – $26,000 adjusted basis).

Answer 14

D. 40% Answer (D) is correct. Substantially disproportionate means that the amount received by shareholders is not in the same proportion as their stock holdings. To qualify, immediately after redemption, the shareholder must own (1) less than 50% of the voting power of outstanding voting stock and (2) less than 80% each of both the common stock and voting stock owned before the redemption by the shareholder. Bob owns 50% of Rice Corporation before the redemption (250 ÷ 500). Thus, Bob must reduce his interest below 40% (50% × 80%).

Answer 15

A. $10,500 Answer (A) is correct. The recapitalization qualifies for tax-free reorganization treatment. No gain or loss is recognized if stock or securities in a corporation are exchanged solely for stock or securities in the same or another corporation pursuant to a plan of reorganization. Tax-free treatment is denied when securities (bonds) are received but none are surrendered. The gain recognized is the lesser of the realized gain or the fair market value of the nonqualifying property received (in this case, the bonds). The realized gain is $118,500 ($108,000 stock + $10,500 bonds) less basis of $95,000 in the stock given up, or $23,500. The recognized gain is limited to $10,500 (the FMV of the bonds received).

Answer 16

B. $75,000 dividend. Answer (B) is correct. Because Ben owns 100% of the stock before and after the redemption, the transaction is a dividend to the extent that N and M Corporation has earnings and profits. Because the distribution ($75,000) is less than earnings and profits ($100,000), the entire amount is taxable as a dividend.

Answer 17

D. Distributions by the S corporation that were not included in the shareholder’s income. Answer (D) is correct. If the distribution was not included in the shareholder’s income, then it does not increase the basis of a shareholder’s stock but decreases it. All separately stated and nonseparately stated income, as well as depletion deductions above basis, increases the basis of the stock.

Answer 18

D. UBI does not include income from business activity not substantially related to the exempt purpose of the organization if the activity is not regularly carried on. Answer (D) is correct. Unrelated business income (UBI) is income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose constituting the basis for an organization’s tax-exempt status. Income is not subject to tax as UBI if substantially all the work is performed for the organization by unpaid volunteers.

Answer 19

D. $25,000 as return of capital and $7,500 as taxable capital gain. Answer (D) is correct. If the S corporation has no accumulated earnings and profits, any distribution a shareholder receives is a return of capital to the extent of the shareholder’s basis. Any excess will be a gain from the sale of property. Therefore, Dorothy will treat the distribution as a $25,000 return of capital and the remaining $7,500 as a taxable capital gain.

Answer 20

A. Must fall into one of the specific classes upon which exemption is conferred by the Internal Revenue Code. Answer (A) is correct. No organization is exempt from tax unless it is one of the specific types upon which the IRC expressly confers exempt status. Types are listed and described in Secs. 501(c) and (d).

Answer 21

B. $0 Answer (B) is correct. The IRC provides guidelines for adjustments to the basis of a shareholder’s S corporation stock. The increases include items of income (including tax-exempt income) that are passed through to the shareholder, nonseparately stated (ordinary) income, and the excess of deductions for depletion over the basis of the property subject to depletion. A loan made to an S corporation also increases the shareholder’s basis for the amount of the loan. The basis of Bobby’s stock is decreased by the amount of loss allocable to him; however, it cannot reduce his basis below zero. Stock Basis Loan Basis Basis at January 1 $ 2,000 Loan to corporation $4,000 Tax-exempt interest 5,000 Ordinary loss of S corporation (7,000) (500) Basis at December 31 $ 0 $3,500

Answer 22

D. $19,000 Answer (D) is correct. A partner receives a basis in a partnership equal to the basis of the property contributed to the partnership. An increase in a partner’s share of liabilities is treated as a contribution of money by such partner, which increases the partner’s basis. Zachary’s basis in the partnership is $23,000 ($20,000 in contributed property and a 30% share of the $10,000 liability). After the $4,000, Zachary’s basis is reduced to $19,000.

Answer 23

D. $35,000 Answer (D) is correct. The partner’s basis is cash contributed, plus adjusted basis on property contributed, plus gain recognized on services rendered. Thus, the partner’s basis is $35,000 ($20,000 + $10,000 + $5,000).

Answer 24

D. For property that was an unrealized receivable in the hands of the contributing partner, any gain or loss on a disposition by the partnership is ordinary income or loss. Answer (D) is correct. The term “unrealized receivable” includes any rights to income that have not been included in gross income under the method of accounting employed. Under Sec. 724, unrealized receivables and inventory items contributed by the partner to the partnership retain their ordinary income character in the hands of the partnership. Unrealized receivables remain ordinary income property up to the time of disposal by the partnership, and inventory items remain ordinary income property for the 5-year period beginning on the date of contribution (Sec. 735).

Answer 25

C. Neither I nor II. Answer (C) is correct. A partner will generally not recognize income upon contribution of property to a partnership. This is true when the fair market value of the contributed property exceeds the adjusted basis. No gain is recognized when the contributed property is subject to a mortgage unless the liability exceeds the basis of the property. In the second situation, Black is treated as contributing $250,000 and receiving a cash distribution of 50% of the liability of $50,000. Since this does not exceed Black’s basis, no gain is recognized.

Answer 26

D. Increased. Answer (D) is correct. A partner’s share of a partnership liability is treated as if the partner contributed an equivalent amount of money to the partnership. The deemed contribution increases the partner’s basis in his or her partnership interest. Normally, general partners share liabilities based on their ratio for sharing economic losses (recourse liability) or partnership profits (nonrecourse liability).

Answer 27

A. $40,000 Answer (A) is correct. Kline’s basis in the partnership is equal to the adjusted basis of the property contributed minus liability relief plus his $5,000 share of partnership liabilities (50% × $10,000). Therefore, he will have an initial basis of $40,000 ($45,000 adjusted basis – $10,000 liability relief + $5,000 share of the partnership liability).

Answer 28

D. $10,000 Answer (D) is correct. The partnership’s basis of property contributed to a partnership by a partner is the adjusted basis of the property to the contributing partner at the time of the contribution. However, if the partnership is an investment company partnership, the partnership’s basis for property contributed is increased by the amount of gain recognized by the contributing partner. Therefore, ABC’s basis in the stock is $10,000 ($5,000 adjusted basis + $5,000 gain recognized by Taxpayer A).

Answer 29

D. No gain or loss. Answer (D) is correct. When property is contributed to a partnership in exchange for a partnership interest, the general rule is that no gain or loss is recognized by the partner or the partnership. This rule applies even though the contributed property is appreciated and the partner receives a disproportionate interest in the partnership. Precontribution gain on the asset will be allocated to the contributing partner when the partnership later sells the asset. Property does not include services, however, and if Norman received part of his interest in the partnership for performing services, he must recognize ordinary income to that extent.

Answer 30

D. I only. Answer (D) is correct. For the computation of personal income tax liability, each partner considers his or her distributive share of the partnership’s taxable income or loss. Therefore, the NOL carryover is a partner determination and not a partnership determination.

Answer 31

C. $13,500 Answer (C) is correct. The basis of a partner’s interest in a partnership is adjusted each year for subsequent contributions of capital, partnership taxable income (loss), separately stated items, variations in the partner’s share of partnership liabilities, and distributions from the partnership to the partner. The operating loss and the decrease in allocable share of partnership liabilities will reduce George’s partnership interest, and the interest and dividend income will increase George’s partnership interest as follows: Beginning basis in partnership $32,500 Less: 50% of operating loss (15,000) 50% of interest and dividend income 4,000 Less: 50% of decrease in allocable share of partnership liabilities [50% × ($40,000 beginning liabilities – $24,000 ending liabilities)] (8,000) George’s partnership interest at year end $13,500

Answer 32

A. The partnership may make an election for an optional adjustment to the basis of partnership assets in the year the interest is transferred. Answer (A) is correct. In the event of a sale or exchange of a partner’s interest in a partnership, the partnership may elect under Sec. 754 to adjust the basis of the partnership’s assets by the amount of the difference between the transferee partner’s basis for the partnership interest and the proportionate share of the basis of all partnership property.

Answer 33

C. $144,750 Answer (C) is correct. For an electing large partnership, the law reduces the number of items that must be separately reported to the partners. While tax-exempt interest must be separately stated, all the other items are considered in the determination of ordinary income. For charitable contributions, the deduction is calculated similarly to the method for corporate donors, with the deduction limited to 10% of the taxable income of the partnership. Since the $1,500 is below the 10% threshold, the entire amount qualifies for a deduction. Therefore, the total amount of ordinary income equals $144,750.

Answer 34

C. $13,000 Answer (C) is correct. Initially, White will include $3,000 as ordinary income. Further, since partnership items flow through to the partner, White receives one-third of the gross income, or $11,000 ($30,000 + $3,000 = $33,000 ÷ 3) and one-third of the deductions, or $1,000 ($3,000 ÷ 3). Therefore, the amount White must include as taxable income from Rapid is $13,000 ($3,000 + $11,000 – $1,000).

Answer 35

D. $75,000 Answer (D) is correct. The basis of a partner’s interest acquired by contribution of property and money is the amount of money contributed plus the adjusted basis of property contributed (Sec. 722). Eng’s basis in the partnership interest is Money contributed $50,000 Adjusted basis of equipment 25,000 Basis $75,000

Answer 36

C. $2,000 $3,000 $5,000 Answer (C) is correct. Most guaranteed payments are in the form of a specific amount (e.g., a stated salary amount). Some guaranteed payments are in the form of a guaranteed minimum; that is, the partner is guaranteed a minimum amount from the partnership each year. In such a situation, the guaranteed payment is the excess of the partner’s guaranteed minimum over the partner’s distributive share. Arthur’s guaranteed payment is $2,000 [$5,000 guaranteed minimum – ($10,000 × 0.30)] and is deductible by the partnership. Arthur’s 30% distributive share of partnership income before the guaranteed payment is $3,000. Arthur reports it on his individual tax return [Sec. 702(a)]. The guaranteed payment of $2,000 is also reported as ordinary income on his individual tax return. Therefore, Arthur’s total distributive share of income is $5,000.

Answer 37

D. 2017: $0 2018: $0 Answer (D) is correct. In 2017, Barb and Bet Partnership sold the land to PTA Partnership for a loss of $10,000 ($35,000 sales price – $45,000 basis). However, Barb and Bet Partnership will not recognize any of the loss because the sale is to a related party. In addition, Barb and Bet Partnership will not recognize any gain or loss on the sale of the land by PTA Partnership to the unrelated party. Note that the gain on the sale that must be recognized by PTA Partnership will be recognized only to the extent that it exceeds the previously disallowed loss ($2,000).

Answer 38

A. $25,000 gain Answer (A) is correct. If a taxpayer purchases property from a related party who sustained a loss on the transaction but was not allowed a deduction for the loss due to the related party rules, any gain realized by the taxpayer on a subsequent sale of the property is recognized only to the extent that the gain exceeds the amount of the previously disallowed loss. In this question, the $15,000 loss in the sale of the property is disallowed since the two partnerships involved are related parties. Beta Partnership recognizes no loss when it sells the property for $40,000 more than it paid for the property, but it does recognize a gain since that $40,000 is greater than the previously disallowed loss of $15,000. Therefore, the recognized gain is $25,000.

Answer 39

A. $35,000 Answer (A) is correct. All taxable items of income, gain, loss, or deduction that are not separately stated are reported as income; additionally, guaranteed payments are reported as income for the partner. A partner does not recognize gain for current money distributions; therefore, the cash distribution is not included in income. The individual’s income is $35,000 ($25,000 ordinary business income + $10,000 guaranteed payment).

Answer 40

B. $5,000 capital gain. Answer (B) is correct. Generally, a capital gain or loss is recognized on the sale of a partnership interest. A selling partner’s relief of liabilities is included in the amount realized. Gain or loss recognized by the selling partner is the difference between the amount realized and the adjusted basis of the partner’s interest in the partnership. Therefore, Scott’s capital gain is $5,000 ($25,000 amount realized – $20,000 adjusted basis).

Answer 41

B. $20,000 Answer (B) is correct. A special allocation for the difference between fair market value at the time of contribution and basis of contributed property is required. The gain attributable to the precontribution appreciation in the securities must be allocated entirely to Todd, and the gain attributable to postcontribution appreciation should be shared equally by Burns, Cooper, and Todd. Todd’s share is Precontribution gain ($50,000 FMV – $35,000 basis) $15,000 Plus 1/3 of postcontribution gain ($65,000 proceeds – $50,000 1/1/16 FMV) 5,000 Todd’s share of the capital gain $20,000

Answer 42

D. Jack and Jill must file separate gift tax returns and report one-half of each gift on each return before applying the $14,000 annual exclusions. Answer (D) is correct. Gift-splitting allows spouses to treat each gift as made one-half by each. This allows each spouse to exclude the first $14,000 of each gift of a present interest to a third person in a calendar year, for a total exclusion of $28,000 per donee. If the gift is less than the exclusion, the couple does not file.

Answer 43

B. The income distribution deduction is the greater of distributable net income or net accounting income. Answer (B) is correct. The deduction for distributions allocates taxable income of a trust or an estate (gross of distributions) between the fiduciary and its beneficiaries. The deduction is the lesser of the amount of the distributions (required) or distributable net income (DNI). DNI, generally, is current net accounting income of the fiduciary reduced by any amounts allocated to principal.

Answer 44

A. Covers income earned before the taxpayer’s death but not collected until after death. Answer (A) is correct. IRD includes those amounts to which a decedent was entitled as gross income but that were not includible in computing taxable income on his final return. For cash-basis taxpayers, IRD is income earned by the decedent before death, but not paid until after death. A common example of IRD is salary earned by an employee prior to death but not paid by the employer until after death.

Answer 45

D. The trust is revocable. Answer (D) is correct. Any beneficial interest held by the decedent at the time of death is included in the gross estate. Retaining a right to revoke the property will cause the property’s inclusion in the gross estate.

Answer 46

D. $0 Answer (D) is correct. Attorney fees, accountant fees, and executor fees are all administration expenses deductible for estate tax purposes under Sec. 2053. They may be deducted on the income tax return only if there is a statement filed that such amounts have not been allowed as deductions under Sec. 2053 and the right to deduct such amounts under Sec. 2053 is waived. Therefore, Estate Z can deduct none of these items without filing a waiver.

Answer 47

A. Frank’s estate’s income tax return. Answer (A) is correct. Because Frank used the cash method and had not received the $5,000 payment before his death, he should not report this amount on his final income tax return. The $5,000 was received before his estate was settled, however. Thus, $5,000 must be included on Frank’s estate income tax return.

Answer 48

A. An individual. Answer (A) is correct. The only entity required to file Form 709 is an individual taxpayer.

Answer 49

C. $0 Answer (C) is correct. Neither a trust nor an estate is allowed a standard deduction on the fiduciary income tax return. A personal exemption deduction, however, is allowed: $600 for an estate; $300 for a simple trust; $100 for a complex trust.

Answer 50

B. $85,000 Answer (B) is correct. The amount of a gift made in property is the fair market value of the property at the date of the gift. The fair market value is that which would occur in an arm’s-length transaction between a willing buyer and a willing seller in the normal market. Therefore, Barbara must include $85,000 of gifts on her 2017 tax return ($10,000 + $25,000 + $50,000).

Answer 51

C. Only if the decedent’s will specifically provides for the contribution. Answer (C) is correct. Charitable contributions to a qualified organization are deductible only to the extent the will specifically provides for the contribution.

Answer 52

C. $100 Answer (C) is correct. The taxpayers may deduct as a charitable contribution the excess of what they gave over the probable fair market value of what they received, or $100. The taxpayers gave $300 ($75 purchase price × 4 tickets) to a qualified charitable organization in return for property with a fair market value of $200 ($50 FMV × 4 tickets). The donation of the two tickets to the needy family was not a donation to a qualified organization and therefore was not deductible. No deduction is allowable for a contribution of services, so the taxpayer may not deduct the value of his time. The pledge of $200 is not deductible until actually paid.

Answer 53

A. $5,000 as an itemized deduction. Answer (A) is correct. Mortgage interest (qualified residence interest) is deductible in full from adjusted gross income (AGI) as an itemized deduction. A qualified residence is the principal residence of the taxpayer and any one other residence owned by the taxpayer. Insurance is allowable as a deduction only if it is a business expense, as long as it is ordinary and necessary. Here, however, the expense is for a second residence. The utilities are not deductible as well. Therefore, only the $5,000 mortgage interest is allowed as an itemized deduction.

Answer 54

B. $52,000 Answer (B) is correct. Gross rents include the $50,000 of recurring rents plus the $2,000 lease cancelation payment. The cancelation payment is in lieu of rent, so it must be included in income the same as rent. The $1,000 of leasehold improvements are excluded from income since they were not in lieu of rent.

Answer 55

A. Unemployment compensation. Answer (A) is correct. Earned income includes all wages, salaries, tips, and other employee compensation (including union strike benefits), plus the amount of the taxpayer’s net earnings from self-employment. For purposes of the Earned Income Credit, earned income also includes nontaxable compensation such as the basic quarters and subsistence allowances for the military, parsonage allowances, the value of meals and lodging furnished for the convenience of the employer, and excludable employer-provided dependent care benefits. Earned income does not include interest and dividends, welfare benefits, veterans’ benefits, pensions or annuities, alimony, Social Security benefits, workers’ compensation, unemployment compensation, or taxable scholarships or fellowships.

Answer 56

A. Rental real estate activities. Answer (A) is correct. A person who actively participates in rental real estate activity is entitled to deduct up to $25,000 of losses from the passive activity from other than passive income.

Answer 57

D. Section 1231 gain of $50,000. Answer (D) is correct. When depreciable property used in a trade or business is sold at a gain, first Sec. 1245 and Sec. 1250 are applied; then the balance of the gain not recaptured as ordinary income is Sec. 1231 gain. In this case, Sec. 1245 does not apply, and Sec. 1250 recapture is limited to the excess of accelerated depreciation over straight-line depreciation. Since the building was depreciated on the straight-line method, the entire $50,000 gain ($210,000 – $160,000) is Sec. 1231 gain.

Answer 58

D. $10,000 Answer (D) is correct. An S corporation that, upon conversion from C to S status after 1986, had net appreciation inherent in its assets is subject to tax of 35% on net gain recognized (up to the amount of built-in gain on conversion) during the recognition period. For conversions made after the 2010 tax year, the recognition period is the 5-year period beginning on the date the S election became effective. Commerce would be subject to built-in gains tax on $10,000 ($30,000 FMV at conversion – $20,000) of the recognized gain from the transaction in March.

Answer 59

C. Ms. Maple does not have to file a 2017 income tax return. Answer (C) is correct. In general, a taxpayer does not have to file a return if his or her gross income is less than the sum of his or her personal exemption and the standard deduction [Publication 501 and Sec. 6012(a)]. For single individuals who are 65 or over, the standard deduction increases by $1,550. Therefore, the filing threshold will be $11,950 ($7,900 standard deduction + $4,050 personal exemption). Ms. Maple’s income does not qualify her Social Security benefits for gross income inclusion in determining her filing requirement.

Answer 60

D. $17,000 Answer (D) is correct. The basis of property received in a like-kind exchange is equal to the adjusted basis of the property surrendered, decreased by any boot received and increased by any gain recognized or boot given. Since this is a like-kind exchange (one van for another) and Leker received boot along with the like-kind property, he will recognize gain to the extent of the lesser of the realized gain or the value of boot received. In this case, however, Leker does not have a realized gain. Thus, no gain is recognized. The basis in the new van (the like-kind property) will be the basis of the property transferred ($20,000), minus the amount of boot received ($3,000), or $17,000.

Answer 61

B. No No Answer (B) is correct. Under Section 11 of the Securities Act of 1933, a purchaser must prove only that the accountant prepared and certified the financial statements, the statements contained a misstatement or omission of material fact, and (s)he incurred a loss. A purchaser does not need to prove fraud or reliance. Criminal liability under Section 24 of the 1933 act and civil liability under Sections 18 and 10(b) of the 1934 act require proof of fraud.

Answer 62

D. $7,000 Answer (D) is correct. Section 1245 property is depreciable personal property (e.g., office furniture). Gain on the disposition of Sec. 1245 property is ordinary income to the extent of the lesser of all depreciation taken or gain realized. The realized gain in excess of the depreciation taken may be treated as a gain from the sale or exchange of Sec. 1231 property (i.e., capital gain). The realized gain of $27,700 is greater than the depreciation taken ($20,700) by $7,000. Because the holding period is greater than one year, the gain is long-term.

Answer 63

B. $35,718 Answer (B) is correct. Depreciation for an asset is first determined based upon the election of the taxpayer to take a Sec. 179 expense on the asset. However, if the taxpayer chooses to expense any of the property, the property’s adjusted basis is reduced by the Sec. 179 expense in determining the applicable depreciation base. Therefore, the depreciation is calculated as follows: Purchase price of asset $100,000 Less: Sec. 179 expense (25,000) Depreciable basis $ 75,000 Times: Depreciation rate (14.29%) (10,718) New Adjusted Basis of Equipment $ 64,282 Total depreciation for the first year equals $25,000 + $10,718 = $35,718.

Answer 64

A. Deductible Keogh contribution and the employer’s portion of self-employment tax. Answer (A) is correct. The deduction for contributions on behalf of a self-employed individual is the same as for corporate contributions to an employee plan. The contribution limit is 25% of the earned income derived by the self-employed individual from the trade or business or $54,000, whichever is less. The earned income must be reduced by the amount of the contribution and the employer’s portion of self-employment tax.

Answer 65

C. Rental income from an office building in which the owner earns 80% of her gross income and materially participates for 700 hours of service during the year. Answer (C) is correct. In general, a passive activity is any activity that involves the conduct of a trade or business or the production of income and in which the taxpayer does not materially participate [Sec. 469(c)(1)]. Losses from rental real estate are no longer subject to the passive activity rules if the taxpayer meets two requirements: (1) More than 50% of the individual’s personal services are performed in real property trades or businesses in which they materially participate during the year and (2) the individual performs more than 750 hours of service in the real property trades or businesses in which the individual materially participates.

Answer 66

B. $3,000 Answer (B) is correct. Short-term capital gains and losses and long-term capital gains and losses are first netted to determine the capital loss deduction. The carryover from 2015 retains its character as a short-term capital loss and is netted with the other short-term transactions. Short-term: ($1,900 – $4,000 – $700) $(2,800) Long-term (15% basket): ($800 – $1,500) (700) Capital loss $(3,500) Since the loss computed above exceeds $3,000, the amount deductible is limited to the lesser of $3,000 or taxable income (Sec. 1211). Long-term capital losses of $500 are carried forward to the 28% basket.

Answer 67

B. The distribution is not essentially equivalent to a dividend, which is determined at the shareholder level rather than at the corporate level. Answer (B) is correct. The determination of whether a distribution is not essentially equivalent to a dividend is made at the corporate level. The distribution must be the result of a bona fide contraction of the corporation’s business. A distribution satisfies the “not essentially equivalent to a dividend” standard if it meets the safe harbor rule under Sec. 302(e)(2).

Answer 68

D. $222,000 Answer (D) is correct. Capital assets include all property held by a taxpayer unless excluded by the IRC. Excluded are inventory (e.g., stock in trade held by a broker for sale to customers), depreciable business property, real property used in a trade or business, copyrights and artistic compositions created by the owner, accounts and notes receivable, and certain U.S. government publications acquired at reduced cost. Personal use property, such as a residence, is a capital asset.

Answer 69

D. A partnership. Answer (D) is correct. A partnership is, by definition, a for-profit association. Also, a partnership is not listed as a type of organization that may qualify for exempt status in Sec. 501(c).

Answer 70

B. Home mortgage interest (debt used to purchase, build, or substantially improve a residence). Answer (B) is correct. Taxable income must be adjusted to arrive at alternative minimum taxable income. The adjustments are described in Secs. 56 and 58, with tax preferences in Sec. 57. The adjustments with respect to itemized deductions of an individual are contained in Sec. 56(b)(1). The only home mortgage interest adjustment made to taxable income in order to arrive at alternative minimum taxable income is home equity loan interest [Sec. 56(b)(1)(C)(i)].

Answer 71

A. $41,000 Answer (A) is correct. Gross income is all income from whatever source derived except as otherwise provided. All compensation (wages) for personal services is gross income. Unemployment benefits received under a federal or state program are gross income. Supplemental unemployment is included in gross income as wages (not under unemployment). Porter’s total gross income is $41,000 ($35,000 wages + $4,000 state unemployment + $2,000 supplemental unemployment).

Answer 72

C. Apply at the shareholder level rather than at the corporate level. Answer (C) is correct. The at-risk rules do not apply directly to S corporations. They apply directly to individuals as shareholders of S corporations. The at-risk rules limit a shareholder’s deduction for losses and other deductions from an S corporation to the total of (1) the adjusted basis of the shareholder’s stock in the S corporation and (2) the shareholder’s adjusted basis of any debt owed by the S corporation to the shareholder.

Answer 73

D. $0 $0 Answer (D) is correct. The January 3, Year 2, sale was a wash sale because substantially the same stock (as that sold at a loss) was purchased within 30 days. The $2,000 loss realized on the wash sale is not recognized in Year 1 or Year 2. The disallowed loss is added to the basis of the stock purchased in the wash sale.

