Simulated Exam 1

Question 1

Under Circular 230, for tax returns:

Answer 1

A practitioner must return all client records at the request of the client.

Question 2

Bob files an extension of his Year 1 income tax return on March 23, Year 2. His withholding for Year 1 is $3,200. He estimates that he will owe an additional $1,000 and includes a check for $1,000 with the extension. Bob files his Year 1 income tax return on May 18, Year 2. The total tax indicated on the return is $5,100. What amount of the tax is subject to the Failure-to-Pay Penalty?

Answer 2

$900

The total tax on the return is $5,100. Bob paid in $4,200 by the original due date of the return ($3,200 withholding plus $1,000 paid in with the extension). The additional $900 ($5,100 − $4,200) is subject to the Failure-to-Pay Penalty because it was paid after the original due date of the return. The exception does not apply because the amount paid in by the original due date was less than 90% of the total tax. ($4,200 / $5,100 = 82%).

Question 3

Nia Johnson invested in a certificate of deposit (CD) at the local bank. The total interest to be earned on the CD amounted to $1,000. However, Nia withdrew the money early and only earned $800. The bank reported $1,000 of interest and a $200 early withdrawal penalty to Nia for tax reporting. How will Nia report the interest earned and the early withdrawal penalty?

Answer 3

$1,000 as interest income and a $200 adjustment to AGI for the early withdrawal penalty

The $1,000 interest income is reported in gross income and a $200 adjustment is taken for the forfeited interest due to withdrawing the money early from the investment.

Question 4

The U.S. Tax Court is:

Answer 4

A specialized trial court that hears only Federal tax cases. The trials are by judge and not by a jury.

It is a court where cases are heard initially. The decisions may be appealed. The U.S. Tax Court is a specialized trial court that hears only Federal tax cases, but does not require the taxpayer to pay the disputed tax before the case is heard. It is the U.S. District Courts that have this requirement.

Question 5

For income to be taxable on a tax return, it must be:

Answer 5

Both realized and recognized

For income to be taxable on a tax return, it must be both realized (i.e., it must involve an accrual or receipt of cash, property, or services, or a change in the form of an investment, such as a sale or an exchange) and recognized (i.e., the tax law requires that the income be reported as taxable in the tax return).

Question 6

Which of the following professional bodies has the authority to revoke a CPA’s license to practice public accounting?

Answer 6

State board of accountancy.

The state board of accountancy is the only body listed that can grant a CPA license and the only body that may revoke such a license.

Question 7

Which of the following requirements is not necessary in order to have a security interest attach?

Answer 7

There must be a proper filing.

A security interest attaches on the last to occur of the following; all three elements are required: (i) the parties must agree to create the security interest evidenced by either the creditor’s taking possession of the collateral or a written security agreement that describes the collateral and is signed by the debtor; (ii) the creditor must give value in exchange for the security interest; and the debtor must have rights in the collateral. Filing is not necessary; it is a possible method of perfecting but is not required for attachment.

Question 8

Which of the following conditions will prevent a corporation from qualifying as an S Corporation?

Answer 8

The corporation has both common and preferred stock.

An S corporation can only have one class of stock outstanding. Common and preferred stock would constitute two classes of stock.

Question 9

Which of the following statements is correct regarding modification of a sales contract under the Uniform Commercial Code?

Answer 9

The modification must satisfy the Statute of Frauds if the contract as modified is within its provisions.

If a sales contract has been modified, it is the contract as it has been modified that determines whether a writing is required under the Statute of Frauds.

The parol evidence rule is a rule that provides that if parties have entered into a fully integrated written contract (i.e., one that appears to embody the entire deal between the parties), neither party may seek to vary the terms of the written contract by introducing evidence of prior or contemporaneous oral terms or prior written terms. The rule does not apply to all sales contracts (only fully integrated written ones). Moreover, under the parol evidence rule, oral or written modifications made after the contract has been entered into are admissible.

Question 10

Shontelle and Teodoro are equal partners in the S&T Partnership. On January 1 of the current year, each partner’s adjusted basis in S&T was $50,000 (including each partner’s $15,000 share of partnership liabilities). During the current year, S&T sustained an operating loss of $25,000 and earned $5,000 of interest and dividend income from investments. The partnership’s liabilities were reduced to $20,000 as of December 31. Assuming the liabilities are shared equally by the partners, the basis of each partner’s interest in S&T on January 1 of the next year is:

Answer 10

$35,000

$50,000 + 2500 - 12500 -5000

Question 11

Which of the following statements is false?

