Simulated Exam 2

Question 1

Stem Corp. bought a machine in February of Year 7 for $20,000. Then Stem bought furniture in November of Year 7 for $30,000. Both machines were placed in service for business purposes immediately after purchase. No other assets were purchased during Year 7. What depreciation convention must Stem use for the machine purchased in February Year 7?

Answer 1

Mid-quarter

Both of these assets are personal property and the general rule is to use the half-year convention. However, more than 40% of all personal property purchased occurred during the fourth quarter [$30,000/($20,000 + $30,000) = 60%]. Therefore, all personal property purchased during the year must be depreciated using the mid-quarter convention.

A full year convention does not exist for tax purposes.

Mid-month is used only for real property, not personal property.

Half year is the general convention for personal property. But mid-quarter must be used because more than 40% of the purchases for the year took place in the fourth quarter.

Question 2

During the current year, Tarbet’s residence was destroyed by a hurricane and a federal disaster was declared for the area.Tarbet’s basis in the property was $150,000. The fair market value determined by an appraiser shortly before the hurricane was $450,000. In November of the current year, Tarbet received $300,000 from the insurance company. Tarbet’s adjusted gross income was $75,000 and she did not have any casualty gains during the year. What total amount can Tarbet deduct as a current year casualty loss itemized deduction, after the application of the threshold limitations?

Answer 2

$0

Smaller loss (lesser of cost or FMV) 150,000

Less: -300,000
Taxable loss -150,000
Less: Floor -100
Eligible Loss 0
Less:10% of AGI -7.500
Deductible Loss 0

Question 3

John Q. Dillinger is the outgoing Commissioner of the Internal Revenue Service. In his final public meeting with IRS employees, he addressed changes that he would like to see made in the IRS audit and appeals process. Which of the following statements that he made at this meeting is correct?

Answer 3

Following an audit, if agreement is reached with the taxpayer, the taxpayer signs Form 870.

Question 4

The statute of limitations for an alleged breach of contract:

Answer 4

Generally commences on the date of the breach.

The statute of limitations refers to the time period in which the case must be filed. The time period varies from state to state depending on the type of case.

Question 5

Dan borrowed money from National Bank and used land he owned as collateral for the bank loan. Dan’s friend Steve has agreed to act as surety for the loan. Soon thereafter, Dan stops making payments to the bank on the loan. Which of the following statements is correct regarding the bank’s rights against Steve?

Answer 5

The bank can immediately demand payment from Steve without demanding payment from Dan or going after the land.

When a debtor defaults in a suretyship situation, the creditor may do any of the following:

(i)

Immediately demand payment from the surety

(ii)

Immediately demand payment from the debtor

(iii)

Immediately go after the collateral, if applicable

The surety does not have the right to require the creditor to take any of the above mentioned action. A guarantor of collectability, however, would have the right to require a creditor to first proceed against the debtor or against available collateral.

Question 6

Taxpayers are allowed to take a charitable contribution deduction on the taxpayer’s federal income tax return for contributions to which of the following tax-exempt organizations?

Answer 6

Public library

Contributions made to Section 501(c)(3) organizations qualify as deductible charitable contributions to the donor. A public library is organized and operated exclusively for literary and educational purposes, so it qualifies as a Section 501(c)(3) organization for which donors can deduct contributions on their federal income tax returns.

Civic organization, Political action committee, Chamber of commerce are tax-exempt organizations. Therefore, donors are not allowed to take a deduction for contributions to the organization on the donor’s income tax return.

Question 7

Which one of the following statements concerning workers’ compensation laws is generally correct?

Answer 7

Employers are strictly liable without regard to whether or not they are at fault.

Under workers’ compensation laws, employers are generally strictly liable for injuries to employees.

Question 8

Bass Corp., a calendar year C corporation, made qualifying Year 2 estimated tax deposits based on its actual Year 1 tax liability. On March 15, Year 3, Bass filed a timely automatic extension request for its Year 2 corporate income tax return. Estimated tax deposits and the extension payment totaled $7,600. This amount was 95% of the total tax shown on Bass’ final Year 2 corporate income tax return. Bass paid $400 additional tax on the final Year 2 corporate income tax return filed before the extended due date. For the Year 2 calendar year, Bass was subject to pay:

Answer 8

Interest on the $400 tax payment made in Year 3.

