Tax Practice Exam Flashcards
Your client is contemplating the exchange of two parcels of investment land for two similar parcels. Given the following details of the proposed transactions, compute the amount of recognized gain and loss (if any) on both parcels if your client does the exchanges.
• Parcel A: Ten acres of land acquired 15 years ago with a current basis of $50,000. In exchange your client will receive eight acres of land (FMV $80,000) and $20,000 of cash.
• Parcel B: Twenty acres of land acquired two years ago with a current basis of $100,000. In exchange your client will receive twelve acres of land (FMV $75,000) and $10,000 of cash
Parcel A Parcel B
Recognized Gain Recognized Loss
a) $20,000 $0
b) $20,000 $10,000
c) $50,000 $10,000
d) $20,000 $15,000
e) $50,000 $15,000
Answer: A
Parcel (A1) New Parcel (A2)
FMV $100,000 $80,000
Adjusted Basis (50,000)
Realized Gain $50,000 $20,000 cash (boot)
A1 must be worth $100,000 because A2 + $20,000 = $100,000. The client must recognize gain up to the boot received $20,000
Parcel (B1) New Parcel (Bz)
FMV $85,000 $75,000
Adjusted Basis (100,000)
Realized Loss ($15,000) $10,000 cash (boot)
The client will receive economic value = $85,000 ($75,000 + $10,000). The client will not recognize loss due to Section 1031. The client will have a new asset worth $75,000 with a basis of $90,000 ($100,000 - 10.000).
Three investors wish to start a manufacturing business. The business is expected to generate a significant income which it will reinvest for many years. Investor #1 has substantial assets he plans to contribute to the company. Investor #l is also concerned about showing too much business income on his return. Which business structure(s) would be most appropriate for the business?
- A limited partnership with Investor #1 as the limited partner.
- A business trust with all three as equal interests.
- An S corporation with all three as equal shareholders.
- A C corporation with all three as shareholders.
a) 1, 2, and 3.
b) 1 and 3.
c) 2 and 4
d) 4 only.
e) 1, 2, 3, and 4.
Answer: D
Only the C corporation will solve investor #1’s concern about income on his return.
Your client, a wealthy physician in the top marginal tax bracket, is interested in purchasing a franchise in a fast-growing chain with some of his colleagues. After carefully reviewing the proposal, you have determined that apart from significant up-front investment, the business will not need to retain income, and the revenue generated in subsequent years will be paid out to the investors. Furthermore, your client wants to be assured that after investing so much, the business would not be disrupted if one of his partners lost interest or encountered personal financial reversals. What form of business makes the most sense given these circumstances?
a) Limited Partnership.
b) General Partnership.
c) C corporation.
d) Professional Corporation.
e) S corporation.
Answer: E
The question asks about legal forms. Partnerships (A and B) are excluded due to disruption if a partner were to leave. Corporation (C) is excluded due to implicit double taxation and no need for capital accumulation. Professional Corporation (D) is not available for a franchise operation. Therefore, the S corporation is the best choice - a flow-through entity, offering limited liability and ease of continuation and exchange of ownership. A Limited Liability Corporation may well have accomplished the same goals had it been a choice.
A client purchased a piece of equipment in 2018 for the client’s computer business. Which depreciation methods should be used if the client wishes to maximize tax depreciation?
a) Modified accelerated cost recovery system (MACRS).
b) Accelerated cost recovery system (ACRS).
c) Units of production.
d) Sum of the year’s digits.
e) Straight line.
Answer: A
This is a depreciation question. MACRS is a 20% declining balance depreciation and will accomplish the maximum allowable depreciation expense. Note, Sec. 179 and bonus depreciation were not choices but could have been coupled with any of the answers and probably would have accomplished the maximum write-off.
