Unit 3: Business Income

Question 1

Advance payments for services are usually taxable in which year?

Answer 1

The year the payment was recieved.

Question 3

The election to defer some income into the year following the receipt of the advance payment does not apply to which types of advance payments?

Answer 3

Rent, Interest, and Insurance Premiums

Question 4

Guarantee or Warranty: When do cash basis tax payers recognize income?

Answer 4

In the year of sale

Question 5

Guarantee or Warranty: When do accrual basis taxpayers recognize income?

Answer 5

Normally, an accrual-basis taxpayer cannot postpone reporting income received under a guarantee of the warranty contract. However, IRC section 451(c) provides a rule for a taxpayer using an accrual method of accounting to elect to defer certain advance payments of gross income, recognizing income in the year of receipt only to the extent income is effectively earned in the first year and recognize all the remaining gross income in the next tax year.

Question 6

If a business receives an advance payment for a service agreement on property it sells, leases, builds, installs, or constructs, the business can:

Answer 6

Postpone reporting income, but only if it offers the property without a service agreement in the normal course of business.

Question 7

Service agreement: A postponement is not allowed if:

Answer 7

• The business will perform any part of the service after the end of the tax year immediately following the year it receives the advance payment.
• The business will perform any part of the service at any unspecified future date that may be after the end of the tax year immediately following the year it receives the advance payment

Question 8

Advance payment for the sales of goods are usually taxed:

Answer 8

In the year the income was recieved. However, there is an alternative method, if elected, in which the advance payment can be included in gross receipts under the method of accounting the taxpayer uses for financial reporting, but only if the income is reported for financial accounting purposes in the year after the receipt of the payment.

Question 9

Who do passive activity rules apply to:

Answer 9

Individuals, estates, trusts (other than grantor trusts), PSCs, and closely held corporations, partners in a partnership, and shareholders of an S corp (but not the entities themselves)

Question 10

Passive business activities:

Answer 10

These are trade or business activities in which the taxpayer does not materially participate during the year

Question 11

Rental real estate activities:

Answer 11

Rental of real estate is generally passive, even if the taxpayer participates in the activity, except for bona fide real estate professionals.

Question 12

A taxpayer is treated as “materially participating” in a business activity if:

Answer 12

He or she is involved in the operations of the activity on a regular, continuous, and substantial basis

Question 13

A taxpayer will be treated as “Materially participating” in an activity if they satisfy any one of the following tests:

Answer 13

1. They participated in the activity for more than 500 hours during the year
2. The taxpayer’s participation was substantially all the participation in the activity of all individuals for the tax year
3. The taxpayer participated in the activity for more than 100hours during the tax year and participated no less than any other individual
4. The activity is a significant participation activity, and the taxpayer participated in all significant participation activities for more than 500 hours.
5. The taxpayer materially participated in the activity during any 5 of the preceding 10 taxable years
6. The activity is a personal service activity in which the taxpayer materially participated for any 3 preceding tax years
7. Based on all the facts and circumstances, the taxpayer participated in the activity on a regular continuous, and substantial basis during the year

Question 14

A closely-held corporation or a personal service corporation is treated as “materially participating” in a rental activity only if:

Answer 14

One or more shareholders who own more than 50% of the corporation materially participate in the activity

Question 15

The following are nonpassive activities:

Answer 15

• A trade of business activity in which the taxpayer has materially participated by meeting one of the seven material participation test
• A “working interest” in an oil or gas well, which the taxpayer holds directly, or through an entity that does not limit the taxpayers liability
• Rental real estate activities in which the taxpayer materially participated as a real estate professional.

Question 16

A taxpayer qualifies as a “real estate professional” if:

Answer 16

• More than 50% rule: More than one-half of the personal services the taxpayer performs in trades or businesses during the tax year are in real property trades or businesses in which the taxpayer materially participates

and

• More than 750-hour rule: Hours spent providing personal services in real property trades or businesses in which the taxpayer materially participates total more than 750 during the tax year.

Question 17

What is the major benefit of being classified as a “real estate professional”

Answer 17

You are not subject to NIIT

Question 18

By definition, “passive activity income” does not include:

Answer 18

• Portfolio income
• personal service income
• Retirement income
• Income from intangible property
• State, local, and foreign income tax refunds
• Income from a covenant not to compete
• Alaska Permanent fund dividends
• Cancellation of debt income

Question 19

Are passive activity losses in excess of passive activity income allowed to be deducted?

Answer 19

No, they must be carried forward to future years and can only be used to offset passive activity income.

Question 20

8582

Answer 20

“Passive Activity Loss Limitations”

Used to summarize income and losses from passive activities and compute deductible losses.

Question 21

What happens if there are qualifying losses from a passive activity, and then the activity is sold?

Answer 21

*Note: The activity must be sold to an unrelated party

Current and suspended losses related to the activity are “released” and may be used to offset gains from the sale.

Question 22

“Former” Passive: A prior year’s disallowed loss from the activity can be deducted up to:

Answer 22

The amount of current year income from the activity if the taxpayer is now materially participaing in the business.

Question 23

Section 469 grouping:

Answer 23

Allows a taxpayer to “group” multiple business activities or multiple rentals as a single activity for purposes fo the passive loss restrictions. If two activities are grouped together into one larger activity, a taxpayer needs only to show material participation in the activity as a whole.

*This election is irrevocable and will remain in effect for any future tax years.

Question 24

Why would the IRS regroup a taxpayer’s activities?

Answer 24

If any of the activities resulting from a grouping is not an appropriate economic unit and one of the primary purposes of the grouping is to avoid the passive activity rules

Question 25

If one component of a grouping is disposed of in a fully taxable transaction, then the suspended passive losses from that activity are not released until:

Answer 25

The entire grouping is disposed of in a fully taxable transaction.

Question 26

In general, a rental activity cannot be grouped with a trade or business activity. However, they can be grouped together if the activities form an “appropriate economic unit” and:

Answer 26

• The rental activity is insubstantial in relation to the trade or business activity
• The trade or business activity is insubstantial in relation the the rental activity
• Each owner of the trade or business activity has the same ownership interest in the rental activity, in which case the part of the rental activity that involves the rental of items of property from us in the trade or business activity may be grouped with the business activity.

Question 27

To be considered “actively participating” in a rental activity, a taxpayer must:

Answer 27

Own at least 10% of the rental property and must make management decisions in a significant and bona fide way.

Question 28

The following taxpayers are not allowed to claim the “special loss allowance”

Answer 28

• A limited partner in a rental activity
• A taxpayer who has less than 10% ownership in a rental activity
• A trust or corporation

Question 29

For a real estate developer, the real estate is tread as

Answer 29

Inventory

Question 30

What types of business-related court awards and damages are taxable?

Answer 30

• Patent or copyright infringement
• Breach of contract, or interference with business operations
• Compensation fro lost profits or back pay
• Compensatory damages for other financial losses
• Interest earned on any type of court award
• Emotional distress damages
• Punitive damages