Answer 11

If an individual files a tax return with a zero tax liability in the prior year, the individual must pay in at least 90 percent of the current year’s tax to avoid underpayment penalties, as the ability to use the 100 percent of prior year tax is lost.

The statement is false. If an individual files a tax return with a zero tax liability in the prior year, the individual is allowed to use the 100 percent of prior year’s tax rule (as the “lesser” of 90 percent of the current year’s tax or 100 percent of the prior year’s tax) to avoid underpayment penalties.

Question 12

Which of the following items should be included on Schedule M-1, Reconciliation of Income (Loss) per Books With Income per Return, of Form 1120, U.S. Corporation Income Tax Return, to reconcile book income to taxable income?

Answer 12

Premiums paid on key-person life insurance policy.

Schedule M-1 reports the reconciliation of income (loss) per books to income (loss) per the tax return. (Note: It reports both permanent and temporary differences that are discussed in the Financial textbook for deferred taxes.) Items that are included on this schedule are those that are (1) reported as income for book purposes but not for tax purposes; (2) reported as an expense for book purposes but not for tax purposes; (3) reported as taxable income for tax purposes but not as income for book purposes; and (4) reported as deductible for tax purposes but not as an expense for book purposes. The only option above that falls into one of these four categories is option b. Premiums paid on a key-person life insurance policy are proper GAAP expenses for book purposes, but they are not allowable deductions for tax purposes.

Question 13

With respect to the penalties for failure to file information returns of tax preparers, which of the following provisions is correct for any person who employed a tax return preparer during the return period?

Answer 13

The penalty for failure to file information returns does not apply to the extent that the failure is due to reasonable cause and not due to willful neglect.

Question 14

A shareholder’s basis in the stock of an S corporation is increased by the shareholder’s pro rata share of income from:

Answer 14

YES. Tax-exempt
YES. Interest Taxable
interest.
Both tax-exempt and taxable interest income increase a shareholder’s basis in S corporation stock.

Question 15

In general, which of the following debts will be discharged under the voluntary liquidation provisions of the Bankruptcy Code?

I.
A debt arising before the filing of the bankruptcy petition due to the debtor’s negligence.

II.
Income taxes due from filing a fraudulent return 7 years prior to filing the bankruptcy petition.

Answer 15

I only.

Bankruptcy discharges most of pre-petition debts. Nondischargeable debts include certain taxes, debts incurred by fraud, unscheduled debts, debts arising from crimes, fines and penalties, alimony/child support debts, and student loans.

Question 16

Tim and Rick cannot come to an agreement as to the exact amount Rick owes Tim. They decide to and do form a new agreement that, on fulfillment, will discharge the prior obligation. Rick fulfills the new terms. This is called:

Answer 16

An accord and satisfaction.

Where both parties agree to new terms that vary from the original contract such that fulfilling the terms of the new agreement will discharge the old agreement completely, it is an accord. When the agreement is fulfilled, the fulfillment is called a satisfaction.

Question 17

Robin, a C corporation, had revenues of $200,000 and operating expenses of $75,000. Robin also received a $20,000 dividend from a domestic corporation and is entitled to a $10,000 dividend-received deduction. Robin donated $15,000 to a qualified charitable organization in the current year. What is Robin’s charitable contributions deduction?

Answer 17

$14,500
Corporations making contributions to recognized charitable organizations are allowed a maximum deduction of 10% of their taxable income. Taxable income is calculated before the deduction of: (1) any charitable contribution; (2) the dividends-received deduction; (3) any capital loss carryback.
Revenues $200,000
Dividends Received 20,000
Less: Operating exp (75,000)
Income bef dds received deduction 145,000
× 10%
charitable 14,500

Question 18

On January 2 of the current year, Fran acquires a business from Chuck. Among the assets purchased are the following intangibles: patent with a 10-year remaining life, a covenant not-to-compete for 5 years, and goodwill.

Sixty thousand dollars was paid for the patent and $30,000 for the covenant. The amount of the excess of the purchase price over the identifiable assets was $45,000. What is the amount of the amortization deduction for the year?

Answer 18

$9,000
All three intangible assets are Section 197 purchased intangibles because they were acquired together with all of the assets of an existing business. Section 197 purchased intangibles are amortized over 180 months, beginning with the month purchased, regardless of the useful life of the intangible asset.
60,000 + 30,000 + 45,000 /180 = 750 x 12 = $9000

Question 19

Which of the following is not considered a primary authoritative source when conducting tax research?