A taxpayer does not extend the time for payment of tax by extending the filing deadline for the return. If there is tax owed when the return is filed, interest must be paid at the rate prescribed by IRC §6621; therefore, Bass was subject to pay interest on the $400 tax payment made in Year 3. There is no delinquency penalty if the taxpayer files its return, the amount owed on the return is not $500 or more, and the taxpayer pays the balance due on or before the extended due date (all of which Bass Corp. complied with).

Question 9

For an individual business owner, which of the following would typically be classified as a capital asset for federal income tax purposes?

Answer 9

Marketable securities

Capital assets include all marketable securities unless the taxpayer is a dealer.

Question 10

Grill deals in the repair and sale of new and used clocks. West brought a clock to Grill to be repaired. One of Grill’s clerks mistakenly sold West’s clock to Hone, another customer. Under the Sales Article of the UCC, will West win a suit against Hone for the return of the clock?

Answer 10

No, because Grill is a merchant to whom goods had been entrusted.

Question 11

The filing of an involuntary bankruptcy petition under the Federal Bankruptcy Code:

Answer 11

Stops the enforcement of judgment liens against property in the bankruptcy estate.

The filing of a petition in bankruptcy invokes an automatic stay against all attempts to collect on most debts of the debtor.

Question 12

Which of the following is an unreasonable position as defined by the Internal Revenue Code?

Answer 12

There is substantial authority for the position, and it does involve a tax shelter. It does not appear that there is a more likely than not chance that the position will be sustained on its merits.

Generally, a position that has substantial authority will not be an unreasonable position. However, because this involves a tax shelter and there is not a more likely than not chance that it will be sustained on its merits, it will be deemed to be an unreasonable position.

Question 13

How is the depreciation deduction of nonresidential real property determined for tax purposes using MACRS?

Answer 13

Straight-line method over 39 years

Nonresidential real property is depreciated straight-line over 39 years.

Question 14

Carlos asked Rick and Peter to guarantee Carlos’ debt to Gord Motors. Both Rick and Peter agree to act as sureties. The contract that all parties signed provides that Rick’s maximum liability is $30,000, and Peter’s is $20,000. Carlos owes Gord Motors $20,000 and is in default. Rick pays Gord Motors the entire amount. In the absence of an agreement to the contrary, Rick can recover from Peter:

Answer 14

$8,000.

As a general rule each surety is liable to the creditor for the entire amount of the debt. However, with respect to co-sureties, each co-surety can seek contribution from the other co-surety (or co-sureties) to the extent any co-surety pays more than his/her/its pro rata share of the debt. In this case Rick’s pro rata share of the debt is $30,000/($30,000 + $20,000) = 3/5. 3/5 x $20,000 = $12,000. Peter’s pro rata share is $20,000/($30,000 + $20,000) = 2/5. 2/5 x $20,000 = $8,000. Peter owes Rick $8,000 in contribution.

Question 15

In computing the ordinary income of a partnership, a deduction is allowed for:

Answer 15

Guaranteed payments to partners.

Guaranteed payments to partners are deductible in arriving at the partnership’s ordinary income. Ordinary income is the “taxable income” of the partnership excluding all items required to be separately stated. Charitable contributions, dividend income, and capital losses are all separately stated items.

Charitable contributions and Dividend income are not deducted to arrive at ordinary income. They are a separately stated item.

Question 16

Which of the following disqualifies an individual from the earned income credit?

Answer 16

The taxpayer has a filing status of married filing separately.

Earned income tax credit is a refundable tax credit. A claimant can have one qualifying child or two or more qualifying children for this credit. There is a maximum credit available for this purpose. Further:

The taxpayer must meet certain earned low-income thresholds.
The taxpayer must not have more than the specified amount of disqualified income.
The taxpayer must be at least age 19 if there are no qualifying children.
If married, the taxpayer must generally file a joint return with his/her spouse (i.e., the married filing separate status disqualifies a taxpayer from claiming the earned income credit).
A qualifying child can be up to and including age 18 (or age 23 if a full-time student) at the end of the tax year, provided the child shared a residence with the taxpayer for 6 months or more.
The taxpayer must be related to the qualifying child (or children) through blood, marriage, or law.
The child must be either in the same generation or a later generation of the taxpayer.
A foster child qualifies if officially placed with the taxpayer by an agency.