Answer 74

``` B. Evelyn must recognize $15,000 of income, and Donna must recognize $17,000 gain on the exchange. Answer (B) is correct. Section 351(a) provides that no gain or loss is recognized if one person or more transfers property to a corporation solely in exchange for stock in such corporation and if, immediately after the exchange, such person or persons are in control of the corporation. “Control” is defined in Sec. 368(c) as the ownership of stock possessing at least 80% of the total combined voting power of all classes of voting stock and at least 80% of the total number of shares of all other classes of stock. However, a tax-free transfer to a controlled corporation applies only to a transfer of property. A transfer of services in exchange for stock is fully taxable. Accordingly, Evelyn must recognize $15,000 of income for the legal services provided. Donna must recognize $17,000 ($35,000 – $18,000) of gain because she is not in control of the corporation for purposes of nonrecognition under Sec. 351. Since Evelyn provided only services, her shares are not counted when determining control. ```

Answer 75

B. Under Rule 147, certain restrictions apply to resales of the limited partnership interests by purchasers. Answer (B) is correct. One exemption from registration under the Securities Act of 1933 is an intrastate issue of securities. Under the safe harbor provision of SEC Rule 147, an issue qualifies as intrastate if (1) the issuer is organized or incorporated in the state in which the issue is made, (2) 80% of the proceeds are to be used in that state, (3) 80% of its assets are located there, (4) the issuer does at least 80% of its business (gross revenues) within that state, (5) all the purchasers and offerees are residents of the state, (6) no resales to nonresidents occur for at least 9 months after the last sale, and (7) steps are taken to prevent interstate distribution.

Answer 76

A. Deductible in full by the dissolved corporation. Answer (A) is correct. The filing fees, professional fees, and other liquidation-related expenses are deductible in the final tax return of the corporation.

Answer 77

C. $205,000 Answer (C) is correct. The sale of the land and the sale of machinery used in the business are Sec. 1231 transactions, if held more than 1 year. Since the gain and loss net to a gain of $12,000, they are a long-term capital gain and loss. The capital losses on the securities are fully deductible because they do not exceed the $12,000 net Sec. 1231 gain.

Answer 78

B. $1,600 Answer (B) is correct. The cost of certain intangibles acquired (not created) in connection with the conduct of a trade or business or income-producing activity is amortized over a 15-year period, beginning with the month in which the intangible is acquired. A franchise is a qualified intangible. Thus, Ral may deduct $1,600 ($48,000 ÷ 15 × 6/12).

Answer 79

C. $15,000 Answer (C) is correct. Amounts paid for qualified medical expenses that exceed 10% of AGI may be deducted for regular income tax purposes if unreimbursed. The doctor bills resulting from the serious fall are deductible to the extent they exceed 10% of AGI. In addition, the cosmetic surgery to correct the congenital deformity is also deductible to the extent it exceeds the threshold. The cost of cosmetic surgery is generally not deductible unless it is necessary to ameliorate a deformity arising from, or directly related to, a congenital abnormality, a personal injury resulting from an accident or trauma, or disfiguring disease. Therefore, Carroll’s qualifying medical expenses are $25,000. The deductible expenses are those in excess of $10,000 ($100,000 × 10%) or $15,000.

Answer 80

A. The taxpayer’s earned income credit will exceed his or her tax liability for the current year. Answer (A) is correct. If tax credits exceed the tax liability, the taxpayer will not owe taxes and thus does not have to pay any estimated taxes. A $1 credit reduces tax liability by $1. Thus, if the earned income credit exceeds the tax liability, no taxes are due.

Answer 81

B. $17,000 Answer (B) is correct. Individuals are entitled to claim itemized deductions in calculating AMT with certain adjustments. The following itemized deductions are not allowed: Miscellaneous itemized deductions, State, local, and foreign income taxes, and Real and personal property taxes. Deductions claimed for medical expenses are allowed but the expenses must exceed 10% of AGI for AMT just as they must for regular tax. Qualified housing interest is deductible which is similar to the qualified residence interest deduction that is allowed against regular tax. The allowable itemized deductions for AMT are $2,000 of medical expenses, $10,000 of qualified housing interest, and $5,000 of charitable contributions.

Answer 82

D. A substantial part of activities are an attempt to influence legislation. Answer (D) is correct. No substantial part of activities of an exempt organization formed for educational purposes may be attempts to influence legislation or a political candidacy; otherwise, it will lose its exempt status. Organizations exceeding an elected expenditure limit for lobbying activities are subject to an excise tax, not loss of exempt status. Direct participation in a political campaign will cause loss of exempt status, not indirect participation. In addition, only unreasonable amounts of compensation for services will cause loss of exemption.

Answer 83

A. Bartlet participates in the business for more than 500 hours during a year. Answer (A) is correct. A passive activity is either rental activity or a trade or business in which the person does not materially participate. A taxpayer materially participates in an activity during a tax year if participation is more than 500 hours.

Answer 84

A. Shifty has $5,000 of income when Easy cancels the debt. Answer (A) is correct. Gross income includes income from the discharge of indebtedness for consideration. When Easy canceled the remainder of the debt in consideration of the $5,000 payment, Shifty was relieved of an obligation and must recognize $5,000 of income. Had there not been any consideration given (e.g., $5,000) the cancelation of debt would have been treated as a gift.

Answer 85

B. $10,000 Answer (B) is correct. Treatment of a distribution is determined by reference to accumulated E&P only after any current E&P have been accounted for. To the extent current E&P are sufficient to cover a distribution, the distribution is treated as a taxable dividend, even if there is a deficit in the accumulated E&P. Thus, the current E&P of $10,000 results in ordinary dividend income to Kee’s shareholders of $10,000.

Answer 86

D. $2,000 Answer (D) is correct. Joint filers with modified AGI below $190,000 may contribute up to $2,000 per beneficiary (child) per year. The amount a taxpayer is able to contribute to a CESA is limited if modified AGI exceeds certain threshold amounts. In 2017, the limit is phased out for joint filers with modified AGI at or greater than $190,000 and less than $220,000, and for single filers with modified AGI at or greater than $95,000 and less than $110,000.

Answer 87

C. Express an opinion (or disclaim an opinion) on internal control. Answer (C) is correct. According to SOX, the registered auditor that issues the audit report for an issuer must attest to, and report on, the assessment made by management in the internal control report. The attestation must be made in accordance with standards for attestation engagements issued or adopted by the Public Company Accounting Oversight Board (PCAOB). Moreover, the auditor’s evaluation must not be the subject of a separate engagement. The auditor must determine whether the entity’s transactional records are (1) accurate and fair and (2) provide reasonable assurance that financial statements may be prepared in conformity with GAAP. The auditor also must describe material weaknesses in internal control. However, AS No. 5 provides for the expression of two opinions: one on the financial statements and one on the effectiveness of internal control. The latter presumably satisfies the statutory requirement that the issuer’s auditor attest to, and report on, the internal control assessment made by management.

Answer 88

A. A qualified personal service corporation. Answer (A) is correct. The cash method of accounting is only permitted for certain taxpayers. The following taxpayers use the accrual method of accounting as their overall method of accounting for tax purposes: (1) C corporations, unless they are small C corporations or personal service corporations; (2) partnerships that have a C corporation as a partner; (3) trusts that are subject to the tax on unrelated income; and (4) tax shelters. Any entity that is not a tax shelter and has average gross receipts of not more than $5 million may also use the cash method of accounting, i.e., small C corporations. An entity meets the $5 million gross receipts test if the annual gross receipts for the 3 tax years ending with the prior tax year do not exceed $5 million. Taxpayers that are required to use inventories must use the accrual method to account for purchases and sales.

Answer 89

C. $5,000 Answer (C) is correct. Section 1038(b) provides that, on the repossession of real property that was sold on the installment method, gain is recognized to the extent the payments received prior to the repossession exceed the gain on the property reported in periods prior to the repossession. This gain is limited to the total gain realized on the sale of the property, less the gain recognized in prior periods. Neptune’s gain on the repossession is $5,000 ($9,000 received prior to repossession – $4,000 recognized gain in Year 1). The limitation is $10,000 ($14,000 gain realized in Year 1 – $4,000 recognized in Year 1), which does not apply because it is greater than the gain computed.

Answer 90

B. $172,000 Answer (B) is correct. The charitable contribution deduction is limited to 10% of a corporation’s taxable income (TI) computed before the charitable contribution deduction, dividends-received deduction (not dividends income), net operating loss carryback, and capital loss carryback. Gero’s base amount is $172,000 ($160,000 operating income + $10,000 contributions + $2,000 dividends).

Answer 91

C. February 15, 2018. Answer (C) is correct. A corporation must file its return on or before the 15th day of the 4th month following the close of the tax year. For a fiscal-year corporation with a year end of October 30, 2017, the return must be filed by February 15, 2018.

Answer 92

D. $1,200 Answer (D) is correct. A Lifetime Learning Credit is limited to the amount of 20% of the first $10,000 of tuition paid. The Lifetime Learning Credit is available in years the American Opportunity Credit is not claimed. The Bakers’ credit for 2017 will be $1,200 ($6,000 × 20%). There is no phaseout of the Lifetime Learning Credit for the Bakers since the credit phaseout for married taxpayers filing jointly commences when modified AGI is $112,000 and ends at $132,000.

Answer 93

B. Committee reports. Answer (B) is correct. Congressional Committee Reports reflect Congress’ intent behind certain tax laws and help examiners apply the law properly.

Answer 94

C. $165,000 Answer (C) is correct. Gross profit equals the contract price minus the cost of goods sold. The contract price equals $250,000 ($200,000 for the property + $50,000 assumed mortgage), and the cost of goods sold equals $85,000 ($75,000 adjusted basis + $10,000 selling expenses). Therefore, the gross profit on the installment sale equals $165,000 ($250,000 – $85,000).

Answer 95

A. $63,000 Answer (A) is correct. Items of income, gain, expense, loss, and credit must be separately stated if those items are specially treated for tax purposes at the shareholder level. These items include interest income, rental income, and net long-term capital gains. The non-separately stated income is $63,000 ($200,000 gross receipts – $127,000 COGS – $10,000 compensation to shareholders).

Answer 96

C. $10,000 $10,000 Answer (C) is correct. All death benefits received by the beneficiaries or the estate of an employee from or on behalf of an employer are included in gross income. Therefore, the widow and the son should each include the full $10,000 received as employee death benefits.

Answer 97

C. Apply at the shareholder level rather than at the corporate level. Answer (C) is correct. The at-risk rules do not apply directly to S corporations. They apply directly to individuals as shareholders of S corporations. The at-risk rules limit a shareholder’s deduction for losses and other deductions from an S corporation to the total of (1) the adjusted basis of the shareholder’s stock in the S corporation and (2) the shareholder’s adjusted basis of any debt owed by the S corporation to the shareholder.

Answer 98

A. Under Rule 147, certain restrictions apply to resales of the limited partnership interests by purchasers. Answer (A) is correct. One exemption from registration under the Securities Act of 1933 is an intrastate issue of securities. Under the safe harbor provision of SEC Rule 147, an issue qualifies as intrastate if (1) the issuer is organized or incorporated in the state in which the issue is made, (2) 80% of the proceeds are to be used in that state, (3) 80% of its assets are located there, (4) the issuer does at least 80% of its business (gross revenues) within that state, (5) all the purchasers and offerees are residents of the state, (6) no resales to nonresidents occur for at least 9 months after the last sale, and (7) steps are taken to prevent interstate distribution.

Answer 99

A. I and II. Answer (A) is correct. Claims by buyers or sellers of securities often arise in connection with releases of information by corporations through reports, speeches, public announcements, or press releases. Subjects of these releases may include mergers, research developments, rumors, or other matters of material importance. The law provides a safe harbor from liability for companies that make such statements if they are (1) not material, (2) made without actual knowledge that they are false or misleading, or (3) accompanied by meaningful cautionary statements that identify risk factors that could cause actual results to differ materially from those in the statement.

Answer 100

C. As a short-term capital loss of $1,000. Answer (C) is correct. Losses are not allowed on sales or exchanges of property between related parties. A father and son are related parties for this purpose. Thus, Daniel’s loss of $3,000 on the sale of the stock to William is disallowed. William takes as his basis for the stock the cost of $7,000. Since William’s stock basis is determined by his cost (not by reference to Daniel’s cost), there is no carryover of Daniel’s holding period to William. Therefore, upon the sale of the stock to an unrelated party for $6,000, William realizes a short-term capital loss of $1,000.

Answer 101

D. $61,000 Answer (D) is correct. A partner’s initial basis in the partnership interest received is equal to any cash contribution made. The basis of a partner’s interest in a partnership is adjusted up for allocable share of partnership taxable income and increases in the partner’s share of partnership liabilities and adjusted down for distributions from the partnership to the partner. Molloy’s basis at year end is $61,000 ($40,000 initial basis + $20,000 taxable income – $5,000 distribution + $6,000 liability assumed).

Answer 102

C. The partner’s holding period of the capital asset began. Answer (C) is correct. The holding period of the partner’s interest includes the holding period of contributed capital and Sec. 1231 assets. The holding period on an interest acquired in exchange for money, ordinary income property, or services begins the day after the exchange.

Answer 103

C. $1,000 Answer (C) is correct. In a liquidation of a partner’s interest, gain is recognized to the extent money distributed exceeds the liquidating partner’s AB in the partnership interest immediately before the distribution. The liquidating partner’s basis in (noncash) property received in a distribution in liquidation is any excess of his adjusted basis in the partnership interest immediately before distribution over any amount of money received. Reid’s adjusted basis in the partnership immediately before the distribution was $60,000 and he received $61,000 in cash. Reid will recognize $1,000 of gain for the excess cash over his adjusted basis. Reid will not recognize any amount for the land and will take no basis in the land.

Answer 104

C. Both I and II. Answer (C) is correct. A partnership will terminate if (1) greater than 50% of the total interest in the partnership’s capital and profits is sold during a 12-month period or (2) the partnership’s business operations are discontinued.

Answer 105

D. $394,500 Answer (D) is correct. A partnership’s ordinary income is the balance of the taxable income of a partnership that is not required to be separately stated. Capital gain (loss) is a separately stated item that is not included in a partnership’s taxable income. Charitable contributions are not deductible in computing a partnership’s taxable income. Ordinary income equals $394,500 ($500,000 fees earned – $100,000 salary – $5,000 utility expense – $500 office supplies).

Answer 106

B. Capital gain of $15,000. Answer (B) is correct. A sale or exchange of partnership interest results in a capital gain or loss, except that any gain realized attributable to unrealized receivables (UR) and substantially appreciated inventory (SAI) is ordinary income. Gain or loss is calculated as amount realized ($55,000) minus adjusted basis ($40,000) equals gain (loss) recognized on sale or exchange ($15,000). The amount realized ($55,000) is calculated by money received ($30,000 cash) + FMV of other property received ($0) + liability relief ($25,000) – money or other property given up ($0) – selling expenses ($0).

Answer 107

D. $140,000 $40,000 Answer (D) is correct. An increase in a partner’s share of liabilities is treated as a contribution of money by such partner, which increases the partner’s basis. Partners share recourse liabilities based on their ratio for sharing economic losses [Reg. 1.752-2(a)]. In the absence of guarantees and special arrangements, the limited partner’s economic loss is usually limited to the amount of additional contributions the partner must make. Ted’s basis in the partnership includes the full $100,000 liability because he would be liable for the $100,000 under the partnership agreement.

Answer 108

A. Increases by the partner’s share of the increase. Answer (A) is correct. A partner’s share of a partnership liability is treated as if the partner contributed an equivalent amount of money to the partnership. The deemed contribution increases the partner’s basis in his or her partnership interest.

Answer 109

C. When at least 50% of the total interest in partnership capital and profits changes hands by sale or exchange within 12 consecutive months. Answer (C) is correct. Under Sec. 708(b)(1), a partnership terminates for tax purposes only if (1) no part of any business, financial operation, or venture of the partnership continues to be carried on by its partners in a partnership or (2) within a 12-month period there is a sale or exchange of 50% or more of the total interest in partnership capital and profits.

Answer 110

B. $80,000 Answer (B) is correct. In a liquidating distribution, a partner’s basis for his or her partnership interest is reduced by the amount of money received. Any remaining basis is then allocated to other property received ($180,000 basis – $100,000 cash).

Answer 111

C. $75,000 Answer (C) is correct. The basis of a partner’s interest acquired by contribution of property and money is the amount of money contributed plus the adjusted basis of property contributed (Sec. 722). Eng’s basis in the partnership interest is Money contributed $50,000 Adjusted basis of equipment 25,000 Basis $75,000

Answer 112

B. $40,000 Answer (B) is correct. The partnership generally does not adjust its basis for its retained property when it distributes other property to a partner. However, if any gain is recognized by the distributee partner, the partnership may elect under Sec. 754 to increase its basis in its retained property by the amount of that recognized gain. Here, Palms recognized a $2,000 gain on the receipt of cash. The partnership can increase its property’s basis by the recognized gain of $2,000 to $40,000.

Answer 113

B. $10,000 Answer (B) is correct. Because there were no unrealized receivables or inventory, the sale of the interest in the partnership results in capital gain or loss (Sec. 741). The relief from partnership liabilities is treated as an amount realized on the sale [Sec. 752(d)]. Partner D’s gain is Proceeds ($20,000 cash + $20,000 liabilities assumed by purchaser) $40,000 Less: Adjusted basis (30,000) Capital gain $10,000

Answer 114

D. $144,750 Answer (D) is correct. For an electing large partnership, the law reduces the number of items that must be separately reported to the partners. While tax-exempt interest must be separately stated, all the other items are considered in the determination of ordinary income. For charitable contributions, the deduction is calculated similarly to the method for corporate donors, with the deduction limited to 10% of the taxable income of the partnership. Since the $1,500 is below the 10% threshold, the entire amount qualifies for a deduction. Therefore, the total amount of ordinary income equals $144,750.

Answer 115

D. $310,000 Answer (D) is correct. Each partner’s basis at the end of the first year is $310,000 [$100,000 initial basis + $10,000 distributive share of partnership income + $200,000 ($600,000 ÷ 3) increase in allocable share of partnership liabilities].

Answer 116

D. Yes Yes Answer (D) is correct. Each partner may deduct no more of his or her distributive share of partnership loss than the amount for which (s)he is at risk in the partnership. Each partner’s share is passive unless the partner materially (or actively) participates in the partnership activity. Thus, each partner must apply passive limits to his or her distributive share. These rules do not apply to partners who are widely held corporations.

Answer 117

D. $10,000 ordinary income; $1,000 capital gain. Answer (D) is correct. Payments made in liquidation of a retiring partner are considered a distribution under Sec. 736(b) to the extent the payments are made in exchange for the interest of the partner in the partnership property. The payment made for the unrealized receivables of $10,000 ($30,000 × 1/3) is ordinary income to Mr. Bonet under Sec. 751. Mr. Bonet is considered to have received a distribution of $10,000 cash plus $3,000 relief of liabilities (share of accounts payable). Under Sec. 731(a), he will have a capital gain of $1,000 ($13,000 remaining proceeds – $12,000 basis).

Answer 118

D. $1,200 Answer (D) is correct. The basis of property acquired in a like-kind exchange is equal to the adjusted basis of property surrendered, decreased by any boot received and increased by any gain recognized or boot given. Since boot is neither given nor received, Clark’s basis in the received property equals the basis of the surrendered property of $6,000. When Clark sells the vehicle, he must report gain of $1,200 ($7,200 sales price – $6,000 basis).

Answer 119

B. The partnership may use the fiscal year ending September 30, provided a Sec. 444 election and payment are made, and the partnership may use the fiscal year ending November 30, as that results in the least deferral. Answer (B) is correct. A partner reports his or her distributive share of partnership items, including guaranteed payments, in that tax year of the partner within (or with) which the partnership’s tax year ended. Unless an exception applies, the partnership must use a required tax year. The required tax year that applies is the first of 1., 2., or 3. following. The partners, not the partnership, are obligated to make any estimated tax payments. Majority interest tax year is the tax year of partners owning more than 50% of partnership capital and profits if they have the same tax year on the first day of the partnership tax year. Principal partners’ tax year is the same tax year of all principal partners, i.e., partners owning 5% or more in capital and profits. Least aggregate deferral tax year is determined by multiplying each partner’s ownership percentage by the number of months of income deferral for each possible partnership tax year and then selecting the tax year that produces the smallest total tax deferral. Under Sec. 444, a partnership may elect a tax year that is neither the required year nor a natural business year. The year elected may result in no more than 3 months’ deferral (between the beginning of a tax year elected and the required tax year). The partnership must also pay an amount approximating the amount of additional tax that would have resulted had the election not been made.

Answer 120

C. Capital gain of $15,000. Answer (C) is correct. A sale or exchange of partnership interest results in a capital gain or loss, except that any gain realized attributable to unrealized receivables (UR) and substantially appreciated inventory (SAI) is ordinary income. Gain or loss is calculated as amount realized ($55,000) minus adjusted basis ($40,000) equals gain (loss) recognized on sale or exchange ($15,000). The amount realized ($55,000) is calculated by money received ($30,000 cash) + FMV of other property received ($0) + liability relief ($25,000) – money or other property given up ($0) – selling expenses ($0).

Answer 121

A. Annualize income and calculate the tax on annualized income, then multiply the computed tax by the number of months in the short period divided by 12. Answer (A) is correct. Businesses filing a short-period (i.e., tax-year) return must calculate tax due based on annualized income. Tax on the annualized income is then multiplied by the number of months in the short period, and then divided by 12 to arrive at tax for the short period.

Answer 122

D. $2,000 ordinary income, $15,000 capital gain. Answer (D) is correct. An installment sale is a disposition of property in which at least one payment is to be received after the close of the taxable year in which the disposition occurs. However, sales of inventory consisting of personal property are not installment sales as a general rule [Sec. 453(b)(2)]. A’s sale of inventory produces $2,000 of ordinary income ($40,000 – $38,000). The sale of the real property was an installment sale. Under the installment method, income recognized for any year from a disposition is that proportion of the payments received in that year that the gross profit bears to the total contract price. A’s gross profit is $60,000 ($80,000 selling price – $20,000 adjusted basis). The contract price is the total amount the seller will ultimately collect from the purchaser ($80,000). The gain is Sec. 1231 gain since straight-line depreciation was used. In the current year, Mr. A should report Sec. 1231 gain of $15,000. Assuming no other transactions involving Sec. 1231 occurred in the current year, the gain is capital gain and goes in the 25% long-term capital gain basket.

Answer 123

D. $99,000 Answer (D) is correct. The amount of $99,000 should be allocated to the limited partner with 3% ownership. The general partner receives $1,200,000 [($1,000,000 × 20%) + ($1,000,000 × 25%) + ($2,500,000 × 30%)]. The limited partner with 3% ownership receives $99,000 [($4,500,000 – $1,200,000) × 3%].

Answer 124

D. Nexus is establishing a physical and/or financial presence within a jurisdiction that allows taxing authorities to tax sales and income-generating activities. Answer (D) is correct. In general, nexus is a link between two or more things. In tax law, nexus is establishing a physical and/or financial presence within a jurisdiction that allows taxing authorities to tax sales and income-generating activities. For example, recently, sales and income taxes on economic activities by Internet sellers have been litigated to the U.S. Supreme court twice, and the outcome was that interstate transactions over the Internet are not subject to sales taxes, nor can foreign companies who lack a physical presence in a state be taxed on income generated in that state.

Answer 125

C. A taxpayer who files as a head of household with two exemptions and who earns $14,200. Answer (C) is correct. Generally, a taxpayer must file a tax return if the taxpayer’s gross income equals or exceeds the sum of his or her personal exemption and standard deduction [Sec. 6012(a)]. Section 151 allows a $4,050 personal exemption for each taxpayer in 2017. Standard deductions in 2017 are $12,700 for married filing jointly, $9,350 for heads of household, and $6,350 for unmarried individuals. A taxpayer who files as a head of household must file a return if his or her gross income equals or exceeds $13,400 ($9,350 + $4,050). The second exemption is not considered.

Answer 126

B. $750 ordinary income. Answer (B) is correct. Capital assets are any property not excluded by IRC definition. Real property used in a trade or business is excluded. Section 1231 property includes all real or depreciable property used in the taxpayer’s trade or business and held more than 1 year. Since the asset was not held long-term, this is not a Section 1231 asset and the gain is ordinary income.

Answer 127

A. Adjusted basis of the partner’s interest reduced by any cash distributed to the partner in the same transaction. Answer (A) is correct. In a liquidating distribution, a partner’s basis for his or her partnership interest is reduced by the amount of money received. Any remaining basis is then allocated to other property received.

Answer 128

A. A consolidated return, because Silver owns at least 80% of both the voting stock and FMV of Gold. Answer (A) is correct. A single federal income tax return may be filed by two or more includible corporations that are members of an affiliated group. An affiliated group includes each corporation in a chain of corporations in which the parent corporation directly owns stock in the subsidiary that represents both 80% or more of total voting power and 80% or more of total value outstanding. Since Silver owns 85% of Gold’s voting stock and FMV, Gold and Silver are an affiliated group, and, therefore, they may file a consolidated return.

Answer 129

D. $146,700 Answer (D) is correct. Calculation of E&P begins with taxable income according to the tax return. Nondeductible expenditures are subtracted from taxable income, e.g., federal income taxes, charitable contributions in excess of the 10% limitation, and net capital losses. Also, E&P are calculated based upon straight-line depreciation using the alternative depreciation system, so excess MACRS depreciation must be added back for property acquired after 1986. E&P at January 1, 2017 $110,000 Taxable income for 2017 46,000 Add: Excess depreciation 1,100 Deduct: Excess contributions (1,800) Net capital loss (3,200) Federal income taxes (5,400) E&P at December 31, 2017 $146,700

Answer 130

D. $30,000 Answer (D) is correct. Under Sec. 1221, a capital asset is defined as any property held by the taxpayer (whether or not it is connected with his or her trade or business) that is not specifically excluded by Sec. 1221. Land used in a business, accounts receivable, inventories, and copyrights created by the owner are specifically excluded. Buildings and furniture and fixtures are excluded as depreciable property used in a business. E’s only capital asset is the goodwill ($30,000) acquired in 1990. This goodwill is not eligible to be amortized under Sec. 197, since it was acquired before July 25, 1991 (the earliest date that Sec. 197 applies to goodwill).

Answer 131

B. $74,000 Answer (B) is correct. The taxpayer has active income of $74,000 ($70,000 ordinary income from Partnership A + $4,000 short-term capital gain). The amount of loss attributable to a person’s passive activities is allowable as a deduction only against, and to the extent of, gross income or tax attributable to those passive activities (in the aggregate). Therefore, although the taxpayer has gross income from passive activities of $7,000, this income is offset by $7,000 of passive activity loss from Partnership B. The excess $2,000 passive activity loss ($9,000 – $7,000) is deductible or creditable in a future year, subject to the same limits. Since all of the taxpayer’s passive activity income is offset by the passive activity loss, the taxpayer’s adjusted gross income for the year is $74,000.

Answer 132

A. III, I, II. Answer (A) is correct. A distribution by an S corporation is treated as first coming from AAA. This portion of the distribution reduces shareholders’ bases in their S corporation stock, but it is tax-free to the shareholders. Once AAA is exhausted, a distribution is next treated as coming from E&P. This portion of the distribution is a taxable dividend to the shareholders, yielding no effect on their basis. If the remaining distribution exceeds E&P, any excess is deemed a return of capital to the shareholders, reducing their bases. To the extent of the shareholders’ bases, this portion of the distribution is tax-free. Remaining distributions that exceed shareholders’ bases are taxable gains to the shareholders, with character determined by the character of the S corporation holdings in the shareholders’ hands.

Answer 133

A. A CPA’s work is not guaranteed to be accurate even though the CPA acted in a reasonably competent and professional manner. Answer (A) is correct. A CPA has a duty to exercise reasonable care and diligence. This does not guarantee that the CPA’s work will be accurate.

Answer 134

D. $315,000 Answer (D) is correct. A decedent’s gross estate includes the FMV of all property (real or personal, tangible or intangible, wherever situated) to the extent the decedent owned a beneficial interest at the time of death. Included in the gross estate are such items as cash; personal residence and effects; securities; other investments; and other personal assets, such as notes and claims and business interests. The gross estate also includes other items, such as the full value of property held as joint tenants with the right of survivorship, except to the extent of any part that is shown to have originally belonged to the other person and for which adequate and full consideration was not provided by the decedent and insurance proceeds on the decedent’s life if either the insurance proceeds are payable to or for the estate or if the decedent had any incident of ownership in the policy at death. Therefore, $315,000 is the value of Sam’s gross estate ($15,000 cash + $200,000 life insurance + $100,000 jointly owned property).

Answer 135

B. $0 Answer (B) is correct. “Taxable gifts” means the total amount of gifts made during the calendar year reduced by the charitable and marital deductions [Sec. 2503(a)]. The first $14,000 of gifts of present interests made to each donee during the year is excluded [Sec. 2503(b)]. All of Joan’s transfers qualify for exclusion from gift taxation.

Answer 136

B. $42,000 Answer (B) is correct. Section 2503(b) authorizes a $14,000 exclusion from gross income for income tax purposes and is available to an unlimited number of donees.

Answer 137

D. $72,000 Answer (D) is correct. Distributable net income (DNI) is the maximum amount of the distribution on which beneficiaries can be taxed. The trust reports DNI of $120,000 and is required to distribute $150,000 ($60,000 to Kent and $90,000 to Lind). Thus, the distribution each beneficiary receives must be prorated to determine his or her share of the distribution includible in gross income. Lind receives 60% of the distribution ($90,000 ÷ $150,000). As a result, she reports $72,000 of the $120,000 DNI.

Answer 138

C. Credit for foreign death taxes and credit for taxes paid on prior transfers. Answer (C) is correct. The tax due is equal to the tax imposed under Sec. 2001, reduced by allowable credits. Section 2012(a) allows a credit for foreign death taxes paid. Section 2014 allows a credit for taxes paid on prior transfers.

Answer 139

D. $9,000 Answer (D) is correct. Administration expenses (and debts of a decedent) are deductible on the estate tax return, and some may also qualify as deductions for income tax purposes on the estate’s income tax return. Sec 642(g), however, disallows a double deduction and requires a waiver of the right to deduct them on Form 706 in order to claim them on Form 1041. Therefore, the attorney’s fees for administration of the estate cannot be deducted on the estate return since it is not stated that a waiver was filed. The income earned by the decedent but taxable to the estate is calculated as follows: Unpaid salary $6,000 Gain on sale of coins 1,000 Dividend income 600 Interest income 2,000 Less: Exemption deduction (600) Estate’s taxable income $9,000

Answer 140

B. $40,000,000 Answer (B) is correct. The marital deduction includes outright transfers to the surviving spouse to the extent that the interest is included in the gross estate.

Answer 141

B. There were no distributions of corpus in the current year. Answer (B) is correct. A simple trust has the following characteristics: It requires current distribution of all its income It requires no distribution of the res (i.e., principal) It allows no charitable contributions

Answer 142

B. March 15, 2018. Answer (B) is correct. The executor is required to file Form 706, United States Estate Tax Return, if the gross estate at the decedent’s death exceeds $5.49 million. Adjusted taxable gifts made by the decedent during his or her lifetime reduce the threshold. The estate tax return is due within 9 months after the date of the decedent’s death. An extension of up to 6 months may be granted.

Answer 143

D. Money distributed to a beneficiary from an estate is taxed twice–on the estate return and on the beneficiary’s return. Answer (D) is correct. Money distributed to a beneficiary from an estate is not taxed twice. DNI is allocated to either the estate or beneficiary and is only taxed to whichever of the two it is allocated.

Answer 144

A. $97.00 Answer (A) is correct. If there is a market for stocks on a stock exchange, the mean between the highest and lowest quoted selling prices on the date of the gift is the fair market value per share. If there were no sales on the date of the gift, the fair market value is determined by taking a weighted average of the means between the highest and lowest sales on the nearest date before and the nearest date after the date of the gift. The average is to be weighted inversely by the respective number of trading days between the selling dates and the date of the gift [Reg. 25.2512-2(b)]. The mean sales price on May 26, 1 trading day before the date of David’s gift, was $96.50, and the mean sales price on May 30, 2 trading days after the date of the gift, was $98. The fair market value of David’s gift is determined as follows: (2 days × $96.50) + (1 day × $98) = $97 per share 3 days

Answer 145

A. 3 Answer (A) is correct. Younger generations refer to generations younger than the transferor’s generation. An individual who is a lineal descendant of a grandparent of the grantor is assigned to that generation that results from comparing the number of generations between the grandparent and such individual with the number of generations between the grandparent and the transferor [Sec. 2651(b)(1)]. An individual who has been married to the transferor is assigned to the transferor’s generation [Sec. 2651(c)(1)]. Since Theresa is married to the transferor, she is assigned to the same generation as Thom. Trevor and Bob are assigned to one generation below the transferor’s generation. Sara is assigned to two generations below the transferor’s generation. Hope is assigned to three generations below the transferor’s generation.

Answer 146

C. $6,112,500 Answer (C) is correct. The value of the gross estate includes the value of all property in which the decedent had an interest at the time of death. Therefore, the value of the home, stocks, car, accrued interest, and jewelry is included in the gross estate. The IRC requires the inclusion of proceeds from life insurance policies when the proceeds are receivable by, or for the benefit of, the estate. A dividend is includible in the decedent’s gross estate only if the decedent died after the record date of the dividend; the record date is the date when the shareholder of record becomes entitled to receive the dividend, in this case, the declaration date. Therefore, all of the items are included in the gross estate.

Answer 147

B. $2,650,000 Answer (B) is correct. A decedent’s gross estate includes the FMV of all property, real or personal, tangible or intangible, wherever situated, to the extent the decedent owned a beneficial interest at the time of death. Included in the gross estate are such items as cash, personal residence and effects, securities, other investments, and other personal assets, such as notes and claims and business interests. The gross estate also includes other items, such as the full value of property held as joint tenants with the right of survivorship, except to the extent of any part that is shown to have originally belonged to the other person and for which adequate and full consideration was not provided by the decedent and insurance proceeds on the decedent’s life if either the insurance proceeds are payable to or for the estate or if the decedent had any incident of ownership in the policy at death. Therefore, $2,650,000 is the value of Harry’s estate ($100,000 certificates + $2,000,000 mortgage receivable + $500,000 paintings and collectibles + $30,000 income tax refund + $20,000 household goods and effects).

Answer 148

C. Entirely by the individual taxpayer. Answer (C) is correct. Generally, the only way a grantor can avoid taxation on the income from the trust is to give up control and benefits of the assets assigned to the trust and give up the right to revoke or amend the trust. The taxpayer retains the right to income from the trust for life, so the taxpayer must pay taxes on the income earned by the trust.

Answer 149

C. $0 Answer (C) is correct. If the decedent accounted for income under the cash method, only the items actually or constructively received before the date of death are included on the final return. Constructive receipt would have occurred if the income had become available for use by the decedent without restriction. Because the money was not available for Tim’s use, it is not included as income on the final return.

Answer 150

B. $2,500,000 Answer (B) is correct. Since the grantor of a revocable trust can control the assets in the trust by altering the terms and/or withdrawing the assets from the trust, Sara is taxed on the value of the revocable trust. A QTIP interest involves a transfer entitling the recipient spouse to all of the income for life. Per Sec. 2044, if the recipient spouse has a life estate, has no general power of appointment, and was not the transferor, then the QTIP is included in the gross estate. Since Sara retained no interest in the irrevocable trust, it is not included in her gross estate. Therefore, Sara’s gross estate is $2,500,000 ($2,000,000 QTIP trust + $500,000 revocable grantor trust).

Answer 151

D. $22,000 Answer (D) is correct. If both spouses consent, a gift made by one spouse to any person other than the other spouse is considered as made one-half by each spouse (Sec. 2513). In addition to his own gifts, Warren is treated as having made one-half of Laura’s gift to her mother. By splitting the gifts, each spouse can take advantage of the $14,000 per donee exclusion. Donee Amount Exclusion/ Deduction Taxable Ronald $ 22,000 $ 14,000 $ 8,000 Laura 100,000 100,000 0 Church 16,000 16,000 0 Suzie 10,000 10,000 0 Laura’s mother 28,000 14,000 14,000 Total taxable gifts $22,000

Answer 152

D. May adopt a calendar year or any fiscal year. Answer (D) is correct. An estate is a new taxable entity and may choose a tax year ending within 12 months after the date of the decedent’s death.

Answer 153

B. Only Apogee may make oral communications at any time if certain conditions are met. Answer (B) is correct. Apogee is a well-known seasoned issuer because it has filed for at least 1 year under the Securities Exchange Act of 1934 and has a market capitalization of at least $700 million. Perigee is a seasoned issuer (having filed for at least 1 year and a market capitalization of at least $75 million). Thus, only Apogee may make oral communications at any time if certain conditions are met. In specified circumstances, a well-known seasoned issuer (Apogee) may make oral and written communications at any time. These may include a free-writing prospectus, a written offer (including one by electronic means) that is not a statutory prospectus.

Answer 154

C. The highest corporate income tax rate. Answer (C) is correct. The tax rate for the built-in gains tax is defined by statute to be the highest corporate income tax rate.

Answer 155

B. Income from trade or business. Answer (B) is correct. An S corporation passes a pro rata share of its total income (loss) through to the individual shareholders except for items that require separate treatment by the shareholder. Royalty income, charitable contributions, and investment interest expense must be separately stated. Income from trade or business, however, is combined with other nonseparately stated income or loss.

Answer 156

B. 2 Answer (B) is correct. A personal exemption is provided for each taxpayer. On a joint return, there are two taxpayers, and a personal exemption is allowed for each.

Answer 157

C. All of the answers are correct. Answer (C) is correct. A gift tax return must be filed for gifts that exceed $14,000 and were split with a spouse. Additionally, a return is required to be filed if more than $14,000 is gifted to any one donee or if any of the gifts were of a future interest.

Answer 158

B. No income from either payment. Answer (B) is correct. If the decedent accounted for income under the cash method, only the items actually or constructively received before the date of death are included on the final return. Constructive receipt would have occurred if the income had become available for use by the decedent without restriction. Because the dividends were not available for use before the date of death, they were not constructively received. For a partnership whose tax year ends after the partner’s date of death, the decedent’s distributive share of income is income in respect of the decedent and will not be reported on the final income tax return.

Answer 159

A. June 20, 2017. Answer (A) is correct. For assets acquired after 1987, long-term capital gain or loss treatment is provided if the asset is held for more than 1 year. The general rule is that the date the property is acquired is excluded and the date that the property is disposed of is included in this computation of the holding period. Since Mr. J bought the asset on June 19, 2016, his holding period is treated as beginning June 20, 2016. Exactly 1 year is considered to have expired on June 19, 2017. Therefore, on June 20, 2017, more than 1 year has passed, which would satisfy the long-term holding period requirement.

Answer 160