Answer 19

IRS publications
IRS publications are not considered a primary authoritative source when one is conducting tax research

Question 20

Which of the following is not a general requirement for a taxpayer to avoid a tax penalty?

Answer 20

The error did not exceed $1,000.
In addition to various defenses, a taxpayer can generally avoid any penalty by showing that the taxpayer acted in good faith, had reasonable cause to support the tax return position, and did not have willful neglect. There is no requirement that the error not exceed $1,000.

Question 21

After an audit of Jan Martin’s individual income tax return, Jan and the IRS agent were unable to agree on the agent’s assessment of additional taxes owed. Jan would like to challenge the agent’s findings at an IRS appeals conference and hire Mary Jones, a respected local CPA to represent her at the conference. Jan would like to pay Mary’s fee based on the outcome of the IRS appeals conference.

Which of the following statements is correct regarding contingent fees of a CPA?

Answer 21

CPA’s may charge a contingent fee to represent a client in certain situations before the IRS.

A contingent fee is where the fee of the CPA is dependent on the outcome of a certain event. Under IRS Circular 230, a CPA may charge a contingent fee where the outcome is determined by a third party. Specifically, a contingent fee may be charged in the following situations before the IRS:

An IRS examination or audit;
Claim solely for a refund of interest and/or penalties; or
A judicial proceeding arising under the Internal Revenue Code.
Contingent fees are permitted for consultation services and certain tax matters.

A CPA may not charge a contingent fee in which the CPA performed:

An audit or review of financial statements,
A compilation,
An examination of prospective financial statements for a client; or
Preparation of an original or amended tax return.

Question 22

Harp entered into a contract with Rex on behalf of Gold. By doing so, Harp acted outside the scope of his authority as Gold’s agent. Gold may be held liable on the contract if:

Answer 22

Gold retains the benefits of the contract, knowing all material facts of the transaction.

The principal will be bound by the agent’s acts if the agent acted with actual authority or apparent authority, or if the principal ratifies the transaction. The principal can impliedly ratify an unauthorized contract made by an agent on behalf of the principal by accepting the benefits of the contract after learning all material facts of the transaction.

A principal cannot ratify a contract after the third party withdraws.

Question 23

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

Answer 23

S corporations.

Individuals, C corporations, estates, and trusts are all taxable entities entitled to the net operating loss (NOL) deduction.

Question 24

Which of the following statements is the best definition of real property?

Answer 24

Real property is land and everything permanently attached to it.

Question 25

Following an audit of Mary Anderson’s individual income tax return, the IRS revenue agent determined additional taxes were due. Mary disagreed. The IRS revenue agent and Mary were not able to reach an agreement at the revenue agent level.

Mary received a copy of the revenue agent’s report and would like to challenge the findings.

Which of the following statements is incorrect regarding the appeals process?

Answer 25

A taxpayer has 60 days to file an appeal in the federal court system upon receipt of a notice of deficiency.

A taxpayer has 90 days to file a petition in the federal court system. The taxpayer cannot take a case to court until the IRS sends a notice of deficiency.

If the taxpayer and the revenue agent cannot reach an agreement on the disputed tax, the taxpayer has 30 days to request an administrative appeal with an appeals officer.

If there is no agreement after the appeals conference, the taxpayer is entitled to take the case through the federal court system. The taxpayer is not required, however, to have an appeals conference before going to court.

Question 26

Jay received a court award for damages to his personal reputation by the National Gossip. He also received punitive damages. Which of the following statements is true?

Answer 26

All of the damages are taxable.

Personal reputation awards and punitive damage awards are both included in taxable income.

Question 27

Which of the following can be claimed as an adjustment to arrive at adjusted gross income?

Answer 27

Educator expenses.

Question 28

Tax return preparers can be subject to penalties under the Internal Revenue Code for failure to do any of the following, except:

Answer 28

Disclose a conflict of interest.

With respect to a tax return preparer’s failure to disclose a conflict of interest, the Internal Revenue Code does not set forth any penalty.

With respect to a tax return preparer’s failure to sign a tax return as a preparer, the Internal Revenue Code sets forth a penalty of $60 for each failure [maximum $31,500 per calendar year (2024)].

With respect to a tax return preparer’s failure to keep a record of returns prepared, the Internal Revenue Code sets forth a penalty of $60 for each failure [maximum $31,500 per calendar year (2024)].