Question 17

Which of the following statements is(are) correct regarding the common law elements that must be proven to support a finding of constructive fraud against a CPA?

I.
The plaintiff has justifiably relied on the CPA’s misrepresentation.

II.
The CPA has acted in a grossly negligent manner.

Answer 17

Both I and II.The elements of constructive fraud:

Misrepresentation of a material fact.
Defendant acts with gross negligence or recklessly.
Intent to induce plaintiff’s reliance.
Actual and justifiable reliance by plaintiff.
Damages.
Actual fraud requires intent to deceive.

Question 18

Which of the following oral agreements is enforceable without a writing under the statute of frauds?

Answer 18

An agreement to employ a person for life.

The statute of frauds provides that certain contracts are not enforceable unless they are evidenced by a writing signed by the party sought to be held liable. Among such contracts are contracts that, by their terms, cannot be performed within a year. A contract to employ a person for life is not such a contract, since the person might not live a year. Thus, such a contract is enforceable even absent a writing.

Question 19

Stem Corp. bought a machine in February of Year 7 for $20,000. Then Stem bought furniture in November of Year 7 for $30,000. Both machines were placed in service for business purposes immediately after purchase. No other assets were purchased during Year 7. What depreciation convention must Stem use for the machine purchased in February Year 7?

Answer 19

Mid-quarter

Both of these assets are personal property and the general rule is to use the half-year convention. However, more than 40% of all personal property purchased occurred during the fourth quarter [$30,000/($20,000 + $30,000) = 60%]. Therefore, all personal property purchased during the year must be depreciated using the mid-quarter convention.

Mid-month is used only for real property, not personal property.

Half year is the general convention for personal property. But mid-quarter must be used because more than 40% of the purchases for the year took place in the fourth quarter.

A full year convention does not exist for tax purposes.

Question 20

Which of the following statements is correct regarding an accountant’s working papers?

Answer 20

The accountant owns the working papers but generally may not disclose them without the client’s consent or a court order.

While a CPA owns his or her workpapers, the ownership rights are very limited. Generally, a CPA may not reveal client workpapers to third parties without the client’s consent.

Question 21

Which of the following must take place for a corporation to be voluntarily dissolved?

Answer 21

Passage by the board of directors of a resolution to dissolve.

For a corporation to dissolve, the directors must adopt a resolution recommending dissolution.

Question 22

Sands purchased 100 shares of Eastern Corp. stock for $18,000 on April 1 of the prior year. On February 1 of the current year, Sands sold 50 shares of Eastern for $7,000. Fifteen days later, Sands purchased 25 shares of Eastern for $3,750. What is the amount of Sand’s recognized gain or loss?

Answer 22

$1,000

Rule: A loss on a wash sale is disallowed for tax purposes. A wash sale exists when a security is sold for a loss and is repurchased within 30 days before or after the sale.

Question 23

Upon her grandfather’s death, Jordan inherited 10 shares of Universal Corp. stock that had a fair market value of $5,000. Her grandfather acquired the shares in 1995 for $2,500. Four months after her grandfather’s death, Jordan sold all her shares of Universal for $7,500. What was Jordan’s recognized gain in the year of sale?

Answer 23

$2,500 long-term capital gain

Unless the executor elects the “alternative valuation date” method (not applicable to this question), the basis of property acquired by bequest or by inheritance is the property’s fair market value on the date of the decedent’s death. The decedent’s basis is irrelevant. Additionally, such acquired property is always considered to be “long-term” property, regardless of how long it has been held by the decedent and by the beneficiary or heir.

Question 24

On January 2 of the current year, Shaw Corp., an accrual-basis, calendar-year C corporation, purchased all the assets of a sole proprietorship, including $300,000 in goodwill. Current-year federal income tax expense of $110,100 and $7,500 for goodwill impairment were deducted to arrive at Shaw’s reported book income of $239,200. What should be the amount of Shaw’s current-year taxable income, as reconciled on Shaw’s Schedule M-1 of Form 1120, U.S. Corporation Income Tax Return?