C. $2,550,000 Answer (C) is correct. The gross value of Mary’s estate includes items valued at their gross amount. The $100,000 mortgage is deducted after the gross valuation of the estate. Therefore, the gross value is $2,550,000 ($400,000 + $150,000 + $2,000,000). The life insurance is excluded under Sec. 2042 because there is no incidence of ownership of the decedent.

Answer 161

C. $27,500 Answer (C) is correct. The basic exemption amount is $40,000. However, this is reduced by 25% of the excess of alternative minimum taxable income over $150,000. Therefore, Rona Corp.’s exemption amount is reduced by $12,500 [($200,000 – $150,000) × 25%]. Rona’s exempt amount is $27,500.

Answer 162

D. All of the answers are correct. Answer (D) is correct. Under a “check-the-box” system, certain business entities are automatically treated as corporations for federal tax purposes, while others may elect to be treated as corporations for federal tax purposes. If an entity has one owner and is not automatically considered a corporation, it may nevertheless elect to be treated as a corporation or, by default, it will be treated as a sole proprietorship. Similarly, if an entity has two or more owners and is not automatically considered a corporation, it can elect to be taxed as a corporation for federal tax purposes; otherwise, it will be taxed as a partnership. Further, if all members of a new foreign entity have limited liability, the entity is classified as a corporation. One type of a corporation as defined in the Internal Revenue Code is an association.

Answer 163

D. The issuer would act unlawfully if it were to sell the common stock without providing the investor with a prospectus. Answer (D) is correct. If an issue is required to be registered under the Securities Act of 1933, a registration statement and a prospectus must be prepared and filed with the SEC. The prospectus contains financial material and other information about the issuer and the offering. A prospectus must be provided to any person interested in investing in the security offered.

Answer 164

A. $10,250 Answer (A) is correct. Deductions from the gross estate include administration and funeral expenses ($3,500 attorney fee + $1,000 burial lot), state taxes ($5,000), and claims against the estate ($750 credit card debt).

Answer 165

C. $4,500 Answer (C) is correct. Unless specifically excluded by the IRC, interest is included in gross income. Although interest on most obligations of a state or political subdivisions of a state are excluded from gross income, this exclusion does not apply to obligations of the U.S. if not a Series EE bond. Furthermore, interest earned on federal tax refunds is not excluded from gross income.

Answer 166

D. $21,325 Answer (D) is correct. Under Sec. 1561(a)(1), component members of a controlled group of corporations are limited to using the taxable income brackets in Sec. 11 as if they were one corporation. Unless the members agree otherwise, the tax brackets are allocated equally. Under the apportionment plan, Y is entitled to 50% of each tax bracket. Y’s income tax is Tax Brackets 50% Tax 1st $50,000 $25,000 × 15% $ 3,750 Next $25,000 12,500 × 25% 3,125 Remainder 42,500 × 34% 14,450 Total $21,325 Note that, although each tax bracket is allocated in the same manner here, different allocations are permitted. Since the total taxable income of the controlled group is less than $100,000, no recapture of the tax savings resulting from the 15% and 25% marginal tax brackets occurs. The additional 5% tax will not apply unless the total taxable income of the controlled group exceeds $100,000. The allocation selected by the group is less than optimal since the full amount of the 15% and 25% tax bracket benefits are not used when taxable income is $97,000. The group should consider revising its allocation for the current year.

Answer 167

D. The taxpayer must have been audited by the IRS. Answer (D) is correct. The Internal Revenue Service is authorized to collect unpaid taxes by levying upon the taxpayer’s property. Before levy action can be taken, it must first be determined that a tax liability exists. Within 60 days after making the assessment, the IRS is required to give a notice and demand for payment to the taxpayer. If the taxpayer neglects or refuses to pay the tax within 10 days after notice and demand, a final notice (Notice of Intent to Levy) must be given to the taxpayer at least 30 days in advance of levy. There is no requirement that a taxpayer first be audited.

Answer 168

D. $32,000 Answer (D) is correct. Gross income includes compensation for services in the form of cash and/or other property. A cash-method taxpayer includes income when cash or a cash equivalent is actually or constructively received. The amount is the amount of money and FMV of other property received. The FMV of a capital interest in a partnership received for services is income when received as soon as it is transferable and not subject to a substantial risk of forfeiture ($15,000 cash + $10,000 FMV of limited partnership interest + $7,000 surveying equipment).

Answer 169

B. 80.00% Answer (B) is correct. “Control” is the ownership of stock possessing at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation.

Answer 170

A. $17,000 Answer (A) is correct. Under Sec. 3306(b)(1), wages are taxed for federal unemployment taxes up to $7,000 for each employee. Wages earned in excess of $7,000 are not subject to federal unemployment taxes. The full amount of wages paid during the current year to employee T and employee E is taxable. Only $7,000 of the wages paid to M is subject to federal unemployment taxes. Thus, the total amount of wages paid in the current year that is subject to federal unemployment taxes is $17,000. Employee Wages Subject to Unemployment Tax T $ 4,200 E 5,800 M 7,000 Total $17,000

Answer 171

A. $85,000 deduction; $70,000 recognized gain. Answer (A) is correct. The employee includes in income the fair value of property received for services. The employer is allowed a deduction for the amount the employee must include in income when the employee includes it in income. However, when property other than cash is distributed in exchange for services, the employer must recognize a gain on the deemed sale. Since the employees will include the $85,000 FMV of shares in income, Spice Corporation may deduct the $85,000. However, Spice Corporation must also recognize a $70,000 gain ($85,000 FMV – $15,000 adjusted basis) on the deemed sale.

Answer 172

A. $88,000 Answer (A) is correct. Section 162(a)(1) allows a deduction for reasonable compensation for personal services actually rendered. Section 83(a) allows the deduction to an employer equal to the fair market value of property given to the employee when the property is transferable or is not subject to a substantial risk of forfeiture. Therefore, Mr. Z’s salary and wage deduction is $88,000 ($80,000 + $8,000 FMV of car).

Answer 173

A. A net operating loss deduction from a prior year. Answer (A) is correct. The accumulated earnings tax is applied to the accumulated taxable income, defined in Sec. 535(a) as taxable income, subject to certain adjustments. The net operating loss deduction is not allowed.

Answer 174

A. Schedule C. Answer (A) is correct. A tax imposed on business assets is an expense of that business and is deductible under Sec. 162. As an ordinary and necessary expense of the business, it is reported on Schedule C, which is used to report the income and expenses of a sole proprietorship, the net income (or loss) of which is carried onto page 1 of Form 1040.

Answer 175

B. Mid-quarter. Answer (B) is correct. The taxpayer must apply the mid-quarter convention to all depreciable property acquired during the tax year when the sum of the bases of all depreciable personal property placed in service during the last quarter of the year exceeds 40% of those placed in service during the entire year. In this case, 100% of the property was placed into service in the last quarter.

Answer 176

A. Justifiably relied on the financial statements. Answer (A) is correct. The tort of intentional misrepresentation (fraud, deceit) consists of a material misrepresentation made with scienter and an intent to induce reliance. The misstatement also must have proximately caused damage to a plaintiff who reasonably relied upon it. Scienter exists when the defendant makes a false representation with knowledge of its falsity or with reckless disregard as to its truth.

Answer 177

A. $0 Answer (A) is correct. Lind has a realized gain of $42,000 on this exchange, calculated as follows: Amount realized from stock $72,000 Mortgage assumed by Ace 10,000 Total amount realized 82,000 Less: Adjusted basis of building (40,000) Realized gain $42,000 However, Sec. 351 requires that no gain or loss be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in the corporation and immediately after the exchange those persons control the corporation. Control is defined as 80% or more of the voting power of stock and 80% or more of the shares of each class of nonvoting stock.

Answer 178

B. $175,000 Answer (B) is correct. Under 1060, both the buyer and the seller involved in a transfer of assets that amount to a trade or business must allocate the purchase price among the assets using the “residual method.” The residual method requires the purchase price to be allocated first to cash and cash equivalents; then to near-cash items such as CDs, government securities, and other marketable securities; then to accounts receivable, mortgages, and credit card receivables; then to stock in dealer inventory or property held for sale in the ordinary course of business; then to assets not already listed; and then to all Sec. 197 intangibles; except goodwill and going concern value. The allocation of the purchase price may not exceed the fair market value for each of these categories. Then any residual purchase price is allocated to intangible assets such as goodwill and going concern value. In this case, Andrew’s purchase price of $3.5 million is in excess of the fair market value of all the assets listed ($3,425,000). Therefore, the purchase price is allocated to each asset listed based on its fair market value, and the remaining $75,000 is allocated to goodwill or going concern value. The covenant not to compete will have a basis equal to its FMV of $175,000. Section 1060 also provides that the transferor and the transferee may agree in writing as to the allocation of consideration or as to the fair market value of any assets. This agreement is binding on the transferor and the transferee unless it is determined inappropriate by the IRS.

Answer 179

A. Must be registered if Dee sells 50% of her shares through her broker to the public. Answer (A) is correct. In general, any offer to sell securities in interstate commerce is subject to registration unless the securities or the transaction is exempt. Most transactions are exempt because they involve sales by persons other than issuers, underwriters, or dealers, e.g., transactions by ordinary investors selling on their own account. Dee, however, is considered an issuer because she is a controlling person, that is, one who owns more than 10% of the company’s stock and who has the direct or indirect ability to control the company. A sale of 6% (12% × 50%) of D&M’s common stock to the public in the ordinary course of business (e.g., through a broker) is not a basis for an exemption under the Securities Act of 1933. Thus, it is subject to SEC registration.

Answer 180

C. Credit for marital deduction. Answer (C) is correct. There is no credit for a marital deduction. Instead, the marital deduction is deductible in arriving at the taxable estate. The estate tax is then computed on the taxable estate.

Answer 181

B. $0 Answer (B) is correct. The distributee’s basis in noncash property received in a distribution in liquidation is any excess of his or her AB in the partnership interest immediately before distribution over any amount of money received. Gain is only recognized to the extent money distributed exceeds the partner’s basis in the partnership. Hoben’s basis in the assets received is $10,000, and Hoben does not recognize any gain on the distribution.

Answer 182

B. Yes, if the working papers are lawfully subpoenaed into court. Answer (B) is correct. The AICPA’s Confidential Client Information Rule states that a member shall not disclose any confidential client information except with the specific consent of the client. But this rule should not be understood to preclude a CPA from responding to an inquiry made by (1) an investigative body of a state CPA society, (2) the trial board of the AICPA, or (3) an AICPA or state peer review body. It also does not prevent compliance with a validly issued and enforceable subpoena.

Answer 183

B. Is liable for obligations of the partnership to the extent of his or her capital contribution. Answer (B) is correct. A limited partner makes a contribution of cash or other property in exchange for an interest and a liability for partnership debts that is restricted to his or her contribution.

Answer 184

B. To be elected as a general partner by a majority vote of the limited partners in number and amount. Answer (B) is correct. A new general partner may be admitted to a limited partnership only with the specific written consent of each and every partner (both limited and general). The limited partners therefore do not have the power to admit new general partners, and unanimous consent is needed unless the partnership agreement provides otherwise.

Answer 185

B. All the partners other than the negligent partner and his or her supervisor. Answer (B) is correct. Partners are not liable for a negligent act committed by another partner in a limited liability partnership. This shield is provided only for liability imputed solely because of partnership status. Thus, the negligent partner is the only partner liable. However, a partner who is an immediate supervisor is also liable for any negligent acts committed by an employee within the scope of employment.

Answer 186

D. Personally have to contribute an additional $5,500. Answer (D) is correct. Upon termination, a partnership must first pay all creditors, including partners who are creditors, and then distribute the remaining assets to the partners. In this case, $20,000 is available for distribution. However, the total of capital contributions is $50,000, and a $30,000 ($50,000 capital contributions – $20,000 available for distribution) loss must be allocated among the partners. When the partnership agreement does not specify otherwise, losses are allocated in the same ratio as profits. Thus, Z is properly allocated 35% of the loss, or $10,500 ($30,000 × 35%). Z’s capital contribution of $5,000 is less than Z’s share of the loss. Thus, Z must contribute an additional $5,500 to the partnership.

Answer 187

C. Can exist as such only if it is formed under the authority of a state statute. Answer (C) is correct. The limited partnership is not available as a form of business organization under the common law. An organization purporting to be a limited partnership but formed in a state with no statutory authority for such a form of business organization will very likely be treated as a general partnership.

Answer 188

A. A general partnership. Answer (A) is correct. An advantage of the general partnership is that it can be created without any formalities. No filings are required, and the existence of the partnership may arise from a written or oral agreement.

Answer 189

A. I and II. Answer (A) is correct. An LLC is formed by one or more persons who file articles of organization with the appropriate secretary of state. Thus, formation is more difficult than for a sole proprietorship or a general partnership.

Answer 190

D. Joint ventures. Answer (D) is correct. The limited liability company (LLC) is a hybrid of a corporation, a partnership, and a limited partnership. Most states have statutorily provided for organization of this entity, which grants investors limited liability but the tax treatment of a partnership. In an LLC, losses are passed through to investors who may be able to use them to offset other taxable income. An LLC is formed by one or more persons who file articles of organization with the appropriate office of the secretary of state.

Answer 191

D. May not earn a secret profit in dealings with the partnership or partners. Answer (D) is correct. A general partner is an agent of the partnership and the other partners and thus owes fiduciary duties of loyalty and due care. A partner also has an obligation of good faith and fair dealing. In dealings with the partnership or other partners, a partner may not earn a secret profit. (S)he must account to the partnership and hold as trustee for it any benefit derived in the conduct or winding up of the partnership business or from use of partnership property (including appropriation of a partnership opportunity).

Answer 192

D. A general partner retires and all the remaining general partners do not consent to continue. Answer (D) is correct. Retirement of a general partner generally dissolves a limited partnership or a general partnership. However, dissolution can be avoided if the business is continued by the remaining general partners either with the consent of all partners or pursuant to a stipulation in the partnership agreement.

Answer 193

A. Results in the limited partner having an intangible personal property right. Answer (A) is correct. The limited partner’s interest is an investment in the entity as a whole. The interest is personal property. It is an intangible because the limited partner has no right to specific partnership property.

Answer 194

D. Wind’s withdrawal causes dissociation from the partnership despite being in violation of the partnership agreement. Answer (D) is correct. Under the RUPA, a partnership is considered an entity substantially separate from its partners. A partner has the power (if not the right) to dissociate at any time. However, if the partner wrongfully dissociates from the partnership, (s)he is liable for any resulting damages to the other partners. After dissociation, the business either continues after purchase of the dissociated partner’s interest or dissolution begins.

Answer 195

C. Watson may not revoke the agreement for a period of 6 months. Answer (C) is correct. Under the RMBCA, such an agreement may not be revoked for 6 months unless (1) otherwise provided by the terms of the subscription agreement or (2) all other subscribers agree. The rationale is that the subscription agreement is an irrevocable continuing offer for the administrative convenience of the promoter.

Answer 196

B. I and II only. Answer (B) is correct. As a defendant in a suit, an organization that is neither a de jure nor a de facto corporation may be treated as a corporation by estoppel if certain conditions are met: (1) The organization has represented itself as a corporation, (2) the representation is followed by reasonable reliance and material alteration of position by the other party based on that representation, (3) the other party demonstrates fair and equitable conduct, and (4) injustice can be avoided only by treating the business as a corporation. In contrast, a de facto corporation is recognized given (1) a statute under which the business could have incorporated, (2) a good-faith but unsuccessful attempt to comply with it, and (3) an actual or attempted exercise of corporate powers.

Answer 197

C. Lobo must obtain a certificate of authority to transact business in California and the other states in which it does business. Answer (C) is correct. Because Lobo has its principal place of business in California, it has sufficient contact to qualify as “doing business” in the state. A corporation doing business but not incorporated in that state is considered a foreign corporation and must obtain a certificate of authority to transact business.

Answer 198

D. Receipt of voting stock by all shareholders of the original corporations. Answer (D) is correct. A consolidated corporation emerges from combining two or more preexisting corporations. Shareholders of the consolidating corporations receive stock in the new corporation, and possibly some boot (other property, including cash). The consolidating corporations are dissolved, and all or some of their businesses continue, or their assets are used by the new, consolidated corporation. No statute requires that each shareholder of the original corporation receive voting stock in the new.

Answer 199

D. Purchased treasury shares for less than par value. Answer (D) is correct. Under traditional rules, if stated par value exceeds the amount a shareholder paid for shares at issuance, the shareholder remains liable to creditors for the difference. A purchaser of treasury shares is not liable for any such excess. Moreover, under the RMBCA, any shareholder is liable only for the authorized consideration agreed to be paid.

Answer 200

A. Number of shares of stock authorized to be issued by the corporation. Answer (A) is correct. Articles of incorporation must contain (1) the name of the corporation, (2) the number of authorized shares, (3) the address of the initial registered office of the corporation, (4) the name of its first registered agent at that address, and (5) the names and addresses of the incorporators. The articles also may include (1) names and addresses of the initial directors; (2) purpose and duration of the corporation; (3) par value of shares; (4) provisions for managing the corporation and regulating its internal affairs; (5) powers of the corporation, its board, and its shareholders; (6) liability of shareholders for corporate debts; (7) a provision limiting directors’ liability (except for certain intentional wrongs); and (8) any provision that may be set forth in the bylaws.

Answer 201

B. The carryover of fixed dividends to subsequent periods from years in which they were not paid. Answer (B) is correct. Normally, a preferred shareholder is entitled to a fixed dividend that must be paid before dividends are received by the common shareholders. If the preferred stock is cumulative, any dividends not paid in preceding years are carried over and must be paid before the common shareholders may receive anything. Under case law, preferred stock dividends are impliedly cumulative unless stated otherwise, but the RMBCA suggests that whether stock is cumulative or noncumulative should be included in the articles.

Answer 202

D. A merger. Answer (D) is correct. Under the RMBCA, when a merger becomes effective, (1) the entity designated in the plan of merger as the survivor comes into existence, (2) every entity merged ceases to exist separately, (3) the property and contract rights of the merged entities are vested in the survivor, and (4) the liabilities of the merged entities also are vested in the survivor.

Answer 203

D. Each is created under a statute and must file a copy of its organizational document with the proper state authorities. Answer (D) is correct. Neither corporations nor limited partnerships are nonstatutory business organizations. They are artificial legal entities that are recognized only if they are formed under authority of a state statute. Filing an organizational document (articles of incorporation or certificate of limited partnership) with applicable state authorities is a requirement for legal entity status for each.

Answer 204

C. A shareholder of Golden Enterprises to enjoin the sale. Answer (C) is correct. Under the doctrine of ultra vires, a corporation may not act beyond the powers inherent in the corporate existence or provided in the articles of incorporation and the incorporation statutes. Ultra vires has been eliminated as a defense. The RMBCA states that, with certain exceptions, “the validity of corporate action may not be challenged on the ground that the corporation lacks or lacked power to act.” Those exceptions provide a cause of action in three instances in which the power to act may be questioned: (1) A shareholder can seek an injunction, (2) corporations can proceed against directors or officers, and (3) the state attorney general can proceed against the corporation.

Answer 205

A. If Abco declares a cash dividend on its preferred stock, Johns becomes an unsecured creditor of Abco. Answer (A) is correct. The holder of preferred stock must be paid the stated dividend before a common shareholder may receive any dividends. If payment of the stated dividend is not made to a cumulative preferred shareholder in any year(s), the dividends accumulate and must be paid in full prior to payment of any dividends to common shareholders. But a dividend on any stock does not become a payment obligation (debt) of the corporation until it has been declared.

Answer 206

C. Quorum requirements. Answer (C) is correct. Under the RMBCA, only the following must be included in the articles of incorporation: (1) the corporation’s name; (2) number of authorized shares; (3) address of initial registered office; (4) name of first registered agent (for service of process) at that address; and (5) the name and address of each incorporator. Other information, such as quorum requirements and additional provisions for managing the corporation and regulating its internal affairs, may but need not be included. Matters relating to governing the corporation are usually covered in the bylaws.

Answer 207

C. Bylaws. Answer (C) is correct. Bylaws govern the internal structure and operation of a corporation. Initial bylaws are adopted by the incorporators or the board. They may contain any provision for managing the business and regulating the affairs of the corporate entity not in conflict with the law or the articles of incorporation.

Answer 208

D. Both authorization by the board of directors and approval by the shareholders. Answer (D) is correct. The effect of the stock split is to increase the number of shares issued and outstanding from two million to four million, which will exceed the number of authorized shares. Such a transaction is a fundamental change in the corporate financial structure and therefore must be approved by the shareholders as well as by the board of directors.

Answer 209

C. The sale would be proper and Shephard would not have to account to the corporation for his profit if the sale was approved by a disinterested majority of the directors. Answer (C) is correct. The fiduciary duty of directors to the corporation does not prohibit them from dealing with the corporation. The view has been that the director must disclose the contract and refrain from voting. Under the RMBCA, conflicting interest transactions between directors and corporations are not voidable and do not otherwise result in sanctions even if the interested director votes for the contract. If the interested director discloses the interest and the decision is by a majority of the disinterested directors, no secret profit exists and no breach of fiduciary duty occurs.

Answer 210

D. Stock splits. Answer (D) is correct. A stock split is not a distribution from assets or capital. The amount of earned or capital surplus or stated capital does not change. Each share of a class of stock is merely divided into a multiple of one share. The value of each share changes, not the shareholder’s proportionate ownership interest. Under the RMBCA, a distribution is “a direct or indirect transfer of money or other property (except its own shares) or incurrence of indebtedness by a corporation to or for the benefit of its shareholders in respect of any of its shares.”

Answer 211

C. Such shares may be purchased by the corporation to the extent of unreserved and unrestricted retained earnings. Answer (C) is correct. A corporation may reacquire its own stock (a redemption), provided certain conditions are met. Under the RMBCA, the redemption of stock must not render the corporation insolvent, and the total assets after the distribution may not be less than the sum of total liabilities and liquidation preferences. Thus, redemptions may be made out of retained earnings that is not restricted.

Answer 212

D. A shareholder may have power to dissolve a close corporation that is similar to a partner’s. Answer (D) is correct. Many close corporations are like partnerships in which all of the shareholders are active in management or are friends and relatives of those who are. In a partnership, a partner’s interest is protected by his or her power to dissolve the association at any time and receive the value of his or her interest. Traditional corporate law did not provide that option for minority shareholders. The RMBCA allows a shareholder agreement (1) set forth in the articles of incorporation, the bylaws, or a separate signed writing and (2) approved by all shareholders at the time of the agreement to include a provision enabling any shareholder to dissolve the corporation either at will or upon the happening of a certain event.

Answer 213

A. A stock dividend is a corporation’s ratable distribution of additional shares of stock to its stockholders. Answer (A) is correct. A stock dividend is payable in the stock of the dividend-paying corporation. New stock generally is issued for this purpose. A shareholder’s equity in the corporation is not increased because a stock dividend does not increase the recipient’s proportional ownership.

Answer 214

B. Have little effect on the creation or operation of a partnership other than the imposition of a fine or other minor penalty for noncompliance. Answer (B) is correct. Fictitious name statutes have been enacted in most states for the protection of creditors. Registration permits creditors to discover the persons liable for the debts of the enterprise. The creation and operation of a partnership is little affected by the requirement because a partnership need not adopt a name, although use of a name may help to distinguish a partnership action from that of a partner. Moreover, the use of a name does not necessarily indicate the existence of a partnership or that a named person is a member of the firm.

Answer 215

D. Is required of all exempt organizations having at least $1,000 of gross income used in computing unrelated business taxable income for the year. Answer (D) is correct. A UBI tax return (Form 990-T) is required of an exempt organization with at least $1,000 of gross income used in computing unrelated business taxable income for the tax year.

Answer 216

D. I only. Answer (D) is correct. Partners are jointly and severally liable for the torts committed by another partner who acted within the ordinary course of the partnership business or with the authorization of the other partners. Joint and several liability means that all of the partners are liable, but a third party may hold any partner liable for the entire amount. Because a general partner is an agent of the business, (s)he has apparent authority to bind the partnership to contracts with third parties formed while carrying on the partnership business in the usual way.

Answer 217

B. Will be effectively limited by the filing of a statement of partnership authority. Answer (B) is correct. Each partner in a general partnership is an agent of the partnership. The partners may not limit partnership liability to third parties by agreement among the partners alone. But apparent authority is effectively limited to the extent a third party knows of limitations imposed on a partner’s authority. The RUPA provides for filing of a statement of authority that may give notice of limitations on the authority of a partner.

Answer 218

C. Notice to a partnership at will of a partner’s express will to withdraw. Answer (C) is correct. Under the RUPA, dissociation of the partner and dissolution of a partnership at will result from a partner’s notice to the partnership of his or her express will to withdraw. A wrongful dissociation results in liability to the other partners for damages.

Answer 219

D. In the same manner as partnership profits. Answer (D) is correct. Without an agreement to the contrary, the RUPA requires that each partner contribute toward the losses of the partnership according to his or her share in the profits. This rule applies only among the partners. All partners remain fully liable to third parties.

Answer 220

A. Neither I nor II. Answer (A) is correct. A limited partner’s liability for partnership obligations is limited to his or her capital contribution to the business, whereas a general partner has unlimited personal liability for partnership debts. The limited partner also is restricted in the right to control the partnership. (S)he is not allowed to participate in the day-to-day management of the partnership business.

Answer 221

D. $20,000 Answer (D) is correct. The partnership agreement, to the extent it allocates partnership losses among partners, governs. Without an agreement, a partner shares losses in the same proportion (s)he shares profits. The partnership agreement, to the extent it allocates partnership profits among partners, governs. Thus, G’s share of the losses is 10% of $200,000.

Answer 222

C. The partners will share in losses according to the allocation of profits specified in the partnership agreement. Answer (C) is correct. Unless the partners agree otherwise, the RUPA provides for equal sharing of the partnership’s profits. Also, unless otherwise agreed, each partner must contribute in proportion to his or her share of the profits toward any losses of the partnership. Thus, Flanigan, Drake, and Berry are responsible for 50%, 25%, and 25%, respectively, of the partnership’s losses.

Answer 223

C. Eller’s personal assets. Answer (C) is correct. The RUPA provides that partners are jointly and severally liable for all obligations of the partnership, including those arising out of a contract. The keys to the question are that (1) Trent sued both the partnership and one partner, (2) that partner can be held individually liable for the entire amount of a partnership obligation (joint and several liability), and (3) only parties who are judgment debtors can be held liable. Because Trent won the lawsuit against Venture and Eller, either Venture or Eller or both are liable for the judgment amount. In this scenario, the partnership is in bankruptcy. A plaintiff with a judgment against a defendant in bankruptcy typically collects very little, if any, of the judgment. The judgment against the partnership will be subordinated to the claims of secured creditors and creditors with priority. As a result, Trent will likely seek to recover the full judgment from Eller’s personal assets, given that Eller was a co-defendant in the lawsuit. Furthermore, because Venture is in bankruptcy, the RUPA provides that Trent need not seek a writ of execution against (compel collection of the judgment amount from) Venture before proceeding against Eller’s personal assets.

Answer 224

B. Fisk and all outside general creditors will receive repayment of their loans prior to any other distributions. Answer (B) is correct. Under the RULPA, a limited (or general) partner is entitled to the same priority for repayment of a loan by the partnership as outside creditors.

Answer 225

C. The SEC is not informed of exempt sales. Answer (C) is correct. Section 4(6) exempts up to $5 million of offers and sales if made only to accredited investors. The number of such investors may be unlimited, and no information is required to be given to them, but general advertising and solicitation are not permitted. Moreover, (1) the SEC must be informed of sales under the exemption, (2) resale is restricted, and (3) precautions must be taken to prevent nonexempt or unregistered resales.

Answer 226

D. A limited partner has the right to obtain from the general partner(s) financial information and tax returns of the limited partnership. Answer (D) is correct. Both general and limited partners have the right to inspect and copy the books of the partnership at any time. Thus, they can obtain financial information and tax returns of the limited partnership.

Answer 227

C. $40,000 $40,000 $40,000 Answer (C) is correct. Partners are not entitled to compensation for their actions, skill, and time applied on behalf of the partnership, except when such an arrangement is explicitly provided for in the partnership agreement. The partnership agreement is silent on this point, so salaries are not paid to the partners. Profits and losses may be divided among the partners according to any formula stated in the partnership agreement. Without a contrary agreement, partners share equally in the profits. Thus, each partner will receive $40,000.

Answer 228

A. Grand has the apparent authority to bind the partnership in contracts she makes with persons unaware of her retirement who have previously dealt with the partnership. Answer (A) is correct. Under the RUPA, a dissociated partner continues to be able to bind the partnership for up to 2 years after dissociation if other parties reasonably believe that the dissociated partner is still a partner and do not have knowledge or notice of the dissociation. A statement of dissociation must be filed by the partnership or a dissociated partner to terminate the partner’s apparent authority and his or her liability for the partnership’s post-dissociation obligations. But after the statement is filed, it is not deemed to provide notice for 90 days.

Answer 229

D. An exempt organization is not taxed on unrelated business income of less than $1,000. Answer (D) is correct. UBI of less than $1,000 is not subject to tax. UBI, generally, is gross income derived from a trade or business unrelated to the exempt organization’s qualified purpose minus directly connected allowable deductions. The $1,000 is, technically, a deduction.

Answer 230

B. II only. Answer (B) is correct. Partnership rights may be assigned without the dissolution of the partnership. The assignee is entitled only to the profits the assignor would normally receive. The assignee does not automatically become a partner and would not have the right to participate in managing the business or to inspect the books and records of the partnership. The assigning partner remains a partner with all the duties and other rights of a partner.

Answer 231

B. Lease on land. Answer (B) is correct. Land is not Sec. 1250 property, but leases are Sec. 1250 intangible properties. Certain improvements to land may be treated as land, e.g., dams and irrigation systems. Section 1250 property includes depreciable real property acquired after 1986.

Answer 232

B. Requires a formal “doing business as” filing under state law if the proprietor plans to do business under a fictitious name. Answer (B) is correct. A proprietor doing business under a fictitious name is usually required to make a d/b/a or “doing business as” filing under state law. Otherwise, the formation of a sole proprietorship is subject to few legal requirements, such as local zoning and licensing. In this respect, the sole proprietorship is the easiest and least expensive to create of all the business organizations.

Answer 233

B. A manufacturing company’s investment in U.S. Treasury bonds. Answer (B) is correct. Capital assets are all property held by a taxpayer not excluded by the IRC. Among the items excluded are accounts receivable, depreciable property, and real property used in a trade or business. The investment in U.S. Treasury bonds is a capital asset.

Answer 234

B. $3,000 Answer (B) is correct. Section 642(e) allows an estate or trust a deduction for depreciation to the extent it is not allowable to beneficiaries. Under Sec. 167(d) and Reg. 1.167(h)-1(b), in the absence of provisions in the trust instrument apportioning the deduction, the deduction is apportioned between the trust and its beneficiaries based on the income allocable to each. Since a reserve is required under the trust instrument, the depreciation deduction is allocated to the trust to the extent income is set aside for a depreciation reserve and actually remains in the trust. The entire $3,000 of depreciation is allocated to and deductible by the trust. If no reserve were required under the trust instrument or local law, the beneficiaries would be entitled to the depreciation deduction, since the trust must distribute all of its income currently.

Answer 235

A. Pro rata share of any nonseparately stated income of the S corporation. Answer (A) is correct. Allocations of income increase a shareholder’s basis. They do not decrease basis.

Answer 236

C. $5,000 Answer (C) is correct. Gain is recognized on a like-kind exchange equal to the lesser of gain realized or boot received. Gain realized is $25,000 ($120,000 FMV of the new van + $5,000 cash – adjusted basis of the van given up). Boot received is the $5,000 cash. Therefore, the recognized gain is $5,000.

Answer 237

D. To no more than 35 purchasers who are not accredited investors. Answer (D) is correct. The amount that may be raised under Rule 506 of Regulation D is unlimited. The offering may be purchased by an unlimited number of accredited investors. If no general solicitation or advertising is made, up to 35 purchasers who are not accredited investors also may purchase.

Answer 238

A. $30,000 Answer (A) is correct. If the requirements of Sec. 351(a) are met, no gain or loss is recognized when property is transferred to a corporation. There are three primary exceptions to Sec. 351(a). Gain can be recognized when Property other than stock (e.g., cash) is received [Sec. 351(b)], A liability is assumed by the corporation for tax avoidance or nonbusiness purposes [Sec. 351(b)], or A liability is assumed in excess of the adjusted basis of the property transferred [Sec. 357(c)]. Since the mortgage is assumed for a valid business reason and does not exceed the $150,000 adjusted basis, none of the mortgage that is assumed is treated as boot property [Sec. 357(a)]. The recognized gain is the lesser of the cash received by the transferor ($30,000) or the realized gain of $100,000 [($100,000 FMV of stock + $120,000 mortgage release + $30,000 cash) – $150,000 adjusted basis].

Answer 239

B. February 28, 2018. Answer (B) is correct. A corporation making any distribution in complete or partial liquidation must file a Form 1099-DIV in each calendar year of the liquidation for each shareholder to whom it makes a distribution of $600 or more. These forms must be sent to the shareholders by January 31 of the year following the calendar year in which the liquidating distribution is made [Sec. 6042(c)] and filed with the IRS by February 28 [Reg. 1.6043-2(a)].

Answer 240

D. Guaranteed payments to partners. Answer (D) is correct. Ordinary income of a partnership is the balance of taxable income excluding all items required to be separately stated. Guaranteed payments to partners are deductible, provided they are ordinary and necessary business expenses.

Answer 241

B. $140,000 Answer (B) is correct. Section 301(b)(1) provides that the distribution to a shareholder is equal to the fair market value of the property distributed. Under Sec. 301(b)(2)(A), this amount must be decreased by any liabilities assumed by the shareholder or to which the property is subject. The distribution to the shareholder is $140,000 ($230,000 FMV – $90,000 liability). Under Sec. 316, a distribution is a dividend to the extent that it comes from earnings and profits. The earnings and profits would be increased by the gain (net of tax) on the distribution. Gain is recognized to the extent the FMV of the building exceeds the adjusted basis [Sec. 311(b)], or $60,000. In any event, the corporation has at least $250,000 of earnings and profits. Therefore, the entire $140,000 is a dividend.

Answer 242

A. $50,000 ordinary loss and $18,000 capital loss. Answer (A) is correct. Up to $50,000 of loss realized on disposition or worthlessness of Sec. 1244 stock is treated as an ordinary loss. This limit applies to Sec. 1244 stock held in all corporations. The remaining $18,000 ($48,000 + $20,000 – $50,000) is a capital loss.

Answer 243

D. Permits accumulation of current income, provides for charitable contributions, or distributes principal during the taxable year. Answer (D) is correct. Complex trusts can accumulate income, provide for charitable contributions, or distribute amounts other than income. These characteristics distinguish a complex trust from a simple trust.

Answer 244

A. Accelerated depreciation on pre-1987 real property to the extent of the excess over straight-line depreciation. Answer (A) is correct. Tax preference items increase adjusted taxable income to arrive at alternative minimum taxable income. Excess depreciation is a tax preference item for real property placed in service prior to 1987. Depreciation on assets placed in service after 1986 is computed as an adjustment rather than as a tax preference.

Answer 245

C. Increases each partner’s basis in proportion to their ownership. Answer (C) is correct. A partner’s share of a partnership liability is treated as if the partner contributed an equivalent amount of money to the partnership. The deemed contribution increases the partner’s basis in his or her partnership interest. Normally, general partners share liabilities based on their ratio for sharing economic losses (recourse liability).

Answer 246

D. Salvage value is ignored for purposes of computing the MACRS deduction. Answer (D) is correct. Salvage value is treated as zero in computing the amount allowable as a depreciation deduction under the MACRS. Used tangible property is depreciable under MACRS. The straight-line method is required for certain property, e.g., listed property. The 10-, 15-, and 20-year MACRS classes include certain real property, e.g., farm buildings.

Answer 247

D. II only. Answer (D) is correct. A partner’s transferable interest consists of a partner’s share of partnership profits and losses and the right to receive distributions. Partners may sell or otherwise transfer (assign) their interests to the partnership, another partner, or a third party without loss of the rights and duties of a partner (except the interest transferred). Moreover, unless all the other partners agree to accept the assignee as a new partner, the assignee does not become a partner in the firm. Without partnership status, the assignee has no obligation for partnership debts.

Answer 248

C. $7,000,000 Answer (C) is correct. Taxpayers may exclude 50% of the gain from the sale or exchange of small business stock if the stock was held for more than 5 years. Danielson has realized gain of $14,000,000 ($16,000,000 sales price – $2,000,000 AB), but only needs to recognize $7,000,000 (50% × $14,000,000) as a taxable gain.

Answer 249

C. A partnership at will. Answer (C) is correct. A partnership at will is one “in which the partners have not agreed to remain partners until the expiration of a definite term or the completion of a particular undertaking” (RUPA).

Answer 250

C. $54,000 Answer (C) is correct. Most farm-related income is reported in Part 1 of Form 1040 Schedule F; however, one exception to that is the reporting of capital gains. Capital assets include livestock used for breeding and are reported on Schedule D. The cost of livestock purchased for resale is calculated in to arrive at gross income. Jon’s gross income includes the gain from nine deer ($100,000 ÷ $10,000 – 1 capital asset) and the debt discharge. The gross income is $54,000 ($90,000 of sales – $45,000 COGS + $9,000 debt discharge). Alimony received is reported on line 11 of Form 1040, not on Schedule F.

Answer 251