With respect to a tax return preparer’s failure to provide a client with a copy of the tax return, the Internal Revenue Code sets forth a penalty of $60 for each failure [maximum $31,500 per calendar year (2024)].

Question 29

Jagdon Corp.’s book income was $150,000 for the current year, including interest income from municipal bonds of $5,000 and excess capital losses over capital gains of $10,000. Federal income tax expense of $50,000 was also included in Jagdon’s books. What amount represents Jagdon’s taxable income for the current year?

Answer 29

$205,000

Taxable income is accounting (book) income adjusted for other items. In this question, the book income is $150,000. That book income includes $50,000 federal income tax expense, and that amount should be added back for taxable income. The $5,000 interest income from municipal bonds should be subtracted because it is not taxable, and the $10,000 excess capital losses over capital gains should be added back because the excess is not a deduction in the current year. The net result is $205,000.

Question 30

Tom, age 66, paid the medical expenses of his mother-in-law, age 86. Although Tom provided more than half the support, his mother-in-law does not qualify as his dependent because her gross income was too high. This expenditure is:

Answer 30

A deduction from adjusted gross income, subject to an AGI floor.

Medical expenses are itemized deductions (from AGI), subject to an AGI floor. Tom can deduct the medical expenses paid on behalf of his mother-in-law even though she does not qualify as his dependent because her gross income is too high. The definition of “dependent” for purposes of qualifying medical expenses does not consider the gross income limit.

Medical expenses are subject to an AGI floor.

Question 31

om, age 66, paid the medical expenses of his mother-in-law, age 86. Although Tom provided more than half the support, his mother-in-law does not qualify as his dependent because her gross income was too high. This expenditure is:

Answer 31

A deduction from adjusted gross income, subject to an AGI floor.

Medical expenses are itemized deductions (from AGI), subject to an AGI floor. Tom can deduct the medical expenses paid on behalf of his mother-in-law even though she does not qualify as his dependent because her gross income is too high. The definition of “dependent” for purposes of qualifying medical expenses does not consider the gross income limit.

Medical expenses are subject to an AGI floor. 7.5%

Question 32

A CPA prepared a tax return that involved a tax shelter transaction that was disclosed on the return. In which of the following situations would a tax return preparer penalty not be applicable?

Answer 32

It is reasonable to believe that the position would more likely than not be upheld.

With regards to a tax shelter, a penalty for understatement of taxpayer liability could apply to a CPA unless it is reasonable to believe that the position would more likely than not be upheld on its merits. This is more stringent than a reasonable basis for the position, a reasonable possibility of success for the position, and substantial authority for the position.

Question 33

Dunn received 100 shares of stock as a gift from Dunn’s grandparent. The stock cost Dunn’s grandparent $32,000 and it was worth $27,000 at the time of the transfer to Dunn. Dunn sold the stock for $29,000. What amount of gain or loss should Dunn report from the sale of the stock?

Answer 33

$0
To determine the amount of gain or loss that should be reported on the sale of gifted property, a determination must be made as to whether the property is sold at a gain or a loss. The stock in this question has a $27,000 value which is less than its $32,000 cost. The basis for gain is the adjusted basis of the donor on the date of gift, or $32,000. However, the stock is sold for $29,000, which is not at a gain. The basis for loss is the lower of the adjusted basis or the fair market value on the date of gift, or $27,000. However, the stock is not sold at a loss. In this situation, neither gain nor loss is recognized, and the “middle” basis of the subsequent sales price is used.

Question 34

Which represents the correct order of deductions in the individual income tax formula?

Answer 34

Adjustments, Standard deduction or Itemized deductions, QBI deduction

The individual income tax formula is:

Gross income – Adjustments = Adjusted gross income – Standard deduction or Itemized deductions = Taxable income before QBI Deduction – QBI deduction = Taxable Income

Question 35

In March of the current year, Star Corporation, a calendar year corporation, purchased and placed into service a building costing $400,000 and land costing $150,000. Later that year, on November 15, the corporation purchased and placed into service office equipment costing $80,000. No other equipment or real estate was placed into service during the year. Under the MACRS depreciation system, what convention must Star Corporation use?

Answer 35

Mid-quarter convention for the equipment and mid-month convention for the building

Question 36

Which of the following claims is (are) generally covered under workers’ compensation statutes?

Answer 36

YES. Occupational disease
YES. Employment aggravated
preexisting disease

Workers’ compensation covers both occupational diseases and aggravations of preexisting diseases.