Answer 24

$336,800

Book income $239,200

Add: Federal income tax expense 110,100

Less: Excess of tax amortization over book impairment of goodwill (12,500)

Taxable income 336,800

[1] Federal income taxes paid are not deductible for tax purposes.

[2] The excess amortization is determined as follows:

Total purchased goodwill 300,000
Divided by 15 years
Tax amortization 20,000
Less: Book impairment (given)
7,500
Excess tax amortization for the current year 12,500

Question 25

An S corporation may deduct:

Answer 25

Compensation of officers.

An S corporation may deduct compensation of officers which is an ordinary and necessary business deduction as long as it is reasonable in amount.

An S corporation may deduct compensation of officers which is an ordinary and necessary business deduction as long as it is reasonable in amount.

Question 26

Which of the following contracts must be evidenced by a signed writing reflecting the material terms of the agreement to be enforceable under the statute of frauds?

Answer 26

A contract to employ a person for two years.

A contract to employ a person for two years is not enforceable under the statute of frauds unless the material terms of the contract are evidenced by a writing signed by the party sought to be held liable. This is because a contract which by its terms cannot be performed within a year is within the statute of frauds.

Question 27

Alex purchased rental property on July 29, Year 6, for $456,000. The price included an amount of $90,000 allocated to land. Alex immediately rented the property to a family to live in. How much depreciation can Alex deduct in Year 6 for the property?

Answer 27

$6,100

The $90,000 amount allocated to land is not depreciated. So the depreciable basis is $366,000. This is depreciated straight-line over 27.5 years because this is residential property. The mid-month convention is used for real estate. Year 6 depreciation is $6,100 ($366,000/27.5 x 5.5 months/12).

Question 28

Chris exchanges his computer for an updated model. The seller of the original computer retained a security interest in the original computer for credit extended to Chris. The debt on the original computer has not been fully paid by Chris. If the seller perfected their interest in the original computer, what is the seller’s status with respect to the new computer?

Answer 28

The seller’s interest is perfected for 20 days in the new computer.

Question 29

In Year 1, Smith, a divorced person, provided over one half the support for his widowed mother, Ruth, and his son, Clay, both of whom are U.S. citizens. During Year 1, Ruth did not live with Smith. She received $9,000 in Social Security benefits. Clay, a 25-year-old full-time graduate student, and his wife lived with Smith. Clay had no income but filed a joint return for Year 1, owing an additional $500 in taxes on his wife’s income. How many people meet the definition of either qualifying child or qualifying relative for Smith?

Answer 29

1

Ruth is the only one who meets the definition of a qualifying relative for Smith. Ruth’s $9,000 Social Security income is considered to be under the gross income limitation for QR because it is nontaxable income and is not considered for the gross income limitation. Clay is over the age limit for qualifying child. Clay files a joint return (with a tax liability) with his wife, so he also does not meet the definition of qualifying relative.

Question 30

Which of the following is the correct order of hierarchy of authority in the tax law?

Answer 30

Internal Revenue Code, IRS Regulations, Tax Court Decisions, IRS Agents’ Reports.

Question 31

Cape Co. reported book income of $140,000. Included in that amount was $50,000 for meal expenses and $40,000 for federal income tax expense. In Cape’s Schedule M-1 of Form 1120, which reconciles book income and taxable income, what amount should be reported as taxable income?

Answer 31

$205,000

Book income 140,000
Federal income tax expense deductible from book income, but not deductible for tax purposes 40,000
50% × $50,000 meal expenses not deductible for tax purposes, but deductible from book income 25,000
Taxable Income 205,000

Question 32

Which of the following is not true with regard to personal holding companies (PHCs)?

Answer 32

Personal holding companies, as specifically defined by the Code, are corporations that meet certain “closely-held” ownership criteria and have over 50% of their adjusted gross income consisting of net rent (less than 50% of ordinary gross income), taxable interest, most royalties, and dividends from an unrelated domestic corporation.

Question 33

A homestead exemption ordinarily could exempt a debtor’s equity in certain property from post-judgment collection by a creditor. To which of the following creditors will this exemption apply?