``` B. Any foreseen or known third party who relied on the tax return. Answer (B) is correct. The majority rule is that the CPA is liable to foreseen (but not necessarily individually identified) third parties (foreseen users and users within a foreseen class of users). ```

Answer 252

D. $19,000 Answer (D) is correct. A partner receives a basis in a partnership equal to the basis of the property contributed to the partnership. An increase in a partner’s share of liabilities is treated as a contribution of money by such partner, which increases the partner’s basis. Zachary’s basis in the partnership is $23,000 ($20,000 in contributed property and a 30% share of the $10,000 liability). After the $4,000, Zachary’s basis is reduced to $19,000.

Answer 253

D. Not recognize gain or loss on the liquidating distribution(s). Answer (D) is correct. When a subsidiary corporation is liquidated into the parent corporation in a Sec. 332 transaction, no gain or loss is recognized on the liquidation.

Answer 254

D. Ordinary income of $25,000. Answer (D) is correct. The general rule of Sec. 351 is that no gain or loss is recognized if one person or more transfers property to a corporation solely for stock and if, immediately after the exchange, such person(s) is(are) in control of the corporation (i.e., own at least 80% of the stock). Section 351(d) states, however, that stock issued for services is not issued in return for property. Stock issued for services falls outside the general rule, and income must be recognized on such a transfer. The fair market value of stock received for services ($25,000) must be included in Aaron’s income. All other stock received was in exchange for property, and no gain or loss is recognized on its transfer.

Answer 255

C. The misstatements were material. Answer (C) is correct. Section 11 is the most frequently invoked basis for suit under the Securities Act of 1933. Under Section 11, the investor need only prove that (s)he suffered losses in a transaction involving the particular securities covered by the registration statement and that the registration statement contained a material misstatement or omission of fact for which the CPAs were responsible, e.g., in the audited financial statements. Unless rebutted, such proof is sufficient to prevail in the lawsuit.

Answer 256

A. $0 Answer (A) is correct. A partner’s initial basis in his or her partnership interest is, among other factors, his or her adjusted basis of property contributed increased for the partner’s share of partnership liabilities and reduced by the amount of the partner’s liabilities assumed by the partnership. Campbell’s basis for his partnership interest in Vogue is calculated as follows: Basis of property contributed $ 40,000 Gain recognized on contributed property 14,000 Partner’s share of partnership liabilities ($60,000 × 10%) 6,000 Less: Partner’s liabilities assumed by the partnership (60,000) Basis in partnership interest $ 0

Answer 257

A. $0 Answer (A) is correct. Up to $14,000 of the FMV of a gift of present interest to a donee is excludable each year. A present interest is an unrestricted right to the immediate use, possession, or enjoyment of property or the income from property (such as a life estate or interest). The donee has no present interest in the transferred property, so none of its present value is excludable by the donor/trustor.

Answer 258

D. $0 Answer (D) is correct. An exemption is allowed for each dependent whose gross income for the taxable year is less than the exemption amount ($4,050 in 2017) or who is a child of the taxpayer and has not attained the age of 19. No personal exemption may be taken on the return of an individual who can be claimed as a dependent on another taxpayer’s return. Dora’s parents are entitled to claim her as a dependent on their return. Therefore, Dora is not entitled to a personal exemption herself.

Answer 259

B. The transaction will qualify as a tax-free reorganization. Answer (B) is correct. A Type B, or stock-for-stock, acquisition qualifies as a tax-free reorganization if the shareholders of one company acquire the stock of the target company solely in exchange for stock of their company. The acquiring company must control at least 80% of the stock of the target company after the exchange.

Answer 260

C. $56,800 Answer (C) is correct. Each shareholder shall include in gross income the pro rata share of the S corporation’s income. The pro rata share is the taxpayer’s share of the corporation’s income after assigning an equal portion of the income to each day of the taxable year and then dividing that portion pro rata among the shares outstanding on each day. Therefore, each day of the year will be assigned $200 of income ($73,000 ÷ 365). Kane’s share will be $56,800 [$8,200 (41 days × $200 × 100% ownership) plus $48,600 (324 days × $200 × 75% ownership)].

Answer 261

C. $31,000 Answer (C) is correct. Net earnings from self employment are gross income derived from a trade or business, less allowable deductions attributable to the trade or business. Capital gains and losses and contributions to retirement plans are not considered income or expenses for self-employment purposes. In addition, net operating losses are not considered for self-employment purposes. Michael’s net self-employment income is computed as follows: Gross receipts $100,000 Cost of goods sold (49,000) Utilities (6,000) Real estate taxes (1,000) Depreciation expense (5,000) Section 179 expense (1,000) Mortgage interest (7,000) Net self-employment income $ 31,000

Answer 262

B. Soliciting by mailings, the contents of which are designed for the general public. Answer (B) is correct. Section 10.51 of Circular 230 lists several examples of disreputable conduct for which a CPA may be disbarred or suspended from practice before the Internal Revenue Service. Solicitation by mailings, the contents of which are designed for the general public, is not prohibited under Sec. 10.30(a)(2) and is not disreputable conduct under Sec. 10.51 of Circular 230.

Answer 263

D. Capital gains. Answer (D) is correct. Section 302(b)(4) allows noncorporate shareholders who receive redemptions in partial liquidation to treat the distribution as payment for their stock. Any gain on the redemption is eligible for capital gain treatment.

Answer 264

C. More than a third of support from members and the general public. Answer (C) is correct. Each domestic or foreign exempt organization is a private foundation unless it generally receives more than a third of its support (annually) from its members and the general public. In this case, the private foundation status terminates, and the organization becomes a public charity.

Answer 265

D. A long-term capital gain of $25,000. Answer (D) is correct. Under Sec. 1015, the basis of property acquired by gift is the same as the adjusted basis of the donor plus gift tax paid by the donor on the property’s appreciation. Hart, Jr.’s basis was therefore $60,000. Section 741 provides that the gain on the sale of a partnership interest is capital gain. Hart, Jr.’s gain is long-term since Sec. 1223(2) provides that if property has the same basis as it did in the hands of the previous owner, the holding period of the present owner includes the holding period of the previous owner. Note that this problem assumes there is no change in basis between August 1 and December 17, which would be unlikely. Under this assumption, Hart, Jr.’s gain is Proceeds $85,000 Less: Adjusted basis (60,000) Long-term capital gain $25,000

Answer 266

C. 0.574% Answer (C) is correct. The apportionment of income to a taxing state under UDITPA. The formula is The property factor = $500,000 ÷ $200,000,000 = 0.250% The payroll factor = $450,000 ÷ $50,000,000 = 0.900% The sales factor = $4,000,000 ÷ $700,000,000 = 0.5714% Therefore, the apportionment percentage for taxing HMC’s income in state Y is 0.574% [(0.250% + 0.900% + 0.5714%) ÷ 3].

Answer 267

D. $41,000 Answer (D) is correct. The basis of an interest in a partnership acquired through the contribution of property is the adjusted basis of such property to the contributing partner. A decrease in a partner’s personal liabilities by reason of the assumption by the partnership of such liabilities is treated as a distribution of money to the partner. This distribution reduces the basis of the partner’s interest (but not below zero). When Barker became a 50% partner, the net liability relief was 50% of the $10,000 mortgage. Barker’s basis in the partnership is the $20,000 cash contributed plus the $26,000 adjusted basis in contributed property less the $5,000 liability relief, or $41,000.

Answer 268

B. Combining the items and disallowing 70% of the deductions in determining partnership taxable income. Answer (B) is correct. Miscellaneous itemized deductions are generally combined at the partnership level. Instead of applying the 2% floor to each deduction, 70% of the total of these deductions are disallowed at the partnership level.

Answer 269

C. Privity with purchasers is not a necessary element of proof. Answer (C) is correct. Under the 1933 act, a purchaser need only prove damages resulting from the purchase of securities covered by a registration statement containing a false statement or omission of a material fact in a section audited or prepared by the auditor. The auditor must then prove that (s)he was not negligent (or fraudulent), usually by showing that (s)he acted with due diligence. To recover damages at common law based on contract or negligence, privity between the plaintiff and accountant may be required. To recover under the Securities Act of 1933, however, a purchaser of securities need not prove privity of contract with a CPA.

Answer 270

B. $12,000 Answer (B) is correct. Section 336(a) provides that a corporation should treat a complete liquidation as a sale using the fair market value. However, Sec. 336(b) requires that the fair market value used should not be less than any liability accepted by the distributee. Since Len is transferring property with a liability of $38,000, which is higher than the $35,000 FMV, the $38,000 is used as the new FMV. Therefore, Len Corporation recognizes a $12,000 gain ($38,000 new FMV – $26,000 adjusted basis).

Answer 271

C. Total gross assets of $100 million or less at all times after August 10, 1993 and before it issued the stock. Answer (C) is correct. Stock qualifies as Section 1202 stock if it is received after August 10, 1993, the corporation is a domestic C corporation, the seller is the original owner of the stock, and the corporation’s gross assets do not exceed $50 million at the time the stock was issued. Additional requirements do exist. However, the total gross assets requirement is $50 million.

Answer 272

C. $(75) Answer (C) is correct. Section 56(g) provides that the ACE adjustment shall be 75% of the difference between ACE and AMTI (excluding the ACE adjustment and the alternative tax NOL deduction). However, in a tax year in which AMTI exceeds ACE, the negative adjustment is limited to the aggregate positive adjustments for prior years over the aggregate negative adjustments for prior years. Bear’s AMTI exceeds its ACE by $200 in Year 3, 75% of which equals $150. However, this negative adjustment amount is limited to the $75 positive adjustment made in Year 1 [($200 ACE – $100 AMTI) × 75% = $75].

Answer 273

D. $0 Answer (D) is correct. The original cost of an asset must be reduced for any Sec. 179 expense up to $510,000 in 2017. Since Mr. Anderson took the Sec. 179 expense deduction of $12,000 in 2017, he must reduce the cost of his property. Mr. Anderson’s depreciable basis is Original cost $12,000 Less Sec. 179 deduction (12,000) Depreciable basis $ 0

Answer 274

A. $8,181 Answer (A) is correct. The tax on self-employment income is imposed by Sec. 1401 on all taxpayers whose net earnings from self-employment exceed $400 [Sec. 1402(b)]. For 2017, the tax is divided into two components: the Social Security and Medicare taxes, which are based on the net earnings from self-employment. The Social Security tax is imposed at a 12.4% rate up to a $127,200 maximum. The Medicare tax is imposed at a 2.9% rate, and there is no maximum. Taxpayers may reduce their tentative net earnings from self-employment by the product of the employer’s portion of the self-employment tax rate (7.65%) times the tentative net earnings from self-employment [Sec. 1402(a)(12)]. The self-employment tax is computed separately for each spouse. Their taxes are Mr. B ``` Mrs. B Net income (tentative net earnings ``` from self-employment) $15,000 $42,900 Less: Employer’s portion of self- employment tax rate times net income (1,148) (3,282) Net earnings from self-employment $13,852 $39,618 Times: Tax Rate × 0.153 × 0.153 Self-employment tax $ 2,119 $ 6,062 The total self-employment tax for Mr. and Mrs. B is $8,181 ($2,119 + $6,062).

Answer 275

D. Gain on sale of investment property. Answer (D) is correct. Business and nonbusiness income and deductions need to be distinguished because nonbusiness deductions are deductible in computing a NOL only to the extent of nonbusiness income. Nonbusiness deductions and income are those that are not attributable to, or derived from, a taxpayer’s trade or business. Also, capital losses are only deductible to the extent of capital gains. A gain on the sale of investment property is a capital gain and not business income.

Answer 276

C. $2,500 Answer (C) is correct. Section 119 provides an exclusion for meals and lodging furnished on the business premises of the employer if they are furnished for the convenience of the employer. Having motel managers remain on the premises to register and take care of guests is for the convenience of the employer. For lodging (but not meals), the employee must be required to accept the lodging as a condition of employment. Since these requirements are met for Hansel and Gretel, they may exclude the entire value of their living quarters. However, while the value of meals may be excluded, there is no exclusion for groceries. Therefore, Hansel and Gretel must include the value of groceries ($2,500) in their gross income.

Answer 277

C. Be deducted on Placebo’s 2017 tax return. Answer (C) is correct. Under Sec. 404, certain contributions paid by an employer are subject to being treated as deferred compensation and are deductible in the year of payment. This limitation is applicable if the deduction would otherwise be allowed under Sec. 162(a). The deduction is required in the payment year unless distributed prior to March 15. Because the present amount was paid on March 13, the time of receipt was within the allocated period of time, and the compensation can be deducted as a business expense under Sec. 162 in 2017.

Answer 278

D. Any shareholder or group of shareholders owning more than 50%. Answer (D) is correct. The consent of shareholders who collectively hold more than 50% of the issued and outstanding stock, both voting and nonvoting, at the revocation is required to successfully revoke the S election.

Answer 279

B. I and IV. Answer (B) is correct. The distinction between trust or estate income and principal is an important one. Tax is imposed on the taxable income (TI) of trusts or estates, but not on items treated as fiduciary principal. The Revised Uniform Principal and Income Act specifies that certain items, including business income, interest, rents, and taxable dividends, are to be treated as income to the trust or estate. The act also lists certain items to be treated as principal, including consideration for property (e.g., gain on sale), stock splits, stock rights, and liquidating dividends.

Answer 280

C. The election may be revoked with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares. Answer (C) is correct. Upon the occurrence of a terminating event, an S corporation becomes a C corporation. An S corporation election is terminated if shareholders collectively holding more than 50% of the outstanding shares of stock on the day of the revocation (voting and nonvoting) consent, any eligibility requirement not being satisfied on any day, and/or a passive income investment income (PII) termination.

Answer 281

B. $15,000 Answer (B) is correct. Determination must first be made as to whether or not the cash distribution is a dividend. Section 316 defines a dividend as a distribution of earnings and profits (E&P). Regulation 1.316-1(a)(1)(ii) states that current E&P is to be computed at the end of the tax year without regard to distributions during the year. At December 31, 2017, Elk has a current E&P of $6,000 and accumulated E&P of $60,000. The cash distribution comes first from current E&P ($6,000 – $6,000 = $0), with the balance from accumulated E&P, thereby leaving a $51,000 balance ($60,000 – $9,000). All $15,000 of the distribution is dividend income.

Answer 282

D. An employee taxpayer’s estimated tax payments were 100% of that shown on the 2016 return, and last year’s AGI was $160,000. Answer (D) is correct. Adjusted gross income above $150,000 subjects the individual taxpayer to a different safe harbor provision. The safe harbor percentage is 110%.

Answer 283

A. Cannot be imposed on a corporation that has undistributed earnings and profits of less than $150,000. Answer (A) is correct. The Accumulated Earnings Credit (AEC) is deducted from taxable income (TI) to determine accumulated taxable income (ATI), the AET base. The minimum credit base is $250,000. However, the minimum credit base is $150,000 for certain service corporations. The AET base is not less than any excess of the minimum credit base ($150,000) over accumulated E&P. Thus, AET is not imposed on a corporation that has undistributed earnings and profits of less than $150,000.

Answer 284

C. Judicial. Answer (C) is correct. The three classes of Treasury Regulations are temporary, final, and proposed regulations. Judicial is not a class of Treasury Regulations.

Answer 285

D. Frank’s estate’s income tax return. Answer (D) is correct. Because Frank used the cash method and had not received the $5,000 payment before his death, he should not report this amount on his final income tax return. The $5,000 was received before his estate was settled, however. Thus, $5,000 must be included on Frank’s estate income tax return.

Answer 286

B. Lending without adequate security. Answer (B) is correct. Certain employee trusts lose exempt status if they engage in prohibited transactions, e.g., lending without adequate security or reasonable interest, or paying unreasonable compensation for personal services.

Answer 287

C. State and local income taxes on net income. Answer (C) is correct. State income taxes are imposed on an individual after income from all taxable sources is aggregated. State income taxes are a personal expense (deductible under Sec. 164) and not an expense of the source of income, e.g., a sole proprietorship. They are deducted from adjusted gross income and are reported as an itemized deduction on Schedule A.

Answer 288

C. $100,000 Answer (C) is correct. Schedule M-1 reconciles income or loss per books with income or loss per return. The $76,000 income per books is adjusted by adding federal income taxes ($18,000), excess contributions ($2,000), and meals in excess of the 50% limitation ($8,000) and by subtracting tax-exempt interest ($4,000).

Answer 289

C. May have an unlimited number of partners. Answer (C) is correct. A valid limited partnership has no maximum limit on the number of partners (limited or general). The only requirement is that it have at least one limited and one general partner. In contrast, S corporations currently have a limit of 100 shareholders.

Answer 290

D. $850,000 Answer (D) is correct. All business income is apportioned to a taxing state by multiplying the business income by the sum of the property, payroll, and sales factors divided by three. Property factor = $540,000 = 18% $3 million Payroll factor = $240,000 = 12% $2 million Sales factor = $2,100,000 = 21% $10 million State 1 income apportionment = 18% + 12% + 21% = 17% × $5 million 3 = $850,000

Answer 291

C. Any losses in excess of the at-risk amount are suspended and carried forward without expiration and are deductible against income in future years from that activity. Answer (C) is correct. The losses are carried forward without expiration and are deductible against income in future years from that activity.

Answer 292

B. Participants may select their own menu of benefits. Answer (B) is correct. Section 125 defines a cafeteria plan as a written plan under which all participants are employees and the participants may choose among benefits consisting of cash and qualified benefits. Participation is restricted to the employee. There is no minimum period of employment required. Benefits that do not qualify include (1) deferred compensation plans other than Sec. 401(k) plans, (2) scholarships and fellowship grants or tuition reductions, (3) educational assistance, and (4) other fringe benefits.

Answer 293

D. $7,000 Answer (D) is correct. A shareholder in an S corporation includes his or her pro rata share of all items of income, loss, deduction, and credit from the S corporation [Sec. 1366(a)]. Sunnie is a 50% shareholder and is allocated 50% of the $22,000 ordinary loss for the current year, or $11,000. However, Sec. 1366(d) limits the losses taken into account by a shareholder to the sum of the shareholder’s basis in the stock and his or her basis in any debt of the S corporation to that shareholder. Sunnie’s guarantee does not increase her basis in the stock. Sunnie’s limit for deduction of losses is the $7,000 basis in her stock. The remaining loss of $4,000 can be carried forward indefinitely until Sunnie has sufficient basis.

Answer 294

C. A deduction of $8,000. Answer (C) is correct. If bonds are issued and subsequently repurchased by the corporation at a price in excess of the issue price, the excess of the purchase price over the issue price is deductible as interest expense for that taxable year. Shaney should therefore report a deduction of $8,000 (repurchase price of $258,000 less issue price of $250,000).

Answer 295

B. Three. Answer (B) is correct. The statute of limitations for assessment of tax liability (except in the case of fraud or other special exceptions) is generally 3 years from the date the return is filed. Note that an early return is treated as filed on the due date.

Answer 296

C. Once made, the election to deduct the loss on the prior-year return cannot be revoked. Answer (C) is correct. If a taxpayer sustains a loss from a disaster in an area subsequently designated as a federal disaster area, a special rule may help the taxpayer to cushion his or her loss. Disaster loss treatment is available with respect to a personal residence declared unsafe and ordered to be demolished by the state or local government. The taxpayer also has the option of deducting the loss on his or her return for the year in which the loss occurred or on the return for the previous year. Revocation of the election to deduct the loss on the preceding year’s tax return may be made before the expiration of time for filing the return for the year of loss. The calculation of the deduction for a disaster loss follows the same rules as those for nonbusiness casualty losses.

Answer 297

D. $54,300 Answer (D) is correct. Section 55(d) provides an exemption amount for individuals for purposes of computing the alternative minimum tax. The amount of this exemption for individuals who are not married and not a surviving spouse is $54,300. As a result, a single individual will not have to pay alternative minimum tax until his or her alternative minimum taxable income exceeds $54,300. Note that this amount would be phased out by reducing the exemption for 25% of the excess of alternative minimum taxable income over a certain amount ($120,700 in the case of a single individual).

Answer 298

A. $132,500 Answer (A) is correct. A partnership agreement is disregarded to the extent a partner receives less than reasonable compensation for services. Of ABC’s $200,000 gross income credited to Andrew and John, $65,000 must be allocated to Andrew for his services. The remaining $135,000 is split between the two. Thus, Andrew should report $132,500 [($65,000 + (1/2 × $135,000)].

Answer 299

D. $10,000 Answer (D) is correct. An S corporation that, upon conversion from C to S status after 1986, had net appreciation inherent in its assets is subject to tax of 35% on net gain recognized (up to the amount of built-in gain on conversion) during the recognition period. For conversions made after the 2010 tax year, the recognition period is the 5-year period beginning on the date the S election became effective. Commerce would be subject to built-in gains tax on $10,000 ($30,000 FMV at conversion – $20,000) of the recognized gain from the transaction in March.

Answer 300

A. $5,000 capital gain. Answer (A) is correct. Generally, a capital gain or loss is recognized on the sale of a partnership interest. A selling partner’s relief of liabilities is included in the amount realized. Gain or loss recognized by the selling partner is the difference between the amount realized and the adjusted basis of the partner’s interest in the partnership. Therefore, Scott’s capital gain is $5,000 ($25,000 amount realized – $20,000 adjusted basis).

Answer 301

B. Capital loss carryback. Answer (B) is correct. The accumulated earnings tax is applied to accumulated taxable income, which is taxable income, subject to certain adjustments. Capital loss carrybacks and carryforwards are not allowed. Instead, capital losses are deductible in full in the year incurred (but must be reduced by prior net capital gain deductions).

Answer 302

C. Chassis cannot take the U.S. Production Deduction. Answer (C) is correct. The U.S. Production Deduction applies to firms that provide manufacturing and production activities in the United States. Chassis does not produce the chassis, but rather only sells it. Therefore, Chassis cannot take the U.S. Production deduction.

Answer 303

B. The trust is included in the gross estate of the grantor. Answer (B) is correct. The gross estate includes assets transferred during life that, at death, the decedent retained the power to revoke, such as transfers made to a revocable trust.

Answer 304

B. In the absence of a provision in the lease to the contrary, Delta does not need Tanner’s consent to assign the lease to another party. Answer (B) is correct. Both assignments and subleases are permitted unless expressly prohibited by the lease. Public policy favors transferability of property.

Answer 305

C. An assignment of rights and a delegation of duties by Neptune. Answer (C) is correct. General language, such as “I hereby assign my contract,” effects both an assignment of the rights and a delegation of performance without clear indications to the contrary.

Answer 306

A. Appraised value. Answer (A) is correct. An element of actionable fraud is a false representation or the concealment of a material fact. A material fact is a fact that forms a basis of the bargain. Stating a false amount to be the appraised value of the subject matter is actionable as fraud, if the other elements are alleged.

Answer 307

D. A contract was formed but would be enforceable only against Kram. Answer (D) is correct. An agreement to sell an interest in real property is within the statute of frauds. An agreement that meets the criteria for the formation of an oral contract (offer and acceptance, consideration, mutual assent, capacity of the parties, and legality) but is within the statute of frauds is enforceable only against a party who signs a written memorandum of the offer. Fargo’s oral acceptance bound Kram but not Fargo.

Answer 308

D. By making the assignment, Burns implicitly warranted a lack of knowledge of any fact impairing the value of the assignment. Answer (D) is correct. When an assignment is made for value, the assignor makes three implied warranties to the assignee: (1) The assignor will do nothing to affect or impair the value of the assignment, and (s)he has no knowledge of any fact that would do so; (2) the right, as assigned, actually exists and is subject to no limitations or defenses good against the assignor, except those stated or apparent; and (3) any writing given or shown to the assignee as evidence of the right is genuine and is what it purports to be.

Answer 309

A. Price involved. Answer (A) is correct. An agreement regarding the sale of real estate or services is not enforceable as a contract unless essential terms are agreed upon with reasonable certainty. A contract must be definite and complete. Essential terms generally include the names of the parties, subject matter and quantity, price, and time and place for performance. No basis for objectively computing the price was agreed to by the parties. An agreement to agree does not create an enforceable obligation at common law.

Answer 310

A. There is mutuality of consideration. Answer (A) is correct. Consideration must be bargained for and given in exchange for the consideration provided by the other party. Thus, consideration is mutual.

Answer 311

C. The $200-a-day cost incurred in renting the pump. Answer (C) is correct. The failure of Travis to perform with reasonable promptness was a breach of contract for which Johnson could recover monetary damages. Johnson may recover its compensatory (general) damages i.e., those likely and foreseeable as a result of the breach (the pump rental costs).

Answer 312

C. Be communicated by words to the offeree by the offeror. Answer (C) is correct. Offers may be made orally, in writing, or through any means of nonverbal communication. The manner of communication of offers is not important provided they are communicated as intended by the offeror.

Answer 313

D. Be able to disaffirm even though Egan was not a minor at the time of disaffirmance. Answer (D) is correct. Most contracts entered into by a minor may be disaffirmed if (s)he acts during minority or a short time thereafter. Tender of goods is usually required. However, a minor may disaffirm even though (s)he cannot return the property or can return it only in damaged condition.

Answer 314

C. Not prevent the admission into evidence of testimony regarding Lennon’s right to report on a monthly basis. Answer (C) is correct. When parties integrate an agreement in a writing, they intend that all negotiations and agreed-to understandings be merged into the writing. The writing constitutes the entire final agreement. The parol evidence rule is a rule of substantive contract law. It prohibits admission of evidence of (1) any prior understanding (oral or written) or (2) an oral understanding reached at the same time as the execution of the final writing that tends to contradict or vary the integrated written agreement. It does not exclude evidence that tends to prove the contract is void or voidable. Neither does it exclude evidence of an understanding reached after the integrated writing was executed. Monthly reporting was agreed to after execution of the writing. Evidence tending to prove the modification is admissible.

Answer 315

A. Automatically terminate prior to Larkin’s acceptance. Answer (A) is correct. Prior to effective acceptance, an offeror may revoke the offer by words or conduct. An offer also is terminated by operation of law under certain circumstances. Death or incompetence of either the offeror or offeree generally terminates the power of acceptance. But it does not terminate an offer contained in a valid option contract.

Answer 316

C. Personal services. Answer (C) is correct. Contracts to purchase certain personal services cannot be assigned without consent of the other party. Part of the consideration underlying the contract is that the services are to be performed by one of the original contracting parties. If the services are highly personal, the assignment is invalid. For example, a college football player could not assign a right to a scholarship to another player.

Answer 317

A. Punitive damages. Answer (A) is correct. The purpose of damages and other contractual remedies is to place the parties in the same position as if the contract had been performed, not to punish a breaching party. Punitive damages are intended to punish especially wrongful conduct and deter future wrongs. Thus, they may be awarded in tort actions. When they are permitted in contracts cases, the facts often involve tortuous behavior.

Answer 318

D. Essex may sue both Green and Free for breach of contract because both of them are liable on the contract. Answer (D) is correct. General language, such as “I hereby assign the contract,” is a delegation of performance as well as an assignment of rights. Delegation is authorization by a person under a duty to perform (Green, the obligor and delegator) for another person (Free, the delegatee) to render the performance to the recipient of the benefit (Essex, the obligee). A delegator may delegate performance if the delegatee’s performance will be substantially similar to the delegator’s (e.g., paying money, manufacturing ordinary goods, building according to a set of plans and specifications, or delivering standard merchandise). Road paving by a person in that business should be substantially similar to the delegator’s performance. (But highly personal services contracts generally are not delegable. The obligee has a strong interest in having the delegator perform. For example, a CPA firm cannot delegate performance of an audit.) Delegation of performance does not relieve the obligor of liability even if notice is given to the obligee (unless the contract provides otherwise). The obligee (Essex) may sue the delegatee (Free), the obligor (Green), or both after a breach.

Answer 319

B. Implied in law. Answer (B) is correct. In these circumstances, the law imposes mutually dependent and concurrent conditions to reach an equitable result even though the actual language of the contract neither implies conditions nor states them expressly. These implied-in-law conditions apply even if the parties have not understood the conditions to be part of their agreement.

Answer 320

C. Valid as to both parties. Answer (C) is correct. A party who enters into a contract under a mistaken belief may rescind the contract under limited circumstances: (1) the mistake was clerical or mathematical and not grossly negligent, (2) the other party knew or should have known of the mistake, or (3) extreme hardship resulting from enforcement would amount to injustice. The mistake must be material.

Answer 321

C. Sky supervised and controlled the manner in which White performed the services. Answer (C) is correct. An employer controls or has the right to control the manner and means of an employee’s work. An employer does not control or have the right to control the manner and means of an independent contractor’s work.

Answer 322

D. When Able has revoked Brown’s authority. Answer (D) is correct. An agent’s actual authority is terminated by the principal’s revocation. Apparent authority of the agent continues to exist until a third party receives notice of the termination by an act of the principal or the agent. Able’s revocation of Brown’s authority is such a termination. Thus, actual notice must be given to a third party who has already dealt with Brown (the agent). Constructive notice must be given to other third parties to terminate apparent authority.