Workers’ compensation is an accident insurance program paid by your employer which may provide you with medical, rehabilitation and income benefits if you are injured on the job.

Question 37

Which of the following cannot be amortized for tax purposes?

Answer 37

Stock issuance costs.
All costs of issuing stock are not eligible to be deducted or amortized as an organizational expenditure or start-up cost.

All organizational meeting costs are eligible to be deducted or amortized as an organizational expenditure.

All incorporation costs are eligible to be deducted or amortized as an organizational expenditure.

All temporary director fees are eligible to be deducted or amortized as a start-up cost.

Question 38

Greed Co. telephoned Stieb Co. and ordered 30 tables at $100 each. Greed agreed to pay 15% immediately and the balance within thirty days after receipt of the entire shipment. Greed forwarded a check for $450 and Stieb shipped 15 tables the next day, intending to ship the balance by the end of the week. Greed decided that the contract was a bad bargain and repudiated it, asserting the statute of frauds. Stieb sued Greed. Which of the following will allow Stieb to enforce the contract in its entirety despite the statute of frauds?

Answer 38

Greed admitted in court that it made the contract in question.

Greed admitted in court that it made the contract in question.

Specially manufactured goods

Written confirmation

Admitted in court

Performed (enforceable to the extent of the performance of the party sought to be held liable)

Question 39

Jermaine and Keesha are married, file a joint tax return, have modified AGI of $50,000, and have two children, Devona and Arethia. Devona is beginning her first year at State University this fall and she will be enrolled on a full-time basis. Arethia is beginning her senior year at Northeast University this fall, but will not be enrolled at least half-time in any academic period. Both Devona and Arethia qualify as dependents on their parents’ tax return. Devona’s qualifying tuition expenses and fees total $3,600 for the fall semester, while Arethia’s qualifying tuition expenses and fees total $4,250 for the fall semester.

Full payment is made for the tuition and related expenses for both children during the fall semester. The American opportunity credit and lifetime learning credit, respectively, available to Jermaine and Keesha for the year are:

Answer 39

$2,400. American
Opportunity Credit

$850. Lifetime
Learning Credit

First $2,000 × 100% = $2,000
Second up to $2,000 × 25% = 400
[$1,600 × 25%]

Maximum $2,400

Lifetime learning credit (Arethia)
$4,250 × 20% = $850

Note: Maximum qualified expenses for the lifetime learning credit are $10,000 per year and the maximum credit per return is $2,000 per year. A taxpayer can claim both credits on the same return, but not for the same student. Arethia’s expenses do not qualify for the American opportunity credit because she was not enrolled at least half-time for at least one academic period during the tax year.

Question 40

Which of the following rights will a third party be entitled to after validly contracting with an agent representing an undisclosed principal?

Answer 40

Performance of the contract by the agent.

If the principal is undisclosed, the third party with whom the agent dealt can hold the agent liable on the contract.

Question 41

Under the Sales Article of the UCC, which of the following statements is correct regarding a seller’s obligation under a F.O.B. destination contract?

Answer 41

The seller is required to tender delivery of conforming goods at a specified destination.

Under an F.O.B. destination contract, the seller has the risk of loss until he places conforming goods into the buyer’s hands at the named destination, not necessarily the buyer’s place of business.

Question 42

Sorus and Ace have agreed, in writing, to act as guarantors of collection on a debt owed by Pepper to Towns, Inc. The debt is evidenced by a promissory note. If Pepper defaults, Towns will be entitled to recover from Sorus and Ace unless:

Answer 42

Towns has not attempted to enforce the promissory note against Pepper.

Sorus and Ace have agreed to be guarantors of collection. Thus, Towns, the creditor, must pursue the debtor, Pepper, before Towns is entitled to recover from Sorus and/or Ace.

Towns, the creditor, will be entitled to recover from Sorus and Ace, the sureties, even if the sureties are in the process of exercising their rights against the debtor (i.e., “right of exoneration”).

Insolvency of the debtor, either at the time the note was signed, or at the time of default, is not a defense of a surety.

Death of the debtor is not a defense of a surety.

Question 43

Which of the following rights does a surety have?

Answer 43

NO. Right to compel
the creditor to
collect from the
principal debtor

NO. Right to compel
the creditor to
proceed against
the principal
debtor’s collateral

A surety generally is primarily liable on the debt the surety agrees to backstop and has no right to compel the creditor to collect from the principal debtor or to compel the creditor to proceed against the debtor’s collateral. (There is, however, a very limited right to both of these in certain circumstances.)