Answer 33

NO. Valid home
mortgage lien

NO. Valid IRS
Tax lien

Generally, a home mortgage lien is not subject to a state homestead exemption if it is a purchase money mortgage and neither is an IRS tax lien.

Question 34

Susan offered to sell Blackacre to Beth. Susan agreed to keep the offer open for one week and Beth paid Susan $10,000 to keep her offer open. Two days later, Susan revoked her offer and immediately returned the $10,000 to Beth. Assuming all the elements of a valid offer have been satisfied, is the offer still open?

Answer 34

Yes, an offeror must keep the offer open for the stated period of time if the offeree provided consideration.

Although the general rule is that all offers can be revoked prior to acceptance, there are three exceptions: (1) where consideration is paid to keep the offer open (called an option contract); (2) a substantial start on a unilateral contract; and (3) a merchant’s firm offer under the UCC.
Here, the offeree provided consideration ($10,000) to keep the offer open for the stated period of time, creating an option contract. The offeror, therefore, would have to keep the offer open for the time period stated.

Question 35

If a security becomes worthless in the current taxable year, it is treated as sold or exchanged on:

Answer 35

The last day of the current taxable year.

The rule is that a worthless security is treated as being sold or exchanged on the last day of the year it becomes worthless.

Question 36

To which of the following transactions does the common law Statute of Frauds not apply?

Answer 36

Contracts that can be performed within one year.

Contracts which by their terms cannot be performed within a year are within the common law Statute of Frauds. The fact that a contract may be performed within a year does not bring the contract within the Statute of Frauds. A contract to perform weekly landscaping services for the next three years must be in writing. A contract to plant three trees within the next two years is not within the statute of frauds.

Question 37

Which of the following items may be deducted from business income to arrive at the ordinary business income or loss of a partnership?

Retirement plan payments for partners, Charitable contributions and Section 179 deduction are separately stated item

Answer 37

Business insurance.

Business insurance is allowed as a deduction in arriving at ordinary business income. Generally, all regular ordinary business expenses that do not have special limitations at the individual partner level will qualify. They are referred to as non-separately stated items. All other items are separately stated items that must be listed separately.

Question 38

A corporation that has been an S corporation from its inception may:

Answer 38

YES. Have passive investment income in
excess of 25% of gross receipts
for 3 consecutive years
and nonpassive income

YES. Be owned by a
bankruptcy estate

Rule:

A corporation that has always been an S corporation may have excess passive income without losing its S corporation status.
Shareholders of an S corporation must be: individuals, estates, a voting trust, a grantor trust, and/or a bankruptcy estate.

Question 39

John Harper’s individual income tax return was audited by the IRS. The IRS revenue agent determined John owed additional taxes on his previously filed return. John disagrees with the agent’s additional assessment and the matter was not agreed upon at the IRS administrative appeals conference. John has decided to initiate resolution of the disputed tax in the Federal Court System.
Which of the following is a correct statement regarding the Federal Court System?

Answer 39

The U.S. Tax Court is the only forum in which the taxpayer may have a claim heard without first paying the disputed tax liability in full.

The U.S. Tax Court is the only federal trial court where taxpayers may have disputes litigated without first paying the disputed tax liability. In other federal trial courts (U.S. District Court and the U.S. Court of Federal Claims), the taxpayer is required to pay the disputed tax and sue the IRS for a refund.

The taxpayer or the IRS must first exhaust remedies at the Federal Trial Court System level (U.S. Tax Court, a U.S. District Court, or U.S. Court of Federal Claims) prior to the dispute being heard at the federal appellate court level. Appellate courts only resolve matters involving questions of law, and not questions of fact.

Question 40

Under Treasury Circular 230, in which of the following situations is a CPA prohibited from giving written advice concerning one or more federal tax issues?

Answer 40

The CPA takes into account the possibility that a tax return will not be audited.

A CPA should not give written federal tax advice if the CPA takes into account the possibility that a tax return will not be audited.

Question 41

Separately Stated Items

Answer 41

• Charitable contributions
• Depreciation Section 179 (-)expense (-)
• Long-term capital gain
  Depreciation from domestic stock (+)
• Section 1231 gain on truck sale (+)
• Net short term capital loss (-)
  -Retirement plan payments for partners