Answer 323

B. Seek recovery of $50 from Simmons only. Answer (B) is correct. Simmons had apparent authority to grant a 10% discount to Hemple because Hemple could reasonably rely on the express authority as implicit authority for the discount. Simmons, however, had actual authority to grant only a 5% discount. Simmons has violated his actual authority and is liable to the principal for any loss [(10% – 5%) of $1,000] sustained as a result of his actions.

Answer 324

C. Musgrove remains primarily liable for Tower’s share of FICA taxes if it fails to withhold and pay the taxes on Tower’s wages. Answer (C) is correct. Under the Federal Insurance Contribution Act (FICA), the employer is required to withhold the employee’s share of Social Security taxes from the employee’s wages and remit that amount, along with the employer’s own equal share, to the government. An employer that underwithholds and underpays is liable for the unpaid balance of the employee’s share.

Answer 325

D. Sims is a surety with regard to credit sales she makes on Paul’s behalf. Answer (D) is correct. A del credere agent is a sales agent who guarantees his or her customers’ obligations. If the customers fail to pay, the sales agent is a surety liable to the principal for their obligations.

Answer 326

D. No Yes Answer (D) is correct. In an agency coupled with an interest, the agent has a specific, current, beneficial interest in property that is the subject matter of the agency. A principal does not have the right or power to terminate an agency coupled with an interest. In any agency, the agent may terminate at any time without liability if no specific period for the agency has been established.

Answer 327

B. Although Ken’s contract is silent on the point, Ken has an implied right to reimbursement for the reasonable and necessary expenses incurred on behalf of Wonder. Answer (B) is correct. All agents have a right to reimbursement for reasonable and necessary expenses incurred on behalf of their principal. This right is implicit in the agency relationship even if not provided for in the agreement.

Answer 328

C. Reimbursed travel expenses. Answer (C) is correct. The Social Security tax imposed by the FICA applies to virtually all compensation received for employment, including money or other forms of wages, bonuses, commissions, vacation pay, severance allowances, and tips. Reimbursed travel expenses are not included as wages to the extent a corresponding deduction is allowable.

Answer 329

B. The real estate contract is unenforceable against Jim because Sally’s authority to sell Blueacre was oral. Answer (B) is correct. Oral agreement usually suffices to form an agency, but a contract involving a sale of land is required to be in writing in some states. Furthermore, the equal dignity rule applies in many states. In these states, the agency must be in writing if the authority granted to the agent is to enter into a contract required to be in writing. For example, an agreement to transfer an interest in land is subject to the statute of frauds and therefore must be in writing. The contract is therefore most likely to be voidable at Jim’s option. It was required by the statute of frauds to be written, and Sally’s agency was oral. In most other situations, the agent’s authority may be oral.

Answer 330

B. Duty of obedience. Answer (B) is correct. Under the duty of obedience, the agent must follow lawful explicit instructions of the principal. If the instructions are not clear, the agent must act in good faith and in a reasonable manner considering the circumstances. If an emergency arises and the agent cannot reach the principal, the agent may deviate from instructions to the extent warranted.

Answer 331

D. Unless the tort was committed within the scope of the agency relationship. Answer (D) is correct. A principal is strictly liable for the torts of an agent committed within the scope of the agent’s employment. An act is within the scope of employment when it is work assigned by the employer or a course of conduct subject to the employer’s control. The principal’s liability to the third party is for acts of the agent within the scope of the agent’s actual or apparent authority.

Answer 332

B. Able had apparent authority to bind Pix. Answer (B) is correct. Apparent authority results from words or conduct of the principal directed to a third party that reasonably induces the third party to infer that the agent has actual authority. It is a form of estoppel. Express limitations do limit an agent’s actual authority. But if they are not known by third parties, they do not affect apparent authority.

Answer 333

B. Crater will be bound because of Borg’s apparent authority. Answer (B) is correct. Apparent authority exists when a third party has reason to believe that an agent has the authority to enter into contracts of the nature involved based upon a principal’s representations. Secret limitations placed on the agent’s normal authority create apparent authority. In this case, it was reasonable for Shady to believe that Borg had the authority to enter into the contract, given Borg’s position in the company as vice president of purchasing. That Dent secretly limited Borg’s authority has no effect, and Crater Corp. can be held liable under the contract.

Answer 334

B. The principal must have capacity. Answer (B) is correct. The principal must have the legal capacity to perform the act authorized. A contract entered into by an agent with a third party on behalf of an incompetent principal, e.g., a minor, is generally voidable by the principal.

Answer 335

D. Specific performance. Answer (D) is correct. The principal has duties to (1) compensate the agent for services performed, (2) reimburse the agent for authorized payments made or expenses incurred, and (3) indemnify the agent for losses suffered or expenses incurred while the agent acted in a legal transaction or in a transaction that the agent did not know to be wrongful. An agent also may withhold performance from the principal if the principal violates a duty owed to the agent. However, the contractual remedy of specific performance is rarely granted in contract cases and then only when no other remedy is adequate. Moreover, it is not available when the relationship of the parties is noncontractual.

Answer 336

D. Kosier will be liable, and Ace will not be liable because Kosier is an independent contractor. Answer (D) is correct. A principal may be liable in tort because of its personal act or the agent’s wrongful act that results in harm to a third party. Whether the principal is vicariously liable for an agent’s tort depends in part on their employment relation. For example, an employer does not control or have the right to control the manner and means of an independent contractor’s work. Thus, a CPA hired to perform a consulting engagement is an independent contractor. The specialized services performed are not subject to the control of their manner and means by the principal. Because a principal ordinarily is not liable for the tort (e.g., negligence) of an independent contractor, Ace is not liable. Ace also is not liable because driving to work is not within the scope of employment. It is not work assigned by the employer or a course of conduct controlled by the employer.

Answer 337

D. Indemnification. Answer (D) is correct. Principals are required to indemnify the agent for losses the agent suffers during the agent’s performance of the agency. Also, regardless of whether the agency is gratuitous or contractual, the principal has a duty to indemnify the agent. The indemnity is for losses suffered or expenses incurred while the agent acted (1) as instructed in a legal transaction or (2) in a transaction that the agent did not know to be wrongful.

Answer 338

A. Car received as a productivity award. Answer (A) is correct. The Social Security tax imposed by the FICA applies to virtually all compensation received for employment, including money or other forms of wages, bonuses, commissions, vacation pay, severance allowances, and tips. A car received as a productivity award is a form of compensation for employment. It is not excepted from application of FICA tax. Income derived from an investment, as opposed to compensation for employment, is not subject to FICA tax. But the NII tax applies to the lesser of (1) NII or (2) the excess of modified AGI over an applicable threshold amount.

Answer 339

C. The broker will have the same actual authority as if Easy’s identity had been disclosed. Answer (C) is correct. Actual authority is conveyed by the principal’s giving express or implied consent to the agent to bind the principal to third parties. Actual authority is not affected by failure to disclose the principal.

Answer 340

B. Price involved. Answer (B) is correct. An agreement regarding the sale of real estate or services is not enforceable as a contract unless essential terms are agreed upon with reasonable certainty. A contract must be definite and complete. Essential terms generally include the names of the parties, subject matter and quantity, price, and time and place for performance. No basis for objectively computing the price was agreed to by the parties. An agreement to agree does not create an enforceable obligation at common law.

Answer 341

B. Valid as to both parties. Answer (B) is correct. A party who enters into a contract under a mistaken belief may rescind the contract under limited circumstances: (1) the mistake was clerical or mathematical and not grossly negligent, (2) the other party knew or should have known of the mistake, or (3) extreme hardship resulting from enforcement would amount to injustice. The mistake must be material.

Answer 342

A. Can be created by estoppel, i.e., implied as a matter of law. Answer (A) is correct. An agency relationship may arise by estoppel when a person represents himself or herself as an agent, the alleged principal knows of the representation and does not deny it, and a third person reasonably but detrimentally relies on the existence of an agency. The “principal” is then prevented (estopped) from asserting the nonexistence of the agency relationship.

Answer 343

B. It must be created by contract. Answer (B) is correct. The agency relationship may be implied based on duties assigned to the agent. It also may arise from the principal’s conduct with third parties (such as remaining silent when another purports to be his or her agent or representing to third parties that another is his or her agent). The agency relationship may also arise in an emergency.

Answer 344

B. $67,800 Answer (B) is correct. If any employee receives a tax credit to buy coverage, the annual penalty paid by an employer with at least 50 full-time or full-time equivalent employees (FTEs) is determined as follows: Annual penalty = $2,260 × (total FTEs – first 30 FTEs) The employer has 60 FTEs and must pay a penalty for not providing coverage. Accordingly, the amount paid is $67,800 [$2,260 × (60 – 30)].

Answer 345

A. Allows the employer to take a credit against the FUTA tax if contributions are made to a state unemployment fund. Answer (A) is correct. FUTA permits an employer who made contributions to a state unemployment fund to take a credit against the federal unemployment tax.

Answer 346

B. Principal or agent dies. Answer (B) is correct. According to the Restatement (Second) of the Law of Agency, an agency and the agent’s power to bind the principal terminate instantly upon the death of the principal because the principal must exist at the time the agent acts. NOTE: According to the Restatement of the Law, Third, Agency, the principal’s death does not automatically terminate actual or apparent authority. Continuation of actual and apparent authority protects from liability the agent and the parties who do business with the agent, respectively.

Answer 347

D. Purchasing an interest in undeveloped land for the principal. Answer (D) is correct. Oral agreement usually suffices to form an agency, but a contract involving a sale of land is required to be in writing in some states. Furthermore, the equal dignity rule applies in many states. In these states, the agency must be in writing if the authority granted to the agent is to enter into a contract required to be in writing. For example, an agreement to transfer an interest in land is subject to the statute of frauds and therefore must be in writing.

Answer 348

D. Fraud in the inducement. Answer (D) is correct. Fraud in the inducement occurs even when the defrauded party is aware of entering into a contract and intends to do so. However, (s)he is deceived about a fact material to the contract (e.g., the nature of the goods or services). Thus, the contract is voidable.

Answer 349

B. The principal must possess contractual capacity. Answer (B) is correct. An agency is an express or implied consensual relationship formed when two parties agree that one (the agent) will act on behalf of the other (the principal) in dealing with third parties. To create this relationship, (1) the principal must intend for the agent to act on the principal’s behalf, (2) the agent must agree to act as a fiduciary for the principal, (3) the agency must have a legal purpose, and (4) the principal must have the legal capacity to perform the act assigned to the agent. Certain personal acts may never be delegated.

Answer 350

D. Capital loss carryback. Answer (D) is correct. The accumulated earnings tax is applied to accumulated taxable income, which is taxable income, subject to certain adjustments. Capital loss carrybacks and carryforwards are not allowed. Instead, capital losses are deductible in full in the year incurred (but must be reduced by prior net capital gain deductions).

Answer 351

A. Insure Frost’s property against fire loss. Answer (A) is correct. An agent has express and implied actual authority that is conveyed by manifestations of the principal to the agent. Authority is implied to do what is reasonably necessary to accomplish the expressly authorized action. Obtaining insurance against fire loss would be implied.

Answer 352

B. Green failed to get the agency agreement in writing. Answer (B) is correct. Formalities, such as a writing, are not required to form an agency relationship. But some states require an agency to be in writing if the contract involves a sale of land. Also, many states apply the equal dignity rule. In these states, an agency must be in writing if the agent is to enter into a contract required to be in writing. Accordingly, the agency agreement most likely needs to be in writing because an agreement to transfer an interest in land is required to be in writing.

Answer 353

A. Decker is not liable under the oral guarantee because Decker’s promise was not in writing. Answer (A) is correct. A contract within the statute of frauds is unenforceable against a party who did not sign a writing expressing its essential terms. An agreement to answer for the debt of another is within the statute if the promise is secondary, that is, its main purpose is to benefit the debtor.

Answer 354

A. May limit Mix’s authority to specific transactions. Answer (A) is correct. A power of attorney is a written authorization for the agent to act on behalf of the principal. A power of attorney can be general, or it can grant the agent specific and restricted authority.

Answer 355

B. Agent’s renunciation of the agency. Answer (B) is correct. Under the Second Restatement, an agency is based on the consent of both principal and agent and may be terminated by an act of either party. Thus, it may be terminated by the agent’s giving notice of renunciation to the principal. This intentional form of termination is in contrast with the automatic termination by operation of law that results from the occurrence of certain events.

Answer 356

D. Lose. King notified Starr and Maple of its withdrawal prior to Maple’s ratification. Answer (D) is correct. When an agent exceeds express, implied, or apparent authority, a principal is not bound until (s)he ratifies. Moreover, certain conditions terminate the power of ratification, such as (1) the third-party’s withdrawal, death, or loss of capacity; (2) changed circumstances; or (3) failure to ratify within a reasonable time. Because King withdrew prior to ratification by Maple, no agreement existed for Maple to ratify and no contract to breach.

Answer 357

C. Clay released Globe. Answer (C) is correct. When Baxter unconditionally assigned its rights to Clay, Baxter no longer had rights in the contract. But Clay has rights, as assignee, against Baxter (1) if Baxter breaches the assignor’s warranties (in that the rights were transferred for value) or (2) if Baxter accepts performance of the contract. But if Clay releases Globe from obligation to perform the contract, there is no basis for holding liable the assignor of the right to receive performance.

Answer 358

B. When an emergency arises and the delegation is necessary to meet the emergency. Answer (B) is correct. As a general rule, an agent may not delegate his or her duties without the consent of the principal. However, an agent may delegate his or her duties when an emergency arises, and the delegation is necessary to meet the emergency. This emergency exception applies to most contractual duties.

Answer 359

A. A principal’s affirmation of an agent’s unauthorized act. Answer (A) is correct. After an unauthorized act by the agent, the principal can assent to the agent’s act if the principal is aware of all material facts. Ratification can be expressed or may be implied by the principal’s words or conduct that reasonably indicates intent to ratify.

Answer 360

B. Both the principal and agent consent to the agency. Answer (B) is correct. Agency is an express or implied consensual relationship. Both the principal and agent must manifest consent to the grant of authority. The purpose and subject matter of the agency must be legal. The principal must have legal capacity to perform the act authorized.

Answer 361

C. An agent’s act of filing a bankruptcy petition. Answer (C) is correct. A principal’s act of filing a voluntary petition in bankruptcy, not an agent’s, terminates an existing agency.

Answer 362

D. Each element of a contract must be present for the relationship to exist. Answer (D) is correct. An agency relationship need not be contractual. But if the agency arises by contract, each element of a contract must be present.

Answer 363

C. Have a right to be reimbursed by the employees for the employees’ share. Answer (C) is correct. An employer is primarily liable to pay an employee’s share of FICA tax if the employer fails to pay and remit it. The employer then has a right to reimbursement of the amount paid.

Answer 364

B. Employer contributions to health-savings accounts may decrease the minimum actuarial value. Answer (B) is correct. According to the ACA, actuarial value is the expected percentage of covered expenses that the plan will pay. The minimum actuarial value allowed for an eligible employer plan is 60%. The minimum actuarial value is set by the ACA and will not be reduced by employer contributions.

Answer 365

A. Lee is paid weekly by Sew. Answer (A) is correct. An employee is any person who is hired by another person or business for a wage or fixed payment in exchange for personal services and who does not provide these services as part of an independent business. Additional characteristics of employment are determined on a case-by-case basis. Thus, weekly payment is the best indicator that Lee is an employee.

Answer 366

C. Sell Ace’s business fixtures. Answer (C) is correct. An agent’s actual authority is conveyed by communication to the agent from the principal. It is not feasible to state expressly each act an agent is authorized to perform. Thus, an agent may have express and implied actual authority. Implied actual authority is for acts reasonably necessary to execute express authority. Selling the business fixtures is not necessary to manage a retail business.

Answer 367

A. Win, because the change of circumstances could have been contemplated by the parties. Answer (A) is correct. Performance was not conditioned on customer usage or demand. The doctrines of impossibility and impracticability excuse performance only if a supervening circumstance was not reasonably foreseeable when the contract was made. Unseasonably warm weather is not such a circumstance. It is an ordinary business risk.

Answer 368

A. The agent guaranteed the principal’s performance. Answer (A) is correct. The agent may assume liability on any contract by (1) making the contract in his or her own name, (2) co-making the contract with the principal, or (3) guaranteeing the principal’s performance. The agent also is liable for his or her torts and crimes.

Answer 369

A. Neither I nor II. Answer (A) is correct. Neither statement is correct because an agent’s acts are deemed to be the acts of the principal. Thus, whether Trent lacks capacity to enter into a contract because she is under 21 years old is irrelevant. In addition, the age of majority in most states is 18 years of age. Furthermore, Post is not liable to Trent if the collection is destroyed because the principal is not required to compensate the agent unless the collection is sold. The agency relationship was terminated by operation of law when the subject matter of the agency relationship was destroyed.

Answer 370

D. It applies to prior or contemporaneous oral agreements that contradict the terms of final written agreements. Answer (D) is correct. The parol evidence rule was created to make the final contract the last word. The parol evidence rule excludes any prior agreement or an oral agreement made at the time of the final writing that would tend to vary or contradict the terms of a written agreement intended to be complete. If the parties meant their written agreement to be the entire agreement, only terms incorporated directly or by reference are part of the contract as it existed at the time it was set forth in writing and signed. Therefore, the parol evidence rule applies to prior or contemporaneous oral agreements that contradict the terms of final written agreements.

Answer 371

B. Credits for this tax are allowed to employers for certain state unemployment taxes paid by the employer. Answer (B) is correct. A credit against FUTA tax liability is provided to an employer who pays state unemployment tax. The credit cannot exceed 5.4% of the first $7,000 of wages.

Answer 372

C. Lax must have knowledge of all material facts relating to the contract at the time it is ratified. Answer (C) is correct. The person who ratifies becomes legally bound on a contract that was entered into by another who, without authority, purported to act as the principal’s agent. To ratify a contract, the principal must have full knowledge of the material facts.

Answer 373

B. No No Answer (B) is correct. Neither unemployment compensation insurance nor workers’ compensation insurance is deducted from an employee’s salary. The employer is required by law to pay these amounts. Under FUTA, an employer pays a specific amount to the IRS to provide temporary financial assistance to workers who become unemployed as a result of being laid off. Workers’ compensation insurance is a state program in which employers must insure employees for losses sustained due to work-related injuries, regardless of fault.

Answer 374

C. Not be liable because Young did not have authority to enter into the contract. Answer (C) is correct. An agency relationship is terminated by operation of law if the principal becomes legally incompetent. Under the Second Restatement, apparent authority ceases upon termination that occurs by the principal’s incapacity. However, under the Restatement of the Law, Third, Agency, the principal’s incapacity does not automatically terminate actual or apparent authority.

Answer 375

A. North will be liable to Orr because of Sutter’s actual and apparent authority. Answer (A) is correct. A principal is liable on contracts made by an agent who has actual or apparent authority. Sutter had apparent authority to make the contract because of the principal’s communication (letter) shown to the third party. Moreover, the third party’s rights against the principal are not affected by the secret limits placed on actual authority. Sutter had actual authority to buy up to 300 units and apparent authority to buy the rest.

Answer 376

B. Requires a secondary promise to pay the debt of another to be in writing. Answer (B) is correct. A primary promise is a promise to pay or perform one’s own obligation. A secondary promise is one to answer for the debt or default of another. It must be in writing under the statute of frauds. A secondary promise for one’s own benefit, however, is an exception.

Answer 377

D. Agent acts outside the grant of actual authority. Answer (D) is correct. An undisclosed principal is generally not liable for acts of the agent beyond the scope of actual authority.

Answer 378

D. An agent’s act of filing a bankruptcy petition. Answer (D) is correct. A principal’s act of filing a voluntary petition in bankruptcy, not an agent’s, terminates an existing agency.

Answer 379

A. A tax-deductible employer’s expense. Answer (A) is correct. The Internal Revenue Code imposes federal unemployment taxes on certain employers. The tax is a deductible business expense of the employer.

Answer 380

C. Violated a regulatory statute. Answer (C) is correct. A principal is liable for his or her own criminal conduct but is generally not liable for a crime committed by the agent. A principal may be held criminally liable for a crime of the agent if (1) the principal approves or directs the crime, (2) the principal participates or assists in the crime, or (3) violation of a regulatory statute constituted the crime. A regulatory statute in this context is one that imposes strict liability, for example, a law that prohibits sales of liquor to minors.

Answer 381

C. The purpose of the agency was contrary to public policy. Answer (C) is correct. Agency is an express or implied consensual relationship. Both the principal and agent must manifest consent to the grant of authority. The purpose and subject matter of the agency must be for a legal purpose. Smith and Jones formed an agency for an illegal purpose, the sale of fraudulent identification cards, which automatically voids the agency by operation of law.

Answer 382

B. Ogden will not be liable because Thorp’s agency ended when Ogden was declared incompetent. Answer (B) is correct. Under the Second Restatement, an agency is terminated automatically by operation of law when the principal is declared incompetent in a judicial proceeding. The agent’s actual authority and apparent authority are terminated. Thus, the principal is not bound by the contract for supplies entered into by the agent after the principal is declared incompetent.

Answer 383

B. Prevail based on the contract. Answer (B) is correct. Meek’s failure to meet the deadline did not result in a breach of contract. Rather, the failure of performance was caused by Sulk’s failure to supply Meek with the necessary information to complete the audit. Every contract contains an implied promise each party will not interfere with the other party’s performance. Consequently, Meek can enforce the contract because Meek was not in breach.

Answer 384

A. Apparent authority may still exist after constructive notice of the termination. Answer (A) is correct. Apparent authority of the agent continues until the third party receives notice. But an effective notification (actual, not constructive) is required if the third party has already dealt with the agent.

Answer 385

B. Green failed to get the agency agreement in writing. Answer (B) is correct. Formalities, such as a writing, are not required to form an agency relationship. But some states require an agency to be in writing if the contract involves a sale of land. Also, many states apply the equal dignity rule. In these states, an agency must be in writing if the agent is to enter into a contract required to be in writing. Accordingly, the agency agreement most likely needs to be in writing because an agreement to transfer an interest in land is required to be in writing.

Answer 386

B. Consumer goods, equipment, farm products, inventory. Answer (B) is correct. UCC Article 9 effectively classifies goods other than fixtures into four categories. Consumer goods are those used or bought for use primarily for personal, family, or household purposes. Equipment means goods other than inventory, farm products, and consumer goods. Farm products are crops, livestock, supplies used or produced in farming operations, or products of crops or livestock in their unmanufactured states. They must be in the hands of one engaged in farming operations. If goods are farm products, they are not equipment or inventory. Inventory consists of goods (1) leased by a person as lessor; (2) held for sale or lease; (3) furnished under contracts of service; or (4) consisting of raw materials, work-in-process, or materials used or consumed in a business.

Answer 387

D. The time for shipment is within a reasonable time. Answer (D) is correct. The time for shipment or delivery is a reasonable time if the parties have not specified a time. Also, the UCC provides for a single shipment of the goods if the contract does not specify otherwise. These provisions reflect the UCC’s policy to find a valid contract if the parties so intended and a reasonable basis for a remedy exists.

Answer 388

C. A contract was formed between the parties. Answer (C) is correct. Additional or different terms in an unconditional, definite, and timely acceptance of an offer for a sale of goods are interpreted as proposals for addition to the contract. But between merchants, such terms become part of the contract unless (1) the offer expressly limits acceptance to its terms, (2) the additional or different terms materially alter the offer, or (3) the offeree objects within a reasonable time. Cookie and Distrib most likely are merchants, the acceptance was unconditional, and no exception applies. Thus, the weighing scale term becomes part of the agreement unless objected to in a reasonable time. (If the parties are not merchants, a contract is formed without the additional term.)

Answer 389

C. An interest in personal property or fixtures that secures payment or performance of an obligation. Answer (C) is correct. A security interest is an interest in personal property or fixtures that secures payment or performance of an obligation. This broad definition encompasses currently existing security devices and new ones that may evolve.

Answer 390

D. The damages for breach by either party may be liquidated in the agreement. Answer (D) is correct. It is efficient for parties to agree on remedies for breach and avoid the trouble, expense, and uncertainty of litigation. Damages may be liquidated or specified in the agreement as long as such damages are reasonable in the circumstances.

Answer 391

D. Tender of delivery is a condition of the buyer’s duty to accept the goods. Answer (D) is correct. The general obligation of a seller is to transfer and deliver. That of the buyer is to accept and pay in accordance with the contract. Tender of delivery is a condition to the buyer’s duty to accept the goods. Tender entitles the seller to demand buyer’s acceptance of the goods and payment according to the contract.

Answer 392

C. Incorrect, because the agreement to change the delivery date was binding. Answer (C) is correct. An oral enforceable contract for the sale of goods was formed on May 2 because the price was not for $500 or more. An oral modification of a contract for the sale of goods does not require consideration to be binding. The modification need not be in writing provided that (1) the contract as modified is for less than $500, (2) the original contract did not require that modification be in writing, (3) the modification was sought in good faith, and (4) another exception does not apply.

Answer 393

C. III, I, II. Answer (C) is correct. The basic rule is that conflicting security interests in the same collateral will rank in priority according to the time of filing or perfection. If a purchase money security interest (PMSI) in goods (e.g., equipment) other than inventory or livestock is perfected when the debtor receives possession of the collateral, or within 20 days afterward, the PMSI has priority over a conflicting security interest even if it was perfected first. The reasonable assumption is that the debtor took possession between April 11 (when the security interest attached) and April 20 (when perfection occurred). Furthermore, a perfected security interest generally has priority over a security interest that has attached but is not perfected.

Answer 394

A. Seller supplied an unreasonable amount. Answer (A) is correct. Requirements and output contracts are permitted if the parties act in good faith and demand or tender reasonable quantities. Without stated estimates, Seller’s normal or otherwise comparable prior output is the measure of a reasonable amount. No estimates were made. Thus, if Seller’s output is twice the reasonable amount, Buyer may avoid performance.

Answer 395

A. Pam probably cannot assert the statute of frauds as a defense to a suit by Matz if she notifies Matz that she will not take the goods after Matz has completed about 40% of the work. Answer (A) is correct. A contract for the sale of specially manufactured goods, which are not suitable for sale in the ordinary course of the seller’s business and upon which a substantial beginning has been made, is enforceable even if not in writing. Thus, the statute of frauds is not defense for Pam.

Answer 396

D. Revest to Lace when they are rejected by Parco. Answer (D) is correct. Title revests in the seller after (1) a rejection or other refusal by the buyer to receive or retain the goods, whether or not justified, or (2) a justified revocation of acceptance. Such revesting occurs by operation of law.

Answer 397

B. Failure of the debtor to have rights in the collateral. Answer (B) is correct. Attachment occurs when the security interest is enforceable against the debtor with regard to the collateral, barring an express agreement postponing attachment. The security interest is enforceable against the debtor and third parties when (1) the secured party has given value, (2) the debtor has rights in the collateral or can transfer them to the secured party, and (3) the debtor has authenticated a security agreement describing the collateral or other evidence of authentication exists (e.g., the secured party has possession or control).

Answer 398

B. Both Burn and Green. Answer (B) is correct. Before attachment of the security interest, the creditor gave value, the debtor had rights in the collateral, and the debtor authenticated a sufficient security agreement. Thus, attachment has occurred, and the security interest is enforceable between the debtor (Burn) and the secured party (Howard). Because Howard’s security interest was perfected by filing a financing statement, Green is assumed to have notice of Howard’s security interest. Howard’s claim has priority over Green’s because Howard filed and perfected before Green. However, if Green had perfected a PMSI in inventory and met the notice requirements, Green would have priority.

Answer 399

B. Tara can reject the suits upon subsequent discovery of the defects. Answer (B) is correct. A buyer has the right to inspect the goods at any reasonable place and time and in any reasonable manner. Tara did not have a reasonable opportunity to inspect on the day of the delivery. After acceptance, a buyer may revoke acceptance of nonconforming goods within a reasonable time if the seller is notified. But the acceptance must have been (1) reasonably induced by (a) the difficulty of discovery or (b) the seller’s assurances or (2) on the reasonable assumption that the nonconformity would be cured.

Answer 400

C. Win, because the agreement was for less than $500. Answer (C) is correct. The UCC’s statute of frauds does not apply because the good was sold for less than $500. Thus, the seller cannot assert the defense that (s)he did not sign a writing sufficient to show that the contract was made.

Answer 401

B. A contract to sell a work of art. Answer (B) is correct. Goods are all things movable and tangible when they are identified as goods to be sold. Thus, a work of art is a good. Generally, contracts for the sale of goods for $500 or more are not enforceable without a writing. However, a writing is unnecessary if (1) the goods are to be specifically made or extensively modified and cannot be sold to others in the ordinary course of business, (2) the goods actually have been received and accepted or payment has been made, or (3) a party admits in pleadings or in court that a contract exists. A contract to sell a work of art is not within these exceptions. Given that the work of art is valued at more than $500, a writing is necessary for the contract to be enforceable.

Answer 402

D. Does not have to do anything further. Answer (D) is correct. Attachment of a security interest is the process by which a security interest becomes enforceable against a debtor by a secured party. Attachment of a security interest in inventory collateral results as soon as the following three events occur (barring an explicit agreement otherwise): (1) The collateral is in the possession of the secured party pursuant to the debtor’s security agreement, or the debtor has authenticated a security agreement describing the collateral; (2) value has been given; and (3) the debtor has rights (or the ability to transfer rights) in the collateral. All these conditions have been satisfied. The detailed contract was a security agreement because it created or provided for a security interest, and the debtor has signed (authenticated) it. Value has been given because Lombard has effectively sold the goods on credit to Gifford. The debtor has rights in the goods because it has the power to sell the goods at a profit. Consequently, the security interest has attached, and Lombard need not do anything further to protect itself against Gifford.

Answer 403

B. The modification must satisfy the statute of frauds if the contract as modified is within its provisions. Answer (B) is correct. If the modification of a contract brings it within the statute of frauds, both the contract and the modification must meet the statute’s requirements even though not originally required. For example, if the original price was $400 and the modification raises it to $500, the contract as modified falls within the statute of frauds and must be written.

Answer 404

B. Open acceptance. Answer (B) is correct. The UCC favors open terms. One or more terms left open does not prevent the formation of a contract if (1) the parties apparently intended to make a contract and (2) a reasonably certain basis exists for granting a remedy. An offer is deemed to invite acceptance in any manner and by any medium reasonable under the circumstances. However, the term “open acceptance” is not used by the UCC Sales Article. Also, prior to acceptance, no contract can be formed.

Answer 405

B. Establishing priority over the claims of most subsequent secured creditors. Answer (B) is correct. Unless perfection is by attachment, to establish priority over a previous unperfected creditor or a subsequent secured creditor, a secured party must give notice by perfecting its security interest. The methods of perfection include (1) filing a financing statement, (2) taking possession of the collateral, or (3) obtaining control of the collateral. The steps taken will depend upon the nature of the collateral.

Answer 406

A. The modification must satisfy the statute of frauds if the contract as modified is within its provisions. Answer (A) is correct. If the modification of a contract brings it within the statute of frauds, both the contract and the modification must meet the statute’s requirements even though not originally required. For example, if the original price was $400 and the modification raises it to $500, the contract as modified falls within the statute of frauds and must be written.

Answer 407

B. March 5. Answer (B) is correct. Attachment occurs when a security interest is enforceable against the debtor with regard to the collateral, barring an express agreement postponing attachment. The security interest is enforceable against the debtor and third parties when (1) the secured party has given value, (2) the debtor has rights in the collateral or can transfer them to the secured party, and (3) the debtor has authenticated a security agreement describing the collateral or other evidence of authentication exists (e.g., the secured party has possession or control). These conditions were satisfied on March 5. First, the seller gave value in the form of the consideration provided by the contractual promise to sell a specific car on credit on March 1. The security agreement is a writing evidencing the contract. If the contract was not signed by the seller, the statute of frauds applying to a sale of goods for $500 or more prevents its enforcement against the seller. Nevertheless, partial performance (the $500 down payment) renders the contract enforceable to the extent of payment made and accepted. Acceptance of a partial payment is the seller’s admission (at least to the extent of payment) that a contract exists. Second, the buyer (debtor) had rights in the collateral (the car). (1) A specific car was identified in the contract, giving the buyer a special property and an insurable interest in it, (2) the car presumably was adequately described in the security agreement, and (3) a down payment was made on March 5. “A debtor’s limited rights in collateral, short of full payment, are sufficient for a security interest to attach” (Official Comment, UCC 9-203). But this interest attaches only to the rights held by the debtor. Third, the debtor authenticated a security agreement on March 5.