Jeffrey and Karen Jones have given cash gifts to their children over the years. Mark, age 13, earns $2,500 in salary. Jennifer, age 18, earns $5,000 in dividends and capital gains. Nancy, age 12, earns $2,500 in dividends and interest. Steven, age 10, eams $900 in dividends and interest. Whose income is subject to the tax at the parent’s rate?
a) Steven’s.
b) Jennifer and Nancy’s.
c) Nancy’s.
d) Steven, Jennifer, and Nancy’s.
e) Nancy and Mark’s.
Answer: B
The question relates to the kiddie tax, which applies to unearned income over $2,300 by a child under the age of 19. E is excluded because Mark, under the age of 19, has only earned income. D is excluded because Steven, age 10, had an unearned income of less than $2,300. Therefore, the answer is B because Nancy, age 12, had unearned income over $2,300, and Jennifer is under 19 with unearned income over $2,300. SECURE Act 20 19 returned the excess unearned income taxation to the parent’s rate, overturning the changes made by TCJA 2017.
A client purchased a mutual fund with a $10,000 lump-sum amount four years ago. During the four years, $4,000 of dividends were reinvested. Today the shares are valued at $20,000 (including any shares purchased with dividends). If the client sells shares of $13,000, which statement(s) is/are correct?
- The taxable gain can be based on an average cost per share.
- The client can choose which shares to sell, thereby controlling the taxable gain.
- To minimize the taxable gain today, the client would sell shares on a higher cost basis.
- The client will not have a gain as long as they sell less than what they invested.
a) 1, 2, and 3 only.
b) 1 and 3 only.
c) 2 and 4 only.
d) 4 only.
e) 2, 3, and 4.
Answer: A
The choice is the client’s if he maintains adequate identification records. Statement #4 is incorrect.
Your client is contemplating the sale of some of her holdings in her employer’s stock. The stock was
acquired in four separate purchases as follows:
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She wants to know the least amount of gain she would be required to report if she sold 500 shares for $12,500. Compute this gain.
a) $500.
b) $3,700.
c) $4,300.
d) $5,000.
e) $5,700.
Answer: B
The client can use specific identification as a method to determine the basis of stock for purposes of calculating gains and losses. This method generally produces negligible income because the highest basis shares can be sold first.
Sale price (500 shares) $12,500
Sell 200 shares @ $20/share $4,000
Sell 200 shares @ $18/share $3,600
Sell 100 shares @ $12/share $1,200 $8,800
$3,700 gain
The basis for stock is either FIFO or Identifying Specific Shares. The average basis is only for mutual funds.
Which of the following dispositions of IRC Section 1245 recapture property would result in the immediate recapture of some or all of previous depreciation deductions?
a) A distribution by a partnership to its partners.
b) A donation to a charity.
c) A disposition at death.
d) A sale for cash and an interest-bearing note.
Answer: D
A represents a transaction that entails a carryover basis. B represents a transaction that entails a carryover basis unless boot is received. C represents the adjustment in basis to FMV at death. D represents a sale for cash that causes recapture of gain to the extent of gain above basis. Any gain over the original purchase price would be Section 1231 gain.
Note: A sale at their adjusted taxable basis would not cause recapture. However, D is the best answer presuming the sale is for an amount over their adjusted taxable basis.
Alisha Sheridan, a CF®® professional and fee-only financial planner has assisted Roger Regate, a self-employed physician, in tax and investment planning during the year. Identify the schedule(s) on which Alisha’s fee may be deductible by Roger on his federal income tax return.
- Schedule A–itemized deductions.
- Schedule C–profit or loss from business.
- Schedule D–capital gains and losses.
a) 1 only.
b) 2 only.
c) 3 only.
d) 1 and 2 only.
e) 1, 2, and 3.
Answer: B
Tax planning for the business is deductible on Schedule C, as is business investment planning. However, usually, the CF® professional is performing services for the individual, which is no longer deductible on Schedule A. Since the question is not definitive as to the services and the word “may” (very permissive) is used, B is the best answer. At no time would these expenses be included on Schedule D, which is used to reflect capital gains and losses.