Answer 408

D. If a debtor has paid 60% or more of the cash price of consumer goods in satisfaction of a purchase money security interest, the debtor has the right to have the creditor dispose of the goods. Answer (D) is correct. To protect the equity interest of debtors who have had property repossessed by secured parties, the UCC provides for compulsory disposition of the collateral in certain cases. In other cases, a secured party may retain the collateral if appropriate authenticated notice is given to the debtor and other parties to whom notice must be given, and no authenticated objection is received within 20 days of sending the notice. If the debtor has paid at least 60% of the cash price in the case of a PMSI in consumer goods, the secured party must dispose of the goods unless the debtor waives the right to require disposal by an agreement entered into and authenticated after default.

Answer 409

D. Pulse has title and an insurable interest. Answer (D) is correct. Unless otherwise explicitly agreed to, title passes to the buyer at the time and place at which the seller completes performance of physical delivery of the goods. The seller has an insurable interest in goods as long as title to, or any security interest in, the goods remains in the seller. A buyer of goods has an insurable interest in them when they are identified to the contract.

Answer 410

B. I and III only. Answer (B) is correct. A warranty of title is made in every contract for the sale of goods, unless it is excluded or modified by specific language or by circumstances. The warranty of merchantability is implied only when the seller is a merchant. Ram is a merchant because it deals in goods of the kind sold. The warranty of fitness for a particular purpose is implied only when a seller has reason (1) to know the particular purpose for which the goods are to be used and (2) that the buyer is relying on the seller’s skill and judgment to select the goods.

Answer 411

C. Risk of loss for the goods passed to the buyer. Answer (C) is correct. If (1) goods are delivered to a person for sale and (2) that person keeps a place of business at which (s)he deals in goods of that kind, the goods are on “sale or return.” Risk of loss in a sale or return passes at the same time and place as in any other sale of goods, i.e., in accordance with the shipping terms. Except for a sale on approval, delivery and receipt of the goods will customarily signify that risk of loss has passed to the buyer.

Answer 412

C. Sale of corporate debentures. Answer (C) is correct. Article 9 applies to security interests created under Articles 2, 2A, 4, and 5. It also applies to (1) security interests in personal property and fixtures created by contract; (2) agricultural liens; (3) consignments; and (4) sales of accounts, promissory notes, and certain other items. It does not apply to sales of corporate debentures, which are bonds not secured by specific collateral. These transactions are governed by Article 8 of the UCC, other state statutes, and possibly the federal securities laws. However, corporate debentures and other investment property may be collateral under Article 9.

Answer 413

A. Four years after the cause of action has accrued. Answer (A) is correct. A 4-year statute of limitations applies to cases involving sales of goods. The parties, however, may reduce (but not extend) the period for suit, but not to less than 1 year. The limitations period generally begins to run when the cause of action has accrued.

Answer 414

B. Pine’s weapon was unlicensed and illegal. Answer (B) is correct. Under the doctrine of respondeat superior, the employer is vicariously liable for the torts of the employee committed within the scope and during the course of employment. However, the doctrine ordinarily does not apply to crimes committed by the employee. Thus, the employer most likely will not be liable. The employee’s possession (and therefore use) of the weapon was criminal. The employer would be liable in exceptional cases, e.g., if it authorized the use of force.

Answer 415

A. A buyer in the ordinary course of business. Answer (A) is correct. A buyer of goods in the ordinary course of business is a person who, in good faith and without knowledge that the sale is in violation of the ownership rights or security interest of a third party in the goods, buys in the ordinary course of business from a person in the business of selling goods of that kind. Such a buyer, except one purchasing farm products from a person engaged in farming, takes free of a perfected security interest granted by the seller even if the buyer knows of its existence.

Answer 416

C. Ajax’s shipment of Strong hammers is a breach of contract. Answer (C) is correct. Shipment of a brand different from that stipulated in the contract was a breach of the contract. Bush may (1) accept the goods despite their nonconformity, (2) rightfully reject them, or (3) resort to any of the buyer’s other remedies under the UCC. Accommodation shipments and the ability to cure, are not applicable. Notice of acceptance was sent, and a cure must be made within the time for performance in most cases.

Answer 417

C. Card is not obligated to sell the stereo to Bend until Bend accepts the offer. Answer (C) is correct. An offer is a statement or other communication by which the offeror grants the offeree the power to accept and form an agreement. A contract is formed when an offeree accepts an offer. Because Bend has not yet accepted the offer, a contract has not been formed, and Card is not obligated to sell the stereo to Bend until Bend accepts the offer.

Answer 418

B. A pawnbroker’s lending money. Answer (B) is correct. A secured party may perfect a security interest by taking possession of the collateral. Thus, pawnbrokers, to secure loans, usually take possession of the collateral. A security interest in goods, instruments, money, negotiable documents, or tangible chattel paper (but not a security interest in electronic chattel paper, which is perfected by control) may be perfected by the secured party’s taking possession of the collateral.

Answer 419

D. The collateral may be sold by Pine at a private proceeding and, if it is consumer goods, without notice to other secured parties. Answer (D) is correct. The secured party may dispose of the collateral at a public or private proceeding provided that every aspect of the disposition is commercially reasonable. Unless the collateral (1) is perishable, (2) threatens to decline rapidly in value, or (3) is of a type customarily sold on a recognized market, reasonable authenticated notice must be given to the debtor and any secondary obligor unless that right has been waived. In the case of consumer goods, no other notice need be sent to other secured parties because many PMSIs in consumer goods are perfected by attachment alone.

Answer 420

C. Taking possession of the instrument. Answer (C) is correct. A security interest in instruments may be perfected by the secured party’s taking possession of the collateral. A security interest in instruments also may be perfected by filing. However, a security interest in instruments is perfected without filing or perfection for 20 days after attachment to the extent of new value given under an authenticated security agreement. Temporary perfection of a security interest in an instrument also is permitted for a 20-day period when such collateral is delivered to the debtor for ultimate sale or exchange or for presentation, collection, enforcement, renewal, or registration of transfer. Possession is the optimal method of perfection because (1) it is not limited to 20 days, and (2) a prior perfected security interest is defeated by a holder in due course.

Answer 421

C. The seller, because risk of loss passes only when the goods reach the purchaser’s loading dock. Answer (C) is correct. The parties to a contract for the sale of goods may agree who will have the risk of loss. Without an express agreement, the intent with respect to risk is determined by shipping and delivery terms. The shipping term FOB purchaser’s place of business indicates a destination contract. The seller bears the risk of loss until the goods reach the destination (the buyer’s loading dock).

Answer 422

C. Passed to Sutter upon Harp’s tender of delivery. Answer (C) is correct. If the parties have no agreement as to risk of loss, no carrier is involved, and the goods are not in the possession of a bailee, the risk of loss passes to the buyer on his or her receipt of the goods if the seller is a merchant; otherwise, the risk passes to the buyer on tender of delivery. Because Harp is not a merchant (a person engaged in selling goods of the kind), risk passed to Sutter on tender of delivery.

Answer 423

B. When the goods are delivered to the first carrier for transmission to the buyer. Answer (B) is correct. The CISG is similar to Article 2 of the UCC. Under Article 2 and the CISG, title to goods passes from the seller to the buyer in any manner and on any conditions explicitly agreed to by the parties. Under a shipment contract, title passes when the goods are delivered to the carrier. In carrier cases, unless otherwise explicitly stated, a shipment contract is assumed.

Answer 424

A. Provision for full payment of administration expenses. Answer (A) is correct. The debtor generally has the exclusive right to file a reorganization plan during the 120 days after the order of relief. To be effective, the plan must be confirmed by the bankruptcy court. The plan must provide for full payment of administration expenses.

Answer 425

B. Inheritances received by the debtor within 180 days after the filing of the petition. Answer (B) is correct. Upon commencement of a Chapter 7 proceeding, an estate in property is formed. The estate consists of all the debtor’s legal and equitable interests in property. It excludes earnings of the debtor for services rendered after commencement of a Chapter 7 proceeding. The estate includes each of the following: (1) all property currently held (wherever located); (2) community property; (3) property the trustee recovers from third parties; (4) proceeds and profits from the property of the estate; (5) inheritances received by will or intestate succession, property settlements, or life insurance proceeds to which the debtor becomes entitled within 180 days after filing; and (6) interests in property acquired by the estate after the filing of the petition.

Answer 426

C. A debt arising before the filing of the bankruptcy petition caused by the debtor’s negligence. Answer (C) is correct. Discharge in a voluntary liquidation proceeding may be denied based on certain acts or circumstances of the debtor or the nature of particular debts if a trustee or creditor objects to the discharge. Examples of debts that will be statutorily denied a discharge include penalties imposed by government entities, unpaid taxes, and unpaid child support. A debt that was the result of negligence, e.g., from a malpractice claim, in contrast to willful or malicious activity, is dischargeable.

Answer 427

D. Employee vacation and sick pay up to $12,850 per employee. Answer (D) is correct. Secured claims must be satisfied in full before any unsecured claims may be paid. Unsecured claims with a higher priority are then paid in full before lower priority claims. The list of priorities among unsecured claims is as follows: Domestic support obligations, Administrative expenses, Claims arising in the ordinary course of business after the petition was filed but before the order for relief was granted, Claims up to $12,850 for wages earned by an individual within 180 days before filing, Claims for contributions to employee benefit plans, Claims of grain producers and fishermen, Claims of depositors of money for the purchase of undelivered consumer goods, Tax claims of governmental units, and Death and injury claims arising from an intoxicated person’s operation of a motor vehicle. Employee vacation pay and sick pay are forms of compensation (wages).

Answer 428

D. A reorganized corporate debtor will be discharged from all debts except as otherwise provided in the plan and applicable law. Answer (D) is correct. At the conclusion of Chapter 11 proceedings, a corporate debtor is discharged from most debts of the business. Exceptions include debts that are provided for in the plan of reorganization approved by the creditors and certain nondischargeable debts.

Answer 429

``` A. Must treat all claims or interests in the same class equally. Answer (A) is correct. The plan must (1) designate classes of creditors’ claims and owners’ interests; (2) state the treatment to be given each class; (3) indicate which classes will or will not be impaired; (4) allow for equal treatment of the members within a class unless they agree otherwise; and (5) provide for an adequate method of payment. If the debtor is a corporation, the plan must also protect voting rights, state that no nonvoting stock will be issued, and require that selection of officers and directors be effected in a manner to protect the parties in interest. ```

Answer 430

D. The commencement of a bankruptcy case may be voluntary or involuntary. Answer (D) is correct. A reorganization proceeding under Chapter 11 of the Bankruptcy Code provides for payment of creditors and restructuring of the debtor’s finances, but permits his or her business to be continued. The commencement of a proceeding may be voluntary or involuntary.

Answer 431

C. II only. Answer (C) is correct. Only federal statutes, not state statutes, may exempt debtor assets from federal tax liens. Social Security benefits, however, are exempt from garnishment.

Answer 432

D. Stops the enforcement of judgment liens against property in the bankruptcy estate. Answer (D) is correct. The automatic stay resulting from filing the petition operates to postpone certain actions against the debtor and his or her property whether the filing is voluntary or involuntary. All acts, with certain exceptions, to establish, enforce, or perfect any lien against estate property are stayed when a petition in bankruptcy is filed. The stay also applies to judgment liens.

Answer 433

B. Mac has the right to contest the validity of the petition and, if Mac is successful, the petition will be dismissed. Moreover, Mac may be able to recover his costs, including a reasonable attorney’s fee. Answer (B) is correct. A debtor has the right to contest an involuntary petition, and it will be dismissed if the statutory requirements are not met. After a dismissal, the court has the power to award the debtor costs, a reasonable attorney’s fee, and damages caused by the trustee’s taking possession of the debtor’s property. If the petition was filed in bad faith, the court may award damages caused by the filing for injury to the debtor’s reputation or punitive damages.

Answer 434

A. The tax lien. Answer (A) is correct. The general rule of priority under common law is that the first in time is the first in right. The perfected mechanic’s lien has priority set by state statute. Its priority generally is established as of the date the work began, provided that recording was completed within the statutorily designated number of days after completing the work. However, statutes typically provide that liens for taxes have priority over otherwise superior liens.

Answer 435

B. Extension agreement. Answer (B) is correct. An extension agreement is a variation of the composition agreement with creditors. Rather than agree to the reduced but immediate payment of debts, the creditors and debtor agree that payments will be made over an extended period. The key characteristic of an extension agreement is the extended payment period.

Answer 436

A. The extension of credit by Day to Victor, contingent upon Anthony’s agreeing to act as a surety, provides the consideration for Anthony’s promise. Answer (A) is correct. A contract for suretyship must be supported by adequate consideration. The extension of credit by the creditor (Day) to the debtor (Victor) is dependent on the agreement of the surety (Anthony) to act as a surety. This extension of credit to Victor by Day supports the promises made by Anthony and Victor. Thus, separate consideration is not required if the surety promise is made when the creditor gives consideration to the debtor.

Answer 437

D. The jurisdiction has enacted a statutory right of redemption. Answer (D) is correct. A foreclosure sale occurs when a mortgage is in default and the mortgagee elects to satisfy its debt by sale of the property rather than by obtaining a personal judgment against the mortgagor. It generally terminates the mortgagor’s equitable right of redemption. A statutory right of redemption provides the mortgagor with the opportunity to repurchase the property after the foreclosure sale, for a certain statutorily specified period generally not exceeding 1 year, by payment of the auction sale price.

Answer 438

B. Receive at least the amounts they would receive in a Chapter 7 liquidation. Answer (B) is correct. A Chapter 13 plan is confirmed if, among other conditions, unsecured creditors receive amounts equivalent to those that received under Chapter 7. Thus, the rights of unsecured creditors may be modified if all claims in a class receive the same treatment.

Answer 439

C. Have debts of any amount. Answer (C) is correct. Under Chapter 7, generally, a debtor’s nonexempt assets are converted into cash, the cash is distributed among creditors, and the debtor is discharged from most remaining obligations. Any person eligible to be a debtor under Chapter 7 may file a petition.

Answer 440

A. Not rescinded before discharge. Answer (A) is correct. To be enforceable, a reaffirmation agreement must conspicuously state the debtor’s right of rescission. The debtor has the right to rescind the reaffirmation until the later of the discharge or 60 days after the agreement is filed with the court.

Answer 441

A. Modification by the principal debtor and the creditor of their contract that fundamentally increases the surety’s risk of loss. Answer (A) is correct. Modification by the principal debtor and the creditor of their contract that fundamentally increases the surety’s risk of loss or creates a substituted contract operates to release a surety from liability unless the surety consents to the modification.

Answer 442

D. April 10. Answer (D) is correct. A proper and sufficient tender of payment discharges an artisan’s lien. The tender also relieves the obligor from liability for further interest or damages (such as legal fees). But tender does not operate to discharge the underlying obligation, which, in this case, was to pay $250.

Answer 443

C. She may be petitioned into bankruptcy by her creditors. Answer (C) is correct. An involuntary petition by creditors contested by the debtor is granted if (1) the debtor is not paying debts as they come due or (2) during the 120 days before the filing of the petition, a custodian (e.g., trustee or receiver) was appointed or took possession of the debtor’s property. For this reason, Di may not be able to avoid bankruptcy.

Answer 444

C. Prepaying an installment loan on inventory. Answer (C) is correct. A preferential transfer is made for the benefit of a creditor within 90 days prior to filing the petition and on account of an antecedent (pre-existing) debt. The transfer must have (1) been made when the debtor was insolvent and (2) resulted in the creditor's receipt of a larger portion of its claim than it otherwise would have received as a distribution in bankruptcy. A prepayment is on account of an existing debt and is therefore a voidable preference.

Answer 445

B. Can request an adjustment of debts under Chapter 13. Answer (B) is correct. An individual with regular income may submit a plan for the payment of a portion of his or her debts while retaining sufficient income to live and support a family. The petitioner must be an individual who owes unsecured debts of less than $394,725 and secured debts of less than $1,184,200. The court grants a discharge of most remaining debts after the plan has been carried out.

Answer 446

A. The principal debtor’s performance is tendered. Answer (A) is correct. A surety is discharged by performance to the extent that the principal debtor’s obligations under the debtor-creditor contract have been performed or tendered. Who tenders the performance is irrelevant. For example, payment in full or a refused tender of payment in full by the principal debtor discharges the surety in full. NOTE: Current suretyship law treats compensated and uncompensated sureties essentially the same.

Answer 447

C. Rice will receive $10,000 out of the proceeds. Answer (C) is correct. A first mortgage holder has priority upon foreclosure and must be paid in full prior to payment of a subsequent mortgage holder. Thus, Dall Bank will receive the first $80,000 of the proceeds, and Rice will receive the remaining $10,000. Rice will be an unsecured creditor for the remaining $10,000 of its debt.

Answer 448

A. Hall may file an involuntary petition in bankruptcy against Tree. Answer (A) is correct. An involuntary bankruptcy proceeding can be commenced only under Chapter 7 and Chapter 11 against an eligible debtor. If the debtor has 12 or more different creditors, any 3 or more creditors who together hold unsecured claims of at least $15,775 can file an involuntary petition. If the debtor has fewer than 12 creditors, any 1 or more creditors who alone or together have unsecured claims of at least $15,775 can file an involuntary petition. Accordingly, Hall may file an involuntary petition in bankruptcy against Tree because she holds an unsecured claim of $16,000.

Answer 449

A. The guarantor is not immediately liable upon default; the creditor must first proceed against the debtor. Answer (A) is correct. A person who guarantees the payment of the debt of another without qualification is required to pay the debt upon default. Such a person is normally called a surety. The guarantor of collection is a person who guarantees a debt upon the condition that the creditor first use ordinary legal means to collect it from the debtor.

Answer 450

A. Bar may be required to file a bond indemnifying Sy for any losses that Sy may incur. Answer (A) is correct. An involuntary petition is a means of harassing a debtor, so the court is empowered to require that the petitioner(s) post a bond to indemnify a debtor who successfully contests the petition. Amounts that the debtor may recover include court costs, attorney’s fees, and damages caused by the trustee’s taking possession of the debtor’s property. If the petitioner(s) acted in bad faith, punitive damages or damages to the debtor’s reputation caused by the filing may be awarded.

Answer 451

B. If both mortgages are foreclosed, the first mortgage must be fully paid before paying the second mortgage. Answer (B) is correct. The second mortgage is subordinate to the first mortgage. Upon foreclosure and judicial sale of the property, the proceeds are distributed to all senior liens (the first mortgage) and to expenses of sale before the second mortgagee receives anything. In some jurisdictions, foreclosure of a second mortgage leaves the first mortgage intact and unaffected by the foreclosure sale.

Answer 452

B. The assets can be recovered as a fraudulent conveyance. Answer (B) is correct. A fraudulent conveyance is one made with actual intent to hinder, delay, or defraud creditors. A conveyance is also fraudulent if it results in insolvency or if the debtor receives less than a reasonable value while (s)he is insolvent. Fraudulent conveyances are voidable if the transfers are made within 2 years before the petition is filed. Thus, without regard to whether the new corporation had knowledge of Burton’s fraud or insolvency, the trustee can recover the assets because Burton transferred them with intent to defraud creditors within 2 years of bankruptcy.

Answer 453

C. Prevents attachment of the debtor’s assets. Answer (C) is correct. An assignment for the benefit of creditors requires the transfer of legal title to the assets from the debtor to a trustee. Creditors cannot attach the transferred assets because the debtor does not own them. Nonparticipating creditors can attach the debtor’s assets prior to the execution of a composition agreement.

Answer 454

D. Writ of garnishment. Answer (D) is correct. Garnishment is the legal procedure by which a creditor acquires money or other property of a debtor when the property is rightfully in the hands of a third party (e.g., an employer). Arrest (placing an individual in legal custody), a mechanic’s lien (a lien against real property), and receivership (a form of trust) are not effective ways for a creditor to collect money from a debtor’s wages.

Answer 455

A. Is an individual engaged in the business of farming. Answer (A) is correct. Creditors may petition a debtor involuntarily into bankruptcy proceedings under Chapters 7 and 11 of the Bankruptcy Code. The debtor must be a person eligible for protection under the particular chapter. But an individual engaged in the business of farming may not be involuntarily petitioned into bankruptcy.

Answer 456

A. $56,000 Answer (A) is correct. A co-surety who pays more than his or her share has a right of contribution, i.e., to proceed against the other co-sureties to recover his or her proportionate or agreed-to share. A co-surety’s contributive share is determined by dividing the maximum liability of each surety by the sum for all co-sureties and multiplying the result by the amount of the default. But contribution cannot be obtained from the co-surety whose obligation was discharged in bankruptcy. Rivers may recover from Zane 40% [$160,000 ÷ ($160,000 + $240,000)] of the default, or $56,000 (40% × $140,000).

Answer 457

A. $40,000 from Bane. Answer (A) is correct. The unconsented-to release of Ott by Cread without reservation of rights against Bane is a true release. Consequently, Bane also is released to the extent that Bane cannot obtain contribution from Ott. Because both co-sureties agreed to be liable for the entire loan, Ott’s pro rata contributive share is $40,000. Thus, Bane’s potential liability to Cread is reduced from $80,000 to $40,000.

Answer 458

C. The petition may be filed by husband and wife jointly. Answer (C) is correct. A bankruptcy case may be commenced voluntarily or involuntarily. In a voluntary case, the debtor files the petition with the bankruptcy court. Debtors may include individuals, partnerships, corporations, and couples, if the husband and wife file together.

Answer 459

C. An order of garnishment. Answer (C) is correct. Garnishment is the legal action by which a creditor acquires money (or other property) of a debtor when the property is rightfully in the hands of a third party, such as an employer (wages) or a financial institution (money in a bank account). Garnishment is limited by state and federal law, especially when used as a prejudgment remedy.

Answer 460

C. $10,000 Answer (C) is correct. In a Chapter 7 bankruptcy case, the Bankruptcy Code requires secured claims to be satisfied in full before any unsecured claims can be paid. Priority claims are then paid followed by claims of general creditors. All higher-ranking unsecured claims must be paid in full before any lower-ranking claims can be paid. The claim for state taxes ranks highest among the listed claims because it is classified as a priority item. Thus, it must be paid in full ($10,000) before any other claims can be satisfied. The fee owed to the CPA is a claim of a general unsecured creditor. The claim for wages owed to Stieb also is a claim of a general unsecured creditor. These wages were earned more than 180 days before the petition was filed. Assuming proofs of these claims were filed on time, they will be prorated. Thus, Best will receive $2,000 and Stieb will receive $1,000.

Answer 461

D. Liquidation of the debtor. Answer (D) is correct. A reorganization proceeding under Chapter 11 of the Bankruptcy Code provides for payment of creditors and restructuring of the debtor’s finances. It permits his or her business to be continued. Chapter 11 enables restructuring instead of liquidation.

Answer 462

B. Towns has not attempted to enforce the promissory note against Pepper. Answer (B) is correct. A surety is primarily liable for the debtor’s obligation. A creditor may proceed directly against the surety upon default. But, a guarantor of collection has secondary liability. The creditor must first proceed against the principal debtor. Only when a judgment is unpaid may (s)he proceed against the guarantor of collection.

Answer 463

A. A secured debt properly perfected on March 20, Year 1. Answer (A) is correct. The Bankruptcy Code classifies creditors into several categories according to the priority of their claims against the debtor. It states that secured creditors’ claims will be satisfied in full to the extent of the value of the security before unsecured creditors’ claims will be considered. To the extent the security is insufficient, the secured creditor becomes an unsecured creditor. The tax lien, even if a security interest, would have lower priority than the secured debt perfected earlier.

Answer 464

B. Must surrender for distribution to the creditors any amount received as an inheritance within 180 days after filing the petition. Answer (B) is correct. The bankruptcy estate available for distribution to creditors includes all the debtor’s nonexempt legal and equitable interests in property on the date of filing. It includes proceeds and profits from that estate. Certain property acquired after filing is also included: inheritances, property settlements (divorce), and life insurance proceeds to which the debtor becomes entitled within 180 days after filing.

Answer 465

B. It does not discharge any of the debts included until performance by the debtor has taken place. Answer (B) is correct. A composition with creditors is a common-law contractual undertaking between the debtor and the creditors. The participating creditors agree to (1) extend time for payments, (2) take lesser sums in satisfaction of the debts owed, or (3) accept some other plan of financial adjustment. Under general contract law, the original debts will not be discharged until the debtor has performed the new obligations.

Answer 466

D. Deft may file an involuntary petition in bankruptcy against Golf. Answer (D) is correct. Deft may file an involuntary petition for bankruptcy against Golf under Chapter 11. A single creditor may file an involuntary petition for relief if (s)he has at least $15,775 of unsecured claims and if the debtor has fewer than 12 creditors.

Answer 467

D. If Royal can show that State was aware of the fraudulent representations. Answer (D) is correct. A debtor’s fraudulent misrepresentation of his or her financial condition at the time of contract is a material fact that the creditor has a duty to disclose to the surety. If State knew of Green’s fraud and did not inform Royal, the nondisclosure is a form of fraud against the surety by the creditor. If State had been unaware of the fraud, Royal would be required to repay the loan.

Answer 468

D. Official bonds. Answer (D) is correct. An official bond is a type of surety bond. A statute may require public officers to provide bonds to secure the appropriate performance of their duties. The surety is obligated for losses caused by the negligence or nonperformance of the official.

Answer 469

B. Simon may employ itself to prepare tax returns if authorized by the court and may receive a separate fee for services in each capacity. Answer (B) is correct. The trustee in bankruptcy is either appointed or elected by the creditors to administer most of the bankruptcy proceeding. Primary duties include collecting estate property and liquidating it. The trustee has authority, with court approval, to employ professionals such as attorneys or accountants to perform services requiring expertise. If (s)he has appropriate qualifications, the trustee may employ himself or herself to perform a professional service, with court approval. Professionals employed by the trustee are entitled to reasonable compensation for their services out of the bankruptcy estate.

Answer 470

A. Sawyer can file a proof of claim, but it must be allowed by the court. Answer (A) is correct. To share in the distribution of the bankrupt’s estate, a creditor must file a proof of claim with the court within 90 days after the first creditors’ meeting. The proof of claim is simply a statement signed by the creditor explaining the nature and source of the claim and the date it is due. All claims not objected to are deemed allowed. If objected to, a claim may be allowed after a hearing to determine its validity.

Answer 471

A. The person must surrender for distribution to the creditors amounts received as an inheritance, if the receipt occurs within 180 days after filing the bankruptcy petition. Answer (A) is correct. The bankruptcy estate consists of all the debtor’s legal and equitable interests in property, including life insurance proceeds, property from divorce settlements, and inheritances received within 180 days of the commencement of bankruptcy proceedings.

Answer 472

A. Alimony. Answer (A) is correct. Under Chapter 7, assets of the debtor are liquidated and proceeds are applied to his or her debts. The debtor is then granted a general discharge from most obligations that remain unsatisfied. But some obligations are not discharged, for example, unpaid alimony and child support, certain taxes, penalties imposed by governmental entities, liabilities arising from false representations or actual fraud, educational loans, and certain cash advances under an open-end credit plan.

Answer 473

D. Ann did not relinquish possession of the car. Answer (D) is correct. An artisan’s lien is a possessory lien. If possession of the personal property is not relinquished by the owner and retained by the improver, the lien cannot exist. Because Art repaired the car at Ann’s home, Ann retained possession.

Answer 474

D. Does not have a lien on Limo No. 1 because possession was relinquished to Dwight on Friday. Answer (D) is correct. The repairer or other improver of property must retain possession of the property to assert a common law possessory lien. Once the improver (artisan) voluntarily surrenders possession of the property, (s)he loses the lien. Thus, Garage lost its lien on Limo No. 1 by relinquishing possession.

Answer 475

A. Failure to provide the requested information may prevent her discharge. Answer (A) is correct. The Bankruptcy Code requires a debtor to file information about his or her debts, property, income, and other matters. The debtor has a duty to cooperate with the trustee and the court that includes surrendering the property of the estate and any pertinent records. The court can refuse to grant a discharge in bankruptcy if the debtor refuses to obey any lawful order.

Answer 476

C. Yes, because Roe’s giving the security interest to Jet created a voidable preference. Answer (C) is correct. A voidable preferential transfer is one made To or for the benefit of a creditor, For or on account of an antecedent (preexisting) debt, During the debtor’s insolvency, Within 90 days prior to filing the petition, and For the purpose of entitling the creditor to receive a larger portion of its claim than otherwise would be received under a distribution in bankruptcy. The security agreement Roe gave to Jet meets all of the requirements of a voidable preferential transfer. Thus, Roe’s trustee can set aside Jet’s security interest in Roe’s inventory.

Answer 477

C. Unless the client is not paying his or her undisputed debts as they become due or a custodian has been appointed or taken possession of the client’s property, the creditors cannot force the client into bankruptcy. Answer (C) is correct. A debtor may contest an involuntary petition. If contested, an order for relief will be granted only if the debtor is generally not paying his or her undisputed debts as they become due or, within the preceding 120 days, a custodian was appointed or took possession of the debtor’s property. If one of these conditions is not met, the involuntary petition will be dismissed. If a petition is filed in bad faith, damages (compensatory and punitive) can be awarded for injury to the debtor’s reputation.

Answer 478

A. The filing of the bankruptcy petition constitutes an order for relief. Answer (A) is correct. The voluntary bankruptcy petition is a formal request by the debtor to the court for an order for relief. Under the liquidation provisions, an order for relief is automatically given to the debtor upon the filing of the petition.

Answer 479

C. A release of Somes by Cox, reserving Cox’s rights against Tabor, would not reduce Tabor’s obligations. Answer (C) is correct. If the creditor releases one co-surety, the others are released to the extent of the released co-surety’s liability for contribution. The rule, however, is not applicable when the creditor reserves his or her rights against the remaining co-sureties. The rationale of the exception is that the release with reservation of rights is a promise or covenant by the creditor not to sue the released co-surety and thus leaves the other co-sureties’ rights of reimbursement from the principal debtor and contribution from all the other co-sureties intact. Thus, the release of Somes by Cox, reserving Cox’s rights against Tabor, would not reduce Tabor’s obligation because Tabor could still seek contribution from Somes and reimbursement from Pax.

Answer 480

B. Arises from an extension of credit based upon false representations. Answer (B) is correct. A discharge terminates the dischargeable debts. It voids existing judgments and operates as an injunction against further proceedings on the discharged obligations. But not all debts are dischargeable in bankruptcy. For example, debts incurred through false representations will not be discharged.

Answer 481

B. Ace is paid in full by King’s spouse. Answer (B) is correct. The surety, Wright, is released from the obligation to repay King’s debt to the extent the loan is repaid. It does not matter who made the performance. When King’s spouse repaid the loan in full, Wright’s obligation as a surety was terminated.

Answer 482

D. The incapacity of the surety. Answer (D) is correct. The surety may assert a defense personal to the surety to limit his or her liability to a creditor. The surety may use the defense of incapacity of the surety to avoid liability to the principal debtor’s creditor.

Answer 483

B. The solvency of the principal debtor. Answer (B) is correct. A suretyship is a relationship in which one person agrees to answer for the debt or default of another person. Whether the principal debtor is solvent at the time the promise is made is immaterial. An insolvent person can incur debts, and a surety can guarantee them.

Answer 484

C. Lack of consideration to support the surety undertaking. Answer (C) is correct. The contract of a surety must be supported by consideration or a legal substitute as must any other contract. If the surety enters into the agreement when the obligation is assumed by the debtor, the consideration given by the creditor to the debtor is extended to the surety. If the surety’s promise is given later, separate consideration is required.

Answer 485

B. Samp says: “Ship goods to my son and I will pay for them.” Answer (B) is correct. A surety makes a secondary promise (Samp promises to pay if her son does not), not a primary promise. Samp’s statement is a primary promise because Samp is establishing her own debt and is not promising to answer for the debt or performance of another.

Answer 486

C. II only. Answer (C) is correct. Fraud or dishonesty committed by the debtor during the bankruptcy proceedings is the basis for revocation of discharge by the bankruptcy court. Revocation may occur after (1) a request by either the trustee or a creditor, (2) notice, and (3) a hearing. The time limit is 1 year. A debt to a creditor omitted from the list of creditors is not discharged, but proof of dishonesty or fraud is required to revoke the general discharge.

Answer 487

B. Most debtors even if they are not insolvent. Answer (B) is correct. Anyone eligible to be a debtor under a specific chapter may file a voluntary petition under that chapter. An individual who files a voluntary petition need not be insolvent in any sense.

Answer 488

D. The surety is a guarantor of collection, and the creditor failed to exercise due diligence in enforcing its remedies against the debtor. Answer (D) is correct. The general rule is that a surety is liable to the creditor immediately upon the debtor’s default without the necessity of notice or demand. When the surety has conditioned the obligation to pay by requiring the creditor to first proceed against the debtor, the surety is described as a guarantor of collection and is not liable until the creditor exercises due diligence in enforcing its remedies against the debtor.

Answer 489

C. Collins is free to apply the $600 to the debts as he sees fit. Answer (C) is correct. If a debtor gives instructions as to the application of partial payment, the creditor must comply. Without instructions, the creditor may apply the payment as (s)he chooses. In this case, Collins may apply the $600 wholly to either obligation or proportionately as he sees fit.

Answer 490

B. The principal debtor’s performance is tendered. Answer (B) is correct. A surety is released to the extent that the principal debtor’s obligations under the debtor-creditor contract have been performed. It does not matter who renders the performance. Moreover, tender of performance by the principal discharges the surety because his or her agreement is not intended to protect against loss arising from the creditor’s refusal to accept the principal debtor’s performance.

Answer 491

D. Stockbrokers. Answer (D) is correct. Relief under Chapter 11 of the Bankruptcy Code is available only for eligible debtors. These include partnerships and corporations, railroads, and any person that may be a debtor under Chapter 7. Ineligible debtors under Chapter 11 include shareholders, commodities and stock brokers, insurers, banks, credit unions, and savings and loan associations.

Answer 492

A. $36,000 from Aker and $54,000 from Burke. Answer (A) is correct. A co-surety who has paid more than his or her proportionate or agreed share of the debt has a right to proceed against the other co-sureties for their proportionate or agreed share. A co-surety’s contributive share is determined by dividing the maximum liability of that co-surety by the sum for all the co-sureties and then multiplying by the amount of the default. Aker $ 72 ÷ ($72 + $108 + $180) = 20% × $180 = $36 Burke $108 ÷ ($72 + $108 + $180) = 30% × $180 = $54 Cey $180 ÷ ($72 + $108 + $180) = 50% × $180 = $90 Hence, Cey should receive contributions of $36,000 and $54,000 from Aker and Burke, respectively. Although the suretyship agreement is between the debtor and the co-sureties, the co-sureties are liable on the contract to the creditor. The creditor can sue on the contract because it is a third-party beneficiary.

Answer 493

B. An unsecured creditor may not obtain a judgment and execution against the debtor’s property. Answer (B) is correct. The order for relief results in an automatic stay of most legal proceedings or other collection efforts by creditors of the debtor. New and pending proceedings are stayed. Creditors, whether or not secured, also may not take action to gain possession of the debtor’s property or to create, perfect, or enforce a lien on it. Thus, an unsecured creditor could not take advantage of a state “grab” law to obtain a judgment and execute it by seizing and selling property of the debtor without concern for the claims of other creditors.

Answer 494

A. Increases the amount of exempt property. Answer (A) is correct. Amounts in the federal bankruptcy statute are indexed to inflation. They are adjusted every three years. For example, for cases filed after April 1, 2016, the federal exemptions include $23,675 equity in a residence or burial plot; $3,775 equity in a motor vehicle; $12,625 in household furnishings, appliances, clothing, and the like (up to $600 per item); $1,000 worth of jewelry; $1,250 of other property plus the unused portion of the residential equity exemption up to $11,850; $2,375 worth of tools; alimony and child support payments, Social Security and disability benefits, and others. The federal law permits the debtor to choose between federal or state exemptions, but it also allows a state to limit its citizens to use of the state exemptions. The majority of states have done so.

Answer 495

B. The creditor failed to notify the surety of a partial surrender of the principal debtor’s collateral. Answer (B) is correct. The creditor’s impairment of collateral, for example, by returning it to the principal debtor or failing to maintain a perfected security interest in it, discharges the surety to the extent of the value of the lost collateral. The reason for permitting this defense is to protect a surety who assumed the obligation solely because the creditor held the security for the debt.

Answer 496

B. Stark is a secured creditor and can assert a claim to the circuit tester that will be superior to the claims of Peter’s other creditors. Answer (B) is correct. Stark obtained a purchase-money security interest in equipment that was perfected because Stark filed a financing statement within 20 days. Thus, Stark has a valid security interest that cannot be voided by the trustee. Stark also may assert a claim to the machine that is superior even to that of a party with a prior perfected security interest.

Answer 497

C. Municipal bond interest received by the debtor within 180 days after the filing of the petition. Answer (C) is correct. Generally, property acquired after the filing of a petition in bankruptcy for liquidation under Chapter 7 is not included in the bankruptcy estate and is not held by the trustee for distribution to the debtor’s creditors. However, certain property to which the debtor becomes entitled within 180 days after filing becomes part of the estate: (1) inheritances; (2) property settlements in a divorce; (3) life insurance proceeds; (4) proceeds, products, offspring, rents, or profits received from property in the estate (e.g., interest on bonds, rent from a building, or property insurance proceeds); (5) property acquired by the estate after the commencement of the case; and (6) property recovered by the trustee under the avoidance powers. Furthermore, Social Security payments, welfare benefits, disability payments, alimony and support awards, and most pension proceeds are exempt.

Answer 498

D. Surety is liable in full immediately upon default by Burns but will be entitled to the collateral upon satisfaction of the debt. Answer (D) is correct. Subrogation is a right of a surety. After paying the obligation of a debtor who has defaulted, a surety has the legal rights of the creditor against the principal debtor, co-sureties, or any collateral. They include (1) rights in the collateral provided by the principal debtor, (2) a priority in bankruptcy, (3) rights against other parties indebted on the same obligation, and (4) rights against co-sureties. Surety is therefore subrogated to Dollar’s rights against the bonds.

Answer 499

B. The debtor pays creditors less than 100% of their claims. Answer (B) is correct. A composition plan may be proposed by a debtor under Chapter 13 of the Bankruptcy Code. Under a composition plan, a debtor pays his or her creditors less than 100% of their claims on a pro rata basis for each class of claims. The repayment time for a Chapter 13 plan is 5 years if the debtor’s income at least equals the relevant state median income. The debtor must give control of future income to a trustee who makes payments on the debtor’s claims. Upon approval of the plan, the debtor is granted injunctive relief against creditors while the plan is being carried out. But the unsecured creditors must receive amounts at least equal to those paid in straight liquidation. Approval of creditors is not required.

Answer 500

B. If not contested will result in the entry of an order for relief by the bankruptcy judge. Answer (B) is correct. If the uncontested involuntary petition is in proper form, the court will issue an order for relief. The debtor will be required to furnish the court with the same information as would have been contained in a voluntary petition, an interim trustee will be appointed by the U.S. Trustee to take control of the estate, and a creditors’ meeting will be called. In general, the procedure is the same whether the bankruptcy is voluntary or involuntary.

Answer 501

D. Tom does not have a mechanic’s lien. Answer (D) is correct. A mechanic’s lien results if the improver of real property performs work under a contract and is not paid. Some jurisdictions require the contract to be in writing. Because Tom paved the driveway without entering into a contract, a mechanic’s lien did not arise.

Answer 502

D. Refuses to explain satisfactorily a loss of assets. Answer (D) is correct. The purpose of Chapter 7 is to assure a fair distribution of assets among the creditors and provide an honest individual with a fresh start. Thus, the debtor, if an individual, is discharged from unsatisfied obligations except for certain nondischargeable debts listed in the Bankruptcy Act. Failure of a debtor to explain satisfactorily the loss or disappearance of assets results in denial of discharge.

Answer 503

D. Proceeds from a life insurance policy received 90 days after the petition was filed. Answer (D) is correct. Most assets in which the debtor has a legal or equitable interest at the date Chapter 7 proceedings began are included in the estate. Other property may be added to the estate. For example, it includes property acquired by the debtor within 180 days after filing the petition if the property was acquired (1) by inheritance, (2) as proceeds of a life insurance policy, or (3) from a property settlement in a divorce case.

Answer 504

A. May elect not to assume the equipment lease. Answer (A) is correct. The trustee in bankruptcy is given several options under the Bankruptcy Code, all of which are subject to court approval. The options are to assume and perform the unexpired lease, to assume and assign the unexpired lease to a third party, or reject the unexpired lease. The trustee must act to assume the lease within 60 days after the order for relief is entered, or it is deemed to be rejected.

Answer 505

C. Is a corporation or a partnership. Answer (C) is correct. A general discharge of most debts is provided a person under Chapter 7. But certain types of entities are not eligible. They include municipalities, railroads, insurance companies, banks, credit unions, and savings and loan associations. Partnerships and corporations do not receive a general discharge under Chapter 7. They are merely liquidated.

Answer 506

D. Unjustifiably failed to preserve his books and records. Answer (D) is correct. Discharge will be denied if the debtor conceals or destroys property with the intent to hinder, delay, or defraud a creditor, or fails to adequately explain the loss of assets. Similarly, unjustifiable or fraudulent concealment or destruction of the debtor’s financial records is a basis for denying discharge of indebtedness.

Answer 507

A. It releases King Surety to the extent of the value of the security. Answer (A) is correct. When a debtor has put up security or collateral, the surety (after payment) succeeds to it if the creditor has not sold it to satisfy the debt. Thus, a creditor who releases collateral interferes with the subrogation rights of the surety to the collateral. This interference releases the surety. When Dustin released the $1,000 (or greater) coin collection, she also released King Surety to that extent.

Answer 508

A. Dunbar is a surety and must satisfy the mortgage if Masters does not. Answer (A) is correct. When a buyer of real estate assumes an existing mortgage, the seller remains liable because a novation has not occurred. Between the seller and buyer, the buyer has become the primary debtor, and the seller is a surety. Because Dunbar is a surety of the assumed mortgage, he must pay if Masters does not.

Answer 509

A. If Master is an insurance company. Answer (A) is correct. A debtor may voluntarily file a petition for protection from creditors under Chapter 7’s liquidation provisions. The debtor, if an eligible person, need only state that it has debts. Persons ineligible to file under Chapter 7 include (1) insurance companies, (2) banks, (3) municipalities, (4) railroads, (5) credit unions, and (6) savings and loan associations.

Answer 510

C. Be bound to answer for the same debt or duty of the debtor. Answer (C) is correct. Co-sureties exist when more than one surety is bound to answer for the same debt or duty of a debtor. Without an agreement to the contrary, co-sureties share equally the loss caused by the debtor’s default.

Answer 511

C. Her current monthly income after deductions is at least $214.17. Answer (C) is correct. Under the means test, the mandatory trigger point for presumed abuse is that the debtor has at least $214.17 of current monthly income after deductions. If CMI after deductions is less than $128.33, the presumption never arises. For other amounts, the presumption arises if 5-year income [(CMI – allowed deductions) × 60 months] suffices to pay 25% or more of general unsecured debt.

Answer 512

D. Lose because the clause providing that the statute of limitations would be limited to 18 months is enforceable. Answer (D) is correct. A 4-year statute of limitations applies to cases involving sales of goods. The parties, however, may reduce (but not extend) the period for suit but not to less than 1 year. An action for breach of warranty accrues (the statute begins to run) when tender of delivery is made. But if (1) the warranty explicitly extends to future performance and (2) discovery of breach must await such performance, the action accrues when the breach is or should have been discovered. Because suit was brought within 4 years of, but more than 18 months after, both delivery of the goods and discovery of the defects, the issue is not when the action accrued but whether the contractual modification of the statute of limitations is effective. The contract provision for an 18-month limitation on suit is permitted, and Sklar therefore will lose.

Answer 513

C. Subrogation. Answer (C) is correct. Subrogation is the right of a surety, after paying the obligation of a debtor who has defaulted, to succeed to the legal rights of the creditor against the principal debtor, co-sureties, or any collateral.

Answer 514

B. A creditors’ committee, if appointed, will consist of unsecured creditors. Answer (B) is correct. Under Chapter 11, the debtor may operate its own business as debtor-in-possession. A trustee would be appointed only for cause shown, such as dishonesty or mismanagement. Chapter 11 requires that, as soon as practicable after an order for relief has been granted, the U.S. Trustee appoint a committee of unsecured creditors. It may participate in formulating the plan of reorganization. Moreover, the court may order the U.S. Trustee to appoint additional committees to assure adequate representation.

Answer 515

B. Baker may resell the word processor to another buyer. Answer (B) is correct. Resale of the goods and recovery of damages is a seller’s remedy. After the buyer’s breach, the resale in good faith and in a commercially reasonable manner permits the seller to recover the difference between the resale price and the contract price, plus any incidental damages allowed, minus expenses saved.

Answer 516

A. It may be possible to avoid bankruptcy if your client and the creditors can agree to form a creditor’s committee with the usual powers incidental to such an arrangement. Answer (A) is correct. One alternative to bankruptcy is to place the assets of the business in the hands of a committee of creditors. The committee has full power to manage the business of the debtor. The advantages of such an arrangement are that it avoids the stigma of bankruptcy, the attendant formalities and legal expenses, and the losses incurred in a forced liquidation.

Answer 517

D. The surety must have the legal capacity to make contracts generally. Answer (D) is correct. All parties to suretyship agreements (including both compensated and uncompensated sureties) are ordinarily required to have the legal capacity to make contracts. A suretyship agreement is a contract.

Answer 518

C. Requires a secondary promise to pay the debt of another to be in writing. Answer (C) is correct. A primary promise is a promise to pay or perform one’s own obligation. A secondary promise is one to answer for the debt or default of another. It must be in writing under the statute of frauds. A secondary promise for one’s own benefit, however, is an exception.

Answer 519

B. The guaranty must be in writing. Answer (B) is correct. A person who guarantees payment without qualification must pay upon default. A guarantor of collection guarantees the debt on condition that the creditor first use ordinary legal means to collect. Surety and guaranty arrangements that are secondary promises are within the statute of frauds and must be in writing.

Answer 520

A. The right to avoid any statutory liens against the debtor’s property that were effective before the bankruptcy petition was filed. Answer (A) is correct. Broad powers are granted to the trustee. They include the power or duty to ``` Collect property, Account for property, Perform investigations, Set aside fraudulent conveyances and preferential transfers, Void certain liens, Operate the debtor’s business, Hire professionals, File reports, and Close the estate. ``` The trustee does not have the right to void statutory liens against the debtor’s property that were effective before the petition was filed. But statutory liens on real property (e.g., mechanic’s liens or materialman’s liens) that are not effective until the filing of the petition or until the time when the debtor becomes insolvent are voidable. The trustee also may void liens that are not perfected against a good faith purchaser on the date of filing.

Answer 521

A. Eagle was a secured creditor not fully satisfied from the proceeds obtained on disposition of the collateral. Answer (A) is correct. Chapter 7 contains the liquidation provisions of the Bankruptcy Code. The nature of the debt or debtor or the debtor’s conduct may prevent discharge of all or specific debts. However, secured creditor status does not guarantee full satisfaction of a debt. If the secured claim is not fully satisfied by the proceeds resulting from the sale of collateral, the unsatisfied portion of the debt may still be discharged.

Answer 522

D. Contribution. Answer (D) is correct. Contribution is the right of a co-surety who has paid more than his or her proportionate or agreed-to share to proceed against the other co-sureties.

Answer 523

D. George’s best remedy is to recover the value of the goods from Freddy and David in a tort action for deceit. Answer (D) is correct. In general, a purchaser of goods acquires only the title that his or her transferor had or had power to transfer. Under the UCC, a purchaser who deceived the transferor as to his or her identity or procured delivery of the goods in exchange for a check that is later dishonored has a voidable rather than a void title. The transferor can recover the goods (or damages) from the wrongdoer. However, a person with voidable title may transfer good title to a good faith purchaser for value. Thus, George cannot recover from Ivan or Irene, each of whom has good title.

Answer 524

B. Most legal or equitable property interests of the debtor are included. Answer (B) is correct. By definition, a debtor’s estate includes most of his or her legal or equitable interests as of the commencement of the case. Most interests are included whether or not the property is exempt from creditor claims. However, such items as subsequent earnings, after-acquired property, and certain contributions (e.g., to retirement plans and educational accounts) are excluded.

Answer 525

B. Subrogation. Answer (B) is correct. Subrogation is the right of a surety, after payment (upon default of the debtor), to succeed to the legal rights of the creditor against the principal debtor, co-sureties, or any collateral.

Answer 526

A. A security agreement where the collateral is in the possession of the secured party. Answer (A) is correct. A security agreement is generally enforceable when the debtor has authenticated a security agreement that describes the collateral. Authentication means signing to indicate that the identified person intends to accept the record of the agreement. However, the secured party’s possession of the collateral may substitute for authentication of a security agreement if it is in accordance with the security agreement.

Answer 527

D. Arises from an extension of credit based upon false representations. Answer (D) is correct. A discharge terminates the dischargeable debts. It voids existing judgments and operates as an injunction against further proceedings on the discharged obligations. But not all debts are dischargeable in bankruptcy. For example, debts incurred through false representations will not be discharged.

Answer 528

A. Quick only. Answer (A) is correct. This contract was an assignment of the account receivable. The assignee (Taft) became the owner of the receivable (rather than a holder for security purposes) and was the only party entitled to payment. The debtor (Pine) was entitled to notice of the assignment so he would know whom to pay. Until given this notice, Pine was entitled to pay Quick and be relieved of the debt. Quick, the assignor, must account to the assignee. Quick holds the amount paid as trustee for Taft.

Answer 529

D. Modifies the price in an existing, enforceable contract from $525 to $475. Answer (D) is correct. An oral modification of a contract for the sale of goods does not require consideration to be binding, but the UCC’s statute of frauds section must be satisfied if the contract as modified is within its provisions. Because the contract as modified is for less than $500, no writing is required, and the oral agreement is enforceable.

Answer 530

B. A contract was formed on the day Sandy mailed the acceptance to Jackson. Answer (B) is correct. A firm offer is an offer by a merchant to buy or sell goods in a signed record that gives assurance that it will be held open and is not revocable, for lack of consideration, during the time stated or, if no time is stated, for a reasonable time. The firm offer did not include an expiration date. Thus, it was not revocable for a reasonable time and Jackson’s revocation most likely is ineffective. The mailbox rule continues to apply under the UCC Sales Article. Accordingly, the acceptance became effective under the mailbox rule on dispatch (when the acceptance was mailed).

Answer 531

A. The destruction of the subject matter of the agency. Answer (A) is correct. Under the Second Restatement, destruction of the subject matter of the agency makes fulfilling the purpose of the agency impossible. Thus, it terminates the agency by operation of law. Because most terminations by operation of law terminate apparent authority under the Second Restatement, notice to third parties of termination of the agency’s existence is usually not necessary.

Answer 532

D. Although the price has some degree of uncertainty, the contract is enforceable. Answer (D) is correct. The agreement is enforceable even though the price term is left open if the parties intended to contract (but if objective intent to be bound is missing, no contract exists). The price of the oil is to be set objectively in the future in accordance with the refinery price on the date of delivery. If the price is not settled in accordance with the agreement, the price will be a reasonable price at the time of delivery. A reasonable price is largely determined by market price absent an applicable course of dealing, usage of trade, or course of performance.

Answer 533

A. The value has been given, the secured party receives a security agreement describing the collateral authenticated by the debtor, and the debtor has rights in the collateral. Answer (A) is correct. For most forms of collateral, a security interest is enforceable against the debtor when (1) the debtor has authenticated a security agreement that describes the collateral or the secured party has possession of the collateral, (2) the secured party has given value, and (3) the debtor has rights in the collateral or the power to transfer such rights.

Answer 534

C. Whether UCC Article 2 is applicable does not depend on the price of the goods involved. Answer (C) is correct. Article 2 applies to transactions in goods. Goods are things movable other than the money in which the price is to be paid, investment securities, and things in action. Applicability of Article 2 does not depend on the dollar amount involved. Article 2 applies to both merchants and nonmerchants, but special rules are provided for certain aspects of transactions between or with merchants.

Answer 535

D. A transaction intended to create a security interest in personal property. Answer (D) is correct. Article 9 of the UCC covers any transaction, regardless of its form or name, that is intended to establish a security interest in personal property or fixtures. Thus, a secured transaction may be in the form of a lease, pledge, chattel mortgage, etc. However, a lease that is essentially a sale to the lessee does not establish a security interest.

Answer 536

D. Risk of loss for the goods passes to the buyer when the goods are accepted after the trial period. Answer (D) is correct. A sale is on approval if the goods are delivered with an understanding that the buyer may test them for the purpose of determining whether (s)he wishes to purchase. The buyer may return them without breaching the contract even though they conform to the contract. In a sale on approval, title and risk of loss do not pass to the buyer until acceptance. Acceptance may be express or implied, e.g., by not returning the goods within a reasonable period.

Answer 537

C. Yes, because it was perfected at the time of attachment. Answer (C) is correct. A PMSI in consumer goods ordinarily is automatically perfected without filing or possession. Thus, it becomes effective at the time of attachment.

Answer 538

D. Gem is free from liability concerning the loan. Answer (D) is correct. A surety contract is an agreement to answer for the debt or default of another unless the main purpose is to obtain a new economic benefit. It is required to be in writing by the statute of frauds, whatever its amount. If the contract is not in writing, it is not enforceable.

Answer 539

A. No, because Zen did not accept by telegram. Answer (A) is correct. The UCC governs because the offer involves a sale of goods. Unless otherwise indicated, an offer involving a sale of goods invites acceptance in any manner and by any medium reasonable in the circumstances. However, the offer required acceptance to be by a stated mode. The purported acceptance by a different mode was therefore not effective.

Answer 540

A. The different terms of the acceptance are to be construed as proposals for changes in the contract. Answer (A) is correct. Conduit’s letter was a definite, reasonable, and unconditional acceptance and thus formed a contract. Ordinarily, additional or different terms are considered proposals for addition to or changes in the contract. However, between merchants, the additional or different terms become part of the contract unless (1) the offer expressly limits acceptance to its terms (which it did), (2) the additional or different terms materially alter the offer, or (3) the offeror objects within a reasonable time. Because the offer expressly limited acceptance to its terms, Conduit’s letter was an acceptance of the original offer with proposals for changes.

Answer 541

D. The theory of agency by estoppel rather than express agency is a plausible basis for finding an agency relationship resulting in liability of the franchisor for the actions of the franchisee. Answer (D) is correct. Two relationships must be established for the customer to recover from Foodco. First, a principal-agency relationship between Foodco and H&M must have existed at the time the customer was injured. Second, the negligent act that injured the customer must have occurred within the scope and during the course of H&M’s franchise agreement with and employment by Foodco. The most likely agency relationship that may be established is an agency by estoppel rather than an actual or express agency. Foodco caused the public (including the injured customer) to have a reasonable belief that each restaurant was part of a chain operated by Foodco, which is a basis for finding an agency by estoppel. Foodco’s actions created an appearance of agency that in fact did not exist. Thus, because of its actions, Foodco is estopped (prevented) from denying the existence of an agency relationship. If an agency relationship is established, Foodco, as principal, is liable for any harm caused to a third party by its agent, H&M, within the course and scope of employment.

Answer 542

D. Passed to Bond on Wool’s tender of delivery. Answer (D) is correct. If (1) the parties have no agreement as to risk of loss, (2) no carrier is involved, and (3) the goods are not in the possession of a bailee, the risk of loss passes to the buyer on his or her receipt of the goods if the seller is a merchant. Otherwise, the risk passes to the buyer on tender of delivery. Because Wool is not a merchant (a person engaged in selling goods of the kind), risk passed to Bond on tender of delivery.

Answer 543

A. The seller’s statement that it is selling only such right or title that it has. Answer (A) is correct. Every contract for the sale of goods warrants that (1) the title is good, (2) its transfer is rightful, and (3) the goods are free of encumbrances not known to the buyer. The warranty of title can be excluded or modified only by specific language or by circumstances giving the buyer reason to know that the transferor has no title or a limited title.

Answer 544

C. A judgment lien creditor who filed its judgment on April 15. Answer (C) is correct. When two perfected security interests conflict, the first secured party to file or perfect ordinarily has priority. A secured party who filed on April 1 would have priority over a judgment lien creditor who filed on April 15. The judgment lien creditor’s interest would be superior to an unperfected security interest or one perfected after attachment of the lien.

Answer 545

C. ABC can avoid strict liability by engaging a contractor to ensure a safe workplace. Answer (C) is correct. Some duties may not be delegated as a matter of law or public policy, e.g., a duty of an employer to provide employees with a safe workplace. Thus, the employer does not avoid liability by engaging an independent contractor to ensure a safe workplace.

Answer 546

C. II only. Answer (C) is correct. A liquidated damages clause in a contract specifies the damages to be paid in the event of breach. The UCC permits such a clause provided it is reasonable in light of the (1) anticipated losses, (2) difficulties of proof of loss, and (3) inconvenience of otherwise obtaining a remedy. If excessive, it is a penalty and is unenforceable. If a seller has properly withheld delivery of goods, the buyer may receive a refund of payments minus any liquidated damages agreed on. If no liquidated damages have been provided for, the seller may retain 20% of the value of the total contract price or $500, whichever is less (UCC 2-718).

Answer 547

A. Dara, because she made a justifiable revocation of acceptance. Answer (A) is correct. Dara decided to take the goods despite their nonconformity and thus accepted them. A buyer may revoke acceptance, however, if certain conditions are met. (1) The goods are nonconforming; (2) the nonconformity substantially impairs their value; and (3) (a) the buyer knew of the nonconformity and acted on the reasonable assumption it would be cured, but it was not seasonably cured; or (b) (s)he did not know, and acceptance was reasonably induced either by the difficulty of discovery or by the seller’s assurances. Moreover, revocation is made within a reasonable time.

Answer 548

A. An indication of the collateral. Answer (A) is correct. To be effective, the financing statement must (1) include the name of the debtor on the public organic record, (2) include the name of the secured party or representative, and (3) indicate the collateral covered.

Answer 549

B. The secured party has priority in the collateral over most creditors who acquire a security interest in the same collateral after the filing. Answer (B) is correct. Perfection of a security interest maximizes a secured party’s rights with respect to the collateral. Although perfection by filing a financing statement does not give the secured party priority over all subsequent secured parties, it does give priority over all unperfected interests and over most subsequent perfected interests.

Answer 550

D. I only. Answer (D) is correct. An express warranty results if any affirmation of fact or promise made by the seller to the buyer that relates to the goods (by any description of the goods or by any sample or model) becomes part of the basis of the bargain. Reliance by the buyer need not be shown.

Answer 551

C. Not be varied insofar as they require the secured party to account for any surplus realized on the disposition of collateral securing the obligation. Answer (C) is correct. If the security interest secures an indebtedness, the secured party must account to the debtor for any surplus on disposition of the collateral after default. This right of the buyer-debtor is absolute when the collateral is sold after default because the risk remains with the debtor. But it would not apply if the secured party is allowed to retain (accept) the collateral and later sells it at a profit.

Answer 552

B. Kirk may deliver the freezer on June 23 if it first seasonably notifies Nix of its intent to do so. Answer (B) is correct. When a buyer rejects delivery for nonconformity, the time for performance may not have expired. The seller then may seasonably notify the buyer of his or her intent to cure and then deliver within the contract period. Accordingly, Kirk can promptly notify Nix and make a conforming delivery by June 23.

Answer 553

B. If collateral in the form of consumer goods secures no obligation and no commitment to give value exists, a termination statement must be filed. Answer (B) is correct. If (1) the collateral consists of consumer goods, (2) no obligation is secured by the collateral, and (3) no commitment to give value exists, the secured party must cause the secured party of record to file a termination statement within 1 month. The filing must be within 20 days after receipt of an authenticated demand from the debtor, if earlier. If the property is not consumer goods, a termination statement must be filed or sent to the debtor within 20 days after the debtor makes an authenticated demand given that no obligation is secured and no commitment to give value exists.

Answer 554

A. Be entitled to rescind the contract and sue for damages resulting from the fraud. Answer (A) is correct. Rescission for fraud does not bar a claim for damages or another remedy.

Answer 555

A. It is not effective against either the debtor or third parties. Answer (A) is correct. A security interest is not effective against anyone before it attaches.

Answer 556

B. The agent owes a fiduciary duty to the principal. Answer (B) is correct. The agent owes a fiduciary duty to the principal. An agent may not profit at the expense of, or compete with, the principal, and must also disclose material facts and obey reasonable instructions.

Answer 557

A. Contribution. Answer (A) is correct. Contribution is the right of a co-surety who has paid more than his or her proportionate or agreed-to share to proceed against the other co-sureties to recover their share.

Answer 558

B. Express warranties must be part of the basis of the bargain between buyer and seller. Answer (B) is correct. Express warranties are any statements of fact or promises made by any seller to the buyer that become part of their agreement.

Answer 559

C. Wilson is obligated to act solely in Young’s interest in matters concerning Young’s business. Answer (C) is correct. An agent has a fiduciary duty to act with the utmost loyalty and good faith solely for the benefit of the principal. Wilson may not compete or otherwise harm Young’s business while employed by Young.

Answer 560

A. May be disclaimed by a seller’s oral statement that mentions merchantability. Answer (A) is correct. Unless the circumstances indicate otherwise, all implied warranties are excluded by the expressions “as is,” “with all faults,” or other language that (1) calls the buyer’s attention to the exclusion of warranties and (2) makes plain that no warranty is implied. A disclaimer of the implied warranty of merchantability must mention merchantability and be conspicuous if in writing. Thus, a disclaimer of the implied warranty of merchantability may be oral.

Answer 561

A. Refund even if Kent had no tax withheld from wages. Answer (A) is correct. The Earned Income Credit is a refundable credit for low-income taxpayers. Having taxes withheld from wages is not a requirement for using the Earned Income Credit.

Answer 562

A. Inspect large firms annually. Answer (A) is correct. The PCAOB will inspect large firms annually and report violations to the SEC and state authorities. All attestation engagements, notably those in litigation, may be reviewed. The inspection also involves a quality control assessment. Furthermore, the inspection report must include the firm’s response. The firm then has 12 months to correct the reported weaknesses.

Answer 563

D. Dana and one other shareholder. Answer (D) is correct. An S election revocation requires the consent of more than 50% of the shares issued and outstanding. Therefore, the consent of Dana and one other is required to meet this threshold.

Answer 564

A. All of the answers are correct. Answer (A) is correct. Basis must be reduced by the larger of the amount of depreciation allowed or allowable (even if not claimed). A return of capital is a tax-free distribution that reduces a stock’s basis by the amount of the distribution. If a shareholder’s basis has been reduced to zero because of a tax-free return of capital, any excess amounts received are treated as a capital gain. The basis of the replacement property from an involuntary conversion is reduced by any gain not recognized and any loss recognized.

Answer 565

D. Both the fiduciary income tax return and the estate tax return. Answer (D) is correct. Income that a decedent had a right to receive prior to death but that was not includible on his or her final income tax return is income in respect of a decedent. The $10,000 is properly includible in the estate’s income tax return because Ross was a cash-basis taxpayer and would not properly include income not yet received at the time of death in his final return. Since the money was owed to Ross (he had a right to receive it), it is an asset of the estate and must be included on the estate tax return also.

Answer 566

B. A promise to pay a minor $500 to paint a garage. Answer (B) is correct. Consideration must be legally sufficient and intended as a bargained-for exchange. A promisee has provided legally sufficient consideration for the promisor’s promise if (s)he incurs a legal detriment or if the promisor receives a legal benefit. Whether the promisee is a minor does not affect the sufficiency of the consideration provided by a promisee who is a minor. The promisor’s promise to pay is supported by the promisee-minor’s legal detriment incurred by painting a garage (the promisor’s legal benefit in the form of a painted garage). The minor could choose to disaffirm the contract but the consideration is legally sufficient.

Answer 567

B. Its passive investment income exceeds 25% of its gross receipts. Answer (B) is correct. If an S corporation has pre-S corporation earnings and profits (from the period it was a corporation) at the end of a tax year and its passive investment income is more than 25% of its gross receipts, the S corporation may be subject to a tax on excess net passive income.

Answer 568

C. School. Answer (C) is correct. Organizations formed and operated exclusively for religious, charitable, scientific, educational (e.g., schools), literary, or similar purposes are exempt organizations. No part of net earnings may inure to the benefit of any private shareholder or individual.

Answer 569

B. $20,000 Answer (B) is correct. A net operating loss may be carried back 2 years and forward 20 years. The net operating loss must be carried to the earliest taxable year to which such loss may be carried. Since 2017 is KAN’s first year of operation, the net operating loss will be carried forward 20 succeeding taxable years or until used up. The amount of the net operating loss carryover is the excess of deductions over gross income. The fire loss (included in the $30,000 loss) may be fully deducted since KAN is a corporation. KAN’s net operating loss carryover is Short-term capital gains $ 10,000 Loss from operations (30,000) Net operating loss carryover $(20,000)

Answer 570

A. January 1, 2017. Answer (A) is correct. The S corporation election is effective for the current tax year if it is made on or before March 15 for calendar-year corporations, subject to certain exceptions relating to ineligibility and complete consent. Since this election was made on February 10 and no exceptions applied, the election will be effective for the entire taxable year in which it was made.

Answer 571

C. $275,000 Answer (C) is correct. Income for tax purposes includes gross receipts net of cost of goods sold (COGS). A corporation is entitled to a special deduction from gross income for dividends received from a taxable domestic corporation. The amount of the deduction is based upon the value and the percentage of the voting stock of the distributing corporation owned by the recipient. Income before special deductions is $275,000 [($500,000 – $250,000) + $25,000].

Answer 572

C. Limited partners may vote to remove a general partner without losing their status as limited partners. Answer (C) is correct. A limited partner is not liable to third parties for partnership obligations if the limited partner does not take part in the control of the business. The RULPA lists several activities in which a limited partner may engage without being considered in the control of the business, among them, voting on the removal of a general partner. Excessive involvement in the management of the business may constitute taking part in the control of the business. The result is liability to those parties who have knowledge of the limited partner’s participation in control or, if the limited partner is exercising the powers of a general partner, to all third parties.

Answer 573

B. Yes No Answer (B) is correct. A party to a contract may generally transfer its rights under the contract to a third party. An option contract may be assigned. However, certain types of personal contracts cannot be assigned. A malpractice insurance contract may not be assigned if the contract prohibits the assignment or if the assignment would be against public policy because it may materially increase the risk of the obligor (insurance company).

Answer 574

A. May be claimed either as a deduction or as a credit, at the option of the corporation. Answer (A) is correct. A deduction is allowed for foreign income taxes paid or accrued during the taxable year. Alternatively, both individual taxpayers and corporations may claim a Foreign Tax Credit on income earned and subject to tax in a foreign country or U.S. possession. One may not claim both the deduction and the credit.

Answer 575

A. $114,000 Answer (A) is correct. Under Sec. 6699, a penalty is imposed on an S corporation for failure to file an S corporation return within 2 ½ months of the end of the tax year. The penalty is imposed in the amount of the number of persons who were shareholders during any part of the year multiplied by $200 for each of up to 12 months (including a portion of one) that the return was late. As a calendar year taxpayer, Shiloh's 1120S was due March 15, 2018. Counting whole and partial months, the return was 6 months late, making the penalty $114,000 (95 shareholders x $200 penalty x 6 months).

Answer 576

A. Not repossess the set from Haynes but is entitled to any payments Haynes makes to Kelly on her note. Answer (A) is correct. Assuming Haynes bought the goods (1) in good faith, (2) without knowledge that the sale was in violation of Thrush’s security interest, (3) in the ordinary course of business, and (4) from a person in the business of selling television sets (not a pawnbroker), she qualifies as a buyer in the ordinary course of business. She therefore takes free of the purchase money security interest in inventory given by Kelly even though it was perfected and she knew of its existence. However, the security interest continues in the proceeds, so Thrush may recover payments made by Haynes to Kelly. A perfected PMSI in inventory extends to identifiable cash proceeds received no later than the time of delivery to a buyer and to proceeds in the form of instruments, chattel paper (e.g., the note and security agreement), and the proceeds of chattel paper.

Answer 577

C. $14,000 Answer (C) is correct. The distributee’s basis in (noncash) property received in a liquidating distribution is any excess of his or her AB in the partnership interest immediately before distribution over any amount of money received. Therefore, Gulde’s basis in the land is $14,000 ($26,000 basis – $12,000 cash received in distribution).

Answer 578

B. $14,000 Answer (B) is correct. A corporation may deduct capital losses only to the extent of capital gains (without regard to whether they are short- or long-term). Therefore, Dowdy can deduct only $14,000 of its net long-term capital loss in the current year. The remaining $4,000 long-term capital loss will be carried back 3 years or carried over to the next year.

Answer 579

A. Limited liability partnership. Answer (A) is correct. An LLP is the most beneficial business entity. Contributions to a partnership are tax-free. The earnings are taxed when they are earned, whether distributed or not, and are not subject to personal holding company tax. In addition, unlike the earnings of a C corporation, which are taxed to the corporation and to recipients of its dividends, earnings of an LLP are not subject to double taxation. Furthermore, a corporation may be a partner in an LLP but not a shareholder in an S corporation.

Answer 580

C. Intentional misconduct. Answer (C) is correct. Rule 10b-5 states that it is illegal for any person, directly or indirectly, to use the U.S. mail or any instrumentality of interstate commerce or a national securities exchange to defraud anyone in connection with the purchase or sale of any security. A plaintiff must prove each of the following: (1) a misstatement or omission of a material fact or other fraud; (2) its connection with any purchase or sale of securities; (3) the defendant’s intent to deceive, manipulate, or defraud; (4) reliance on the misstatement; and (5) loss caused by the reliance.

Answer 581

C. For the statutory period within which legal action may be brought against the independent CPA. Answer (C) is correct. Working papers should be retained by a CPA for a period sufficient to meet the needs of the CPA’s practice and to satisfy the relevant legal standards for records retention. State and federal statutes specify the period of time within which legal action must be initiated to hold a CPA liable, but the auditor may find it beneficial to retain working papers for a longer period. Under the Sarbanes-Oxley Act of 2002, auditors of public companies must retain their working papers for at least 7 years. Furthermore, it is a crime for auditors of public companies to fail to maintain all audit or review working papers for at least 5 years.

Answer 582

C. Both I and II. Answer (C) is correct. Prizes and awards made primarily in recognition of charitable, scientific, educational, etc., achievement are excluded from gross income only if the recipient was selected without any action on his or her part, is not required to render substantial future services as condition of receiving the prize or award, and assigns it to charity.

Answer 583

A. $50,000 Answer (A) is correct. A single federal income tax return may be filed by two or more includible corporations that are members of an affiliated group. Certain items are consolidated separately (e.g., capital gain or loss, charitable contributions). However no member of this group reported any separately consolidated items, therefore the consolidated net operating loss is $50,000 ($50,000 ParentCo – $60,000 SubOne – $40,000 SubTwo), the sum of all three taxable incomes (losses) for the year.

Answer 584

``` B. Shares listed on a national securities exchange. Answer (B) is correct. The following must file periodic reports under the 1934 act: (1) national securities exchanges, (2) an issuer with more than $10 million in total gross assets and a class of equity securities with (a) at least 2,000 shareholders or (b) 500 who are not accredited investors, (3) an issuer whose securities are listed on a national exchange, and (4) an issuer that has registered under the 1933 act. These issuers must file annual (10-K), quarterly (10-Q), and material events (8-K) reports and send similar reports to shareholders. ```

Answer 585

C. Corporation is planning to redeem all the shares of one of its current shareholders. Answer (C) is correct. For a corporation to justify its accumulation of earnings, there must be evidence that the future needs of the business will require such an accumulation and that the corporation has specific and feasible plans for the use of the accumulation [Reg. 1.537-1(b)]. A plan to redeem the shares of a shareholder does not qualify as a reasonable need of a business because the tax was imposed to prevent earnings accumulation. However, a stock redemption plan that involves a deceased shareholder whose stock is included in his gross estate can qualify as a reasonable need [Sec. 537(a)(2)].

Answer 586

A. 12 months. Answer (A) is correct. Under Sec. 1222, capital assets must be held for more than 1 year in order for the gain or loss on sale or exchange to be treated as long-term.

Answer 587

D. An implied-in-fact contract. Answer (D) is correct. Enforceable contracts may be formed without an express agreement of terms if the facts of the situation indicate (imply) an objective intent of both parties to contract. Objective intent means the apparent intent of an ordinary, reasonable person and not the actual (subjective) intent. When a client accepts the services of an accountant, an agreement to pay for them is implied. Because the facts indicate a contract was formed, it is an implied-in-fact contract.

Answer 588

C. No No Answer (C) is correct. Creditors and shareholders accept, not confirm plans of reorganization under Chapter 11. Confirmation is performed by the bankruptcy court. The holders of more than 50% of the creditors’ claims representing at least two-thirds of the dollar amount of the claims in a class must accept. A class of equity shareholders accepts the plan if holders of at least two-thirds in dollar amount of the interests approve the plan.

Answer 589

A. Goods are destroyed while risk of loss is with the buyer. Answer (A) is correct. A seller may be entitled to recover the full contract price for conforming goods lost or damaged after risk of their loss has passed to the buyer.

Answer 590

D. Consumers. Answer (D) is correct. A purchase money security interest (PMSI) is created when the security interest secures payment of the purchase price of the collateral. The appliances are consumer goods when they are purchased by consumers (for personal, family, or household purposes). A PMSI in consumer goods, other than those subject to certain statutes or treaties (e.g., a certificate-of-title statute), is perfected upon attachment.

Answer 591

C. Quantity of the goods. Answer (C) is correct. A writing is usually sufficient if it indicates that a contract for sale was made between the parties and is signed by the party sought to be bound or by his or her authorized agent or broker. A writing is also usually sufficient even if it omits or misstates a term, but it is not enforceable beyond the quantity shown. Thus, the quantity term must be included in a writing.

Answer 592

D. Void. Answer (D) is correct. Contracts that are of no effect and not recognized under law are void. Neither party has a legal obligation to the other based on the contract. The parties may go through with their performance, but the law provides no remedy for a breach.

Answer 593

A. Increases the amount of exempt property. Answer (A) is correct. Amounts in the federal bankruptcy statute are indexed to inflation. They are adjusted every three years. For example, for cases filed after April 1, 2016, the federal exemptions include $23,675 equity in a residence or burial plot; $3,775 equity in a motor vehicle; $12,625 in household furnishings, appliances, clothing, and the like (up to $600 per item); $1,000 worth of jewelry; $1,250 of other property plus the unused portion of the residential equity exemption up to $11,850; $2,375 worth of tools; alimony and child support payments, Social Security and disability benefits, and others. The federal law permits the debtor to choose between federal or state exemptions, but it also allows a state to limit its citizens to use of the state exemptions. The majority of states have done so.

Answer 594

A. Covers income earned before the taxpayer’s death but not collected until after death. Answer (A) is correct. IRD includes those amounts to which a decedent was entitled as gross income but that were not includible in computing taxable income on his final return. For cash-basis taxpayers, IRD is income earned by the decedent before death, but not paid until after death. A common example of IRD is salary earned by an employee prior to death but not paid by the employer until after death.

Answer 595

D. $10,000 Answer (D) is correct. The basis is increased by the ordinary income to $25,000. The $35,000 distribution is taken next and, since it exceeds the basis, there is a $10,000 gain. The capital loss is nondeductible because there is no basis left after the deduction from the distribution for Craig and it is carried over.

Answer 596

C. $1,000 short-term capital loss. Answer (C) is correct. When a nonbusiness bad debt becomes worthless, the loss that results is treated as a short-term capital loss. A nonbusiness bad debt is one that arises other than in connection with a trade or business of the taxpayer.

Answer 597

A. Yes No Yes Answer (A) is correct. Attachment occurs when the security interest is enforceable against the debtor with regard to the collateral, barring an express agreement postponing attachment. The security interest is enforceable against the debtor and third parties when (1) value has been given by the secured party, (2) the debtor has rights in the collateral or can transfer them to the secured party, and (3) the debtor has authenticated a security agreement describing the collateral or other evidence of authentication exists (e.g., the secured party has possession of the collateral). Filing is relevant to perfection, not attachment.

Answer 598

D. Conformity of goods to the sample. Answer (D) is correct. Any statement of fact or promise made by a seller to the buyer that (1) relates to the goods and (2) becomes part of the basis of the bargain is an express warranty that the goods conform to the statement or promise. Express warranties also may be created by description, model, or sample. A sample that is part of the basis of the bargain is an express warranty that the goods conform to the sample.

Answer 599

B. Partially deductible from gross income in arriving at adjusted gross income. Answer (B) is correct. To arrive at AGI, a self-employed person is allowed a deduction for the employer’s portion of the self-employment tax paid. This is an above-the-line deduction.

Answer 600

B. Risk of loss and title remain with Sand. Answer (B) is correct. In a sale on approval, title and risk of loss do not pass to the buyer until acceptance. Acceptance may be express or implied, i.e., by acts or inaction. A sale is on approval if the goods are delivered to the buyer with an understanding that (s)he may test them for the purpose of determining if (s)he wishes to purchase them and may be returned by the buyer without breaching the contract even though they conform to the contract. Normally, the goods are primarily for the use of the buyer. If the goods are delivered primarily for resale, the transaction is a sale or return, and risk of loss and title pass to the buyer in accordance with the particular delivery situation.

Answer 601

A. A repair completed prior to year end but not invoiced. Answer (A) is correct. The accrual-method taxpayer may claim an allowable deduction when all events have occurred that establish the fact of the liability (including that economic performance has occurred), and the amount can be determined with reasonable accuracy. Economic performance occurs as services are performed or as property is provided or used. A repair completed prior to year end but not paid is an accrued expense.

Answer 602

D. Provision for full payment of administration expenses. Answer (D) is correct. The debtor generally has the exclusive right to file a reorganization plan during the 120 days after the order of relief. To be effective, the plan must be confirmed by the bankruptcy court. The plan must provide for full payment of administration expenses.

Answer 603

C. Title to the mixers passes to Razor at the time they are delivered to the carrier, even if the goods are nonconforming. Answer (C) is correct. Unless otherwise explicitly agreed upon, title passes to the buyer when the seller completes performance of physical delivery of the goods. The shipping point was the seller’s loading dock. Thus, the contract is a shipment contract. The seller’s performance obligation is to deliver the goods to the place of shipment. If the buyer rejects, with or without justification, title reverts to the seller by operation of law.

Answer 604

D. $13,500 Answer (D) is correct. The basis of a partner’s interest in a partnership is adjusted each year for subsequent contributions of capital, partnership taxable income (loss), separately stated items, variations in the partner’s share of partnership liabilities, and distributions from the partnership to the partner. The operating loss and the decrease in allocable share of partnership liabilities will reduce George’s partnership interest, and the interest and dividend income will increase George’s partnership interest as follows: Beginning basis in partnership $32,500 Less: 50% of operating loss (15,000) 50% of interest and dividend income 4,000 Less: 50% of decrease in allocable share of partnership liabilities [50% × ($40,000 beginning liabilities – $24,000 ending liabilities)] (8,000) George’s partnership interest at year end $13,500

Answer 605

D. Yes No Answer (D) is correct. Compositions and assignments are alternatives to bankruptcy. However, only a composition will ordinarily result in a debtor’s release. An assignment for the benefit of creditors allows for the discharge of debts only to the extent that actual payments are made to creditors by the trustee. It does not act as a full release of the debt. A composition is a contractual agreement in which creditors agree to accept less than the total amount of debt owed in full satisfaction of the debt.

Answer 606

D. I only. Answer (D) is correct. A guaranteed payment is a payment to a partner that is determined without regard to the partnership income. These payments can be in addition to regular profit shares and are deductible by the partnership.

Answer 607

D. $9,000 Answer (D) is correct. Administration expenses (and debts of a decedent) are deductible on the estate tax return, and some may also qualify as deductions for income tax purposes on the estate’s income tax return. Sec 642(g), however, disallows a double deduction and requires a waiver of the right to deduct them on Form 706 in order to claim them on Form 1041. Therefore, the attorney’s fees for administration of the estate cannot be deducted on the estate return since it is not stated that a waiver was filed. The income earned by the decedent but taxable to the estate is calculated as follows: Unpaid salary $6,000 Gain on sale of coins 1,000 Dividend income 600 Interest income 2,000 Less: Exemption deduction (600) Estate’s taxable income $9,000

Answer 608

C. Real estate that will be passed to John when his parents die. Answer (C) is correct. A decedent’s gross estate includes the FMV of all property, real or personal, tangible or intangible, wherever situated, to the extent the decedent owned a beneficial interest at the time of death. Special tax-avoidance rules are established for U.S. citizens or residents who surrender their U.S. citizenship or long-term U.S. residency. Included in the GE are items such as cash, personal residence and effects, securities, other investments (e.g., real estate, collector items), other personal assets such as notes and claims (e.g., dividends declared prior to death if the record date had passed), and business interests (e.g., in a sole proprietorship, partnership interest). The GE includes the value of the surviving spouse’s interest in property as dower or curtesy. John does not own the real estate at his death.

Answer 609

A. The fair market value of the property received. Answer (A) is correct. The receipt of property for services provided is a taxable transaction. Accordingly, the fair market value of the property must be included in gross income as compensation, and the basis of the property will be its fair market value.

Answer 610

B. A buyer of goods in the ordinary course of business. Answer (B) is correct. A buyer in the ordinary course of business, other than a buyer of farm products from a farmer, takes the goods free of any security interest created by the seller. This right is extended to the buyer regardless of whether (1) the security interest is perfected or (2) the buyer knows of its existence. A buyer of goods in the ordinary course of business buys (1) in the ordinary course, (2) from a person in the business of selling goods of that kind, (3) in good faith, and (4) without knowledge that the sale violates a third party’s rights.

Answer 611

D. $180 Answer (D) is correct. For original issue discount bonds issued after July 1, 1982, Sec. 1272(a) requires the inclusion in gross income of an amount equal to the sum of the daily portions of the original issue discount for each day during the taxable year the instrument is held. The daily portions are determined under Sec. 1272(a)(3) as the ratable portion of the excess of the product of the bond’s yield to maturity and its adjusted issue price over the interest payable for the bond year. The adjusted issue price is the original issue price adjusted for the original issue discount previously taken into income (which is zero in the current year). Yield times adjusted issue price ($12,000 × 14%) $ 1,680 Less interest payable ($15,000 × 10%) (1,500) Ratable portion (entire year) $ 180

Answer 612

B. No No Answer (B) is correct. State homestead exemption acts ordinarily exempt a debtor’s equity in his or her home from post-judgment collections by a creditor. However, these acts generally do not apply to a holder of a valid mortgage against the home or a valid IRS tax lien.

Answer 613

D. $30,000 Answer (D) is correct. If a shareholder assumes a liability of the liquidating corporation or receives property that is subject to a liability, then the liability reduces the amount realized by the shareholder, thus reducing the shareholder’s gain or increasing the shareholder’s loss. Nevertheless, the shareholder’s basis for the property is the property’s fair market value, in this case $30,000.

Answer 614

C. Filing of a financing statement in the office where a mortgage on the real estate would be recorded. Answer (C) is correct. A fixture filing is usually required to obtain priority over conflicting interests in fixtures. A fixture filing is not necessary for certain readily removable items. In addition to meeting the basic requirements for any financing statement, a fixture filing must (1) indicate that it covers fixtures and that it is to be filed in the real property records, (2) sufficiently describe the real property, and (3) provide the name of the record owner if the debtor has no recorded interest in the real property.

Answer 615

``` A. The plaintiff acquired the securities in question. Answer (A) is correct. Section 12(a)(1) of the Securities Act of 1933 permits a civil action by an acquirer of securities if (1) the required registration was not made, (2) a registered security was sold but a prospectus was not delivered, (3) a security was sold using a prospectus that was not current, or (4) an offer to sell was made before a required registration. Section 11 allows an acquirer to sue for misstatements or omissions of material facts in the registration statement. ```

Answer 616

D. Green failed to get the agency agreement in writing. Answer (D) is correct. Formalities, such as a writing, are not required to form an agency relationship. But some states require an agency to be in writing if the contract involves a sale of land. Also, many states apply the equal dignity rule. In these states, an agency must be in writing if the agent is to enter into a contract required to be in writing. Accordingly, the agency agreement most likely needs to be in writing because an agreement to transfer an interest in land is required to be in writing.

Answer 617

B. The income distribution deduction is the greater of distributable net income or net accounting income. Answer (B) is correct. The deduction for distributions allocates taxable income of a trust or an estate (gross of distributions) between the fiduciary and its beneficiaries. The deduction is the lesser of the amount of the distributions (required) or distributable net income (DNI). DNI, generally, is current net accounting income of the fiduciary reduced by any amounts allocated to principal.

Answer 618

D. The guaranty must be in writing. Answer (D) is correct. A person who guarantees payment without qualification must pay upon default. A guarantor of collection guarantees the debt on condition that the creditor first use ordinary legal means to collect. Surety and guaranty arrangements that are secondary promises are within the statute of frauds and must be in writing.

Answer 619

D. Yes No Answer (D) is correct. Since Harold is a skip person to Grandma and Grandpa, the transfer is subject to the generation-skipping transfer tax (GSTT). However, each individual is allowed a $5.49 million exemption that (s)he may allocate to generation-skipping transfer property. Gift-splitting rules apply, so Grandma and Grandpa may effectively transfer $10.98 million to Harold without incurring a current GSTT liability. Even if Grandma and Grandpa also apply gift-splitting rules to their gift tax exemptions, their combined yearly exemption will amount to only $28,000. Therefore, a gift tax liability will exist as a result of the transfer.

Answer 620

B. If the security interest secured an indebtedness, the debtor has an absolute responsibility to pay any deficiency remaining following disposition. Answer (B) is correct. The secured party may dispose of collateral at a public or private proceeding if the disposition is commercially reasonable. Proceeds are applied to reasonable sale expenses, the secured debt, and subordinate secured debt. If proceeds are insufficient, the creditor may seek a deficiency judgment against a debtor for the balance owed.

Answer 621

C. $20,000 Answer (C) is correct. In the case of a bond, the amount of amortizable bond premium for the taxable year shall be allowed as a reduction of interest income. The amount is amortized over the life of the bond. Thus, Sanders must report $20,000 [($1,200,000 – $1,000,000) ÷ 10].

Answer 622

A. The time for shipment is within a reasonable time. Answer (A) is correct. The time for shipment or delivery is a reasonable time if the parties have not specified a time. Also, the UCC provides for a single shipment of the goods if the contract does not specify otherwise. These provisions reflect the UCC’s policy to find a valid contract if the parties so intended and a reasonable basis for a remedy exists.

Answer 623

D. May be disclaimed by a seller’s oral statement that mentions merchantability. Answer (D) is correct. Unless the circumstances indicate otherwise, all implied warranties are excluded by the expressions “as is,” “with all faults,” or other language that (1) calls the buyer’s attention to the exclusion of warranties and (2) makes plain that no warranty is implied. A disclaimer of the implied warranty of merchantability must mention merchantability and be conspicuous if in writing. Thus, a disclaimer of the implied warranty of merchantability may be oral.

Answer 624

A. If Royal can show that State was aware of the fraudulent representations. Answer (A) is correct. A debtor’s fraudulent misrepresentation of his or her financial condition at the time of contract is a material fact that the creditor has a duty to disclose to the surety. If State knew of Green’s fraud and did not inform Royal, the nondisclosure is a form of fraud against the surety by the creditor. If State had been unaware of the fraud, Royal would be required to repay the loan.

Answer 625

B. A lien arising by operation of law subsequent to the perfection of any security interest will be subordinate to the earlier perfected security interest because of the first-in-time, first-in-priority rule. Answer (B) is correct. A person who in the ordinary course of business furnishes services or materials with respect to goods may receive a common law or statutory lien to secure payment if the goods are in the person’s possession. The UCC describes this lien as a possessory lien. Such a person has priority over a security interest in the goods (whether or not perfected) unless the lien is statutory and the statute expressly provides otherwise.

Answer 626

D. Yes No Answer (D) is correct. The filing of a valid petition in bankruptcy automatically postpones certain actions and proceedings that involve the debtor or his or her property. This automatic stay operates to give the debtor protection from creditors. Actions and proceedings not covered by the automatic stay include criminal prosecution of the debtor, collection of child support, and collection of alimony.

Answer 627

C. Hold conforming goods and give the buyer whatever notification is reasonably necessary to enable the buyer to take delivery. Answer (C) is correct. The seller must transfer and deliver the goods, and the buyer must accept and pay the price in accordance with the contract. If the goods or the seller’s tender of delivery fail to conform to the contract in any respect, the buyer may reject the goods or the tender. In noncarrier situations, the seller must put and hold conforming goods at the buyer’s disposition for a time sufficient for the buyer to take possession. The tender must be at a reasonable hour, and the seller must give notice to enable the buyer to take possession.

Answer 628

C. The incapacity of the surety. Answer (C) is correct. The surety may assert a defense personal to the surety to limit his or her liability to a creditor. The surety may use the defense of incapacity of the surety to avoid liability to the principal debtor’s creditor.

Answer 629

A. The risk of accidental loss is on the debtor to the extent of any deficiency in any effective insurance coverage. Answer (A) is correct. In most cases, a secured party in possession of the collateral must use reasonable care in its custody and preservation. However, Article 9 states that “the risk of accidental loss or damage is on the debtor to the extent of a deficiency in any effective insurance coverage.”

Answer 630

B. Reportable by Ryan as self-employment income subject to Social Security self-employment tax. Answer (B) is correct. A person is not an employee of a corporation when acting as a director. However, fees for acting as a director are treated as earnings from self-employment, subject to both income tax and Social Security self-employment tax.

Answer 631

B. The distribution is not essentially equivalent to a dividend, which is determined at the shareholder level rather than at the corporate level. Answer (B) is correct. The determination of whether a distribution is not essentially equivalent to a dividend is made at the corporate level. The distribution must be the result of a bona fide contraction of the corporation’s business. A distribution satisfies the “not essentially equivalent to a dividend” standard if it meets the safe harbor rule under Sec. 302(e)(2).

Answer 632

D. $1,300 Answer (D) is correct. When a shareholder has the option of receiving either stock rights or cash, the entire amount of the distribution received by the shareholder will be treated as a taxable dividend under Sec. 305(b)(1). Section 316(a) defines a dividend as a distribution made from current and accumulated earnings and profits. The amount by which the distribution exceeds current and accumulated earnings and profits shall be treated as a return of capital and will reduce the shareholder’s basis in the stock. XYZ’s total distribution is $150,000 (10,000 shares × $15). The amount considered a dividend would be $13,000 ($8,000 + $5,000), and the remaining $137,000 would be a return of capital. The total amount taxable to Ms. Y would be $1,300 ($13,000 × 10%). Accordingly, Ms. Y would reduce the basis in her 1,000 shares of stock by $13,700 (1,000 shares × $15 per share – $1,300 dividend). Any excess of the $13,700 over Ms. Y’s basis is a capital gain.

Answer 633

B. Legal services for drafting the charter; cost of organizational meetings. Answer (B) is correct. Organizational expenditures include those that are incidental to the creation of a corporation, chargeable to a capital account, and amortizable over a limited life if they are expended incident to the creation of a corporation with such a life. Examples of organizational expenditures include expenses to obtain the corporate charter, fees paid to the state of incorporation, and expenses of temporary directors. Organization costs must be distinguished from start-up and investigation costs.

Answer 634

C. $15,000 Answer (C) is correct. Generally, an active participant in rental real estate may deduct up to $25,000 per year in rental real estate losses. For taxpayers whose MAGI exceeds $100,000, the amount of the active real estate loss deduction is reduced for 50% of the excess of MAGI over $100,000. For the Jacksons, this means the currently deductible portion of real estate losses is $15,000 {$25,000 – [($120,000 MAGI – $100,000 base amount) × 50% limitation]}.

Answer 635

D. $9,000 Answer (D) is correct. Tracy’s basis at year end in the S corporation stock is $9,000 ($13,000 beginning balance + $4,000 contribution – $7,000 share of the net operating loss – $1,000 distribution).

Answer 636

A. $3,000 Answer (A) is correct. A partner is allowed to deduct the pro rata share of the partnership’s ordinary loss only to the extent of his or her basis in the partnership. Partner A’s pro rata share of the $10,000 loss is $5,000 (50%) and A’s basis is $3,000 ($5,000 – $2,000). Thus, A’s deductible loss is limited to A’s basis of $3,000.

Answer 637

A. Glaze will win because Glaze substantially performed and Parc prevented complete performance. Answer (A) is correct. Strict performance of each contract term is not always required. Glaze, in good faith, substantially performed the contract and did not willfully breach it. Parc prevented completion. Glaze is entitled to recover the contract price minus the cost to correct or complete.

Answer 638

A. Punitive damages. Answer (A) is correct. If the CPAs have merely been negligent, they will not be liable for punitive damages. Punitive damages are awarded only when the circumstances are extreme or aggravated.

Answer 639

D. The highest corporate income tax rate. Answer (D) is correct. The tax rate for the built-in gains tax is defined by statute to be the highest corporate income tax rate.

Answer 640

D. $2,000 Answer (D) is correct. Joint filers with modified AGI below $190,000 may contribute up to $2,000 per beneficiary (child) per year. The amount a taxpayer is able to contribute to a CESA is limited if modified AGI exceeds certain threshold amounts. In 2017, the limit is phased out for joint filers with modified AGI at or greater than $190,000 and less than $220,000, and for single filers with modified AGI at or greater than $95,000 and less than $110,000.

Answer 641

C. The repair of the leak should be deducted, while the overhaul should be capitalized. Answer (C) is correct. Repairs and maintenance that do not materially add to the value of property or prolong its life may be deducted. All other repair and improvement expenditures should be capitalized and depreciated (Reg. 1.162-4). Expenditures to repair damage and put the property back in the same condition as it was before the damage are generally deductible as repairs, provided that they do not materially add to the value of the property or prolong its life. The expenditure for fixing the leak would be deductible. However, the cost of a major overhaul that changes the operation of a vehicle, such as increasing its speed and saving fuel costs, would be considered to add materially to the value of the property. Therefore, the overhaul of the power source in the spaceship may not be deducted. It must be capitalized and depreciated.

Answer 642

B. The sale or offer to sell the securities is made by a person other than an issuer, underwriter, or dealer. Answer (B) is correct. Under Section 4(1) of the 1933 act, an initial offering of securities is exempt from registration if the sale is made by an ordinary investor, that is, a person who is not an issuer, an underwriter, or a dealer.

Answer 643

D. The contract must involve the sale of goods for a price of $500 or more. Answer (D) is correct. Article 2 of the UCC applies to sales of goods. An oral contract for the sale of goods for $500 or more is unenforceable without a writing. However, a dollar amount is not required to bring a sale of goods within Article 2.

Answer 644

D. If the parcel is not rezoned by July 31, Year 2, and Alpha refuses to purchase it, Alpha would not be in breach of contract. Answer (D) is correct. An express condition precedent must occur to trigger an absolute contractual duty to perform. Without a present duty, no breach can occur.

Answer 645

A. The payments are not deductible because they are not ordinary. Answer (A) is correct. Section 162(a) allows a deduction for the ordinary and necessary expenses paid or incurred in carrying on a trade or business. Courts have held that ordinary does not mean habitual or normal in terms of frequency, rather that it is the common and accepted means of dealing with the situation. Courts have also held that the payment of debts of others without legal obligation or a definite business requirement is not considered ordinary and is not deductible.

Answer 646

B. A corporate office building for a vacant lot. Answer (B) is correct. Property qualifying for a like-kind treatment under IRC Sec. 1031 depends on the property’s nature or character, but not necessarily in grade or quality. Real property is of like kind to other real property, except foreign property. Thus, the corporate office building and vacant lot qualify as a nontaxable exchange even though they are not used for the same purpose.

Answer 647

D. Insure Frost’s property against fire loss. Answer (D) is correct. An agent has express and implied actual authority that is conveyed by manifestations of the principal to the agent. Authority is implied to do what is reasonably necessary to accomplish the expressly authorized action. Obtaining insurance against fire loss would be implied.

Answer 648

D. $0 Answer (D) is correct. For employer-owned policies issued prior to August 17, 2006, proceeds of a life insurance policy paid by reason of death of the insured are excluded by the beneficiary. Since no part of the $10,000 represents interest on proceeds retained by the insurance company, no part of it is reported as gross income.

Answer 649

C. $35,000 Answer (C) is correct. If the shareholder’s pro rata share of passed-through losses exceeds his or her amount at risk at the close of his or her tax year, the excess is not deductible. The shareholder’s at-risk amount equals the adjusted basis of property contributed to the corporation plus amounts lent to the corporation to the extent the shareholder has personal liability for repayment. Thus, the at-risk amount is $35,000 ($25,000 + $13,000 – $3,000 repayment of the loan). The excess $5,000 ($40,000 – $35,000) is suspended and carried forward indefinitely.

Answer 650

C. $3,680 Answer (C) is correct. The deduction for MACRS depreciation is calculated using the 200%-declining-balance method for 5-year property. The basis is reduced by $510,000 (the Sec. 179 deduction for 2017). The half-year convention allows one-half year depreciation in the year of acquisition and one-half year depreciation in the year of disposition. Therefore, Mainstream’s 2018 MACRS depreciation is $3,680. Cost of equipment $533,000 Less Sec. 179 deduction (510,000) Depreciable basis $ 23,000 Times MACRS percentage (5-year property, year 2) × .32 $ 7,360 Times one-half (half-year convention) × .50 2018 depreciation $ 3,680 The 2018 depreciation amount can also be determined by using the MACRS tables.

Answer 651

D. The corporation’s capital losses can be claimed on the tax returns of the shareholders. Answer (D) is correct. Capital losses of the corporation will flow-through to the shareholders, who may use them to offset any of their own capital gains.