Tax Planning - Module 5

Which of the following methods of accounting is mandatory for businesses that maintain inventory and have gross receipts in excess of $27 million?

Accrual method of accounting

Which of the following is a permissible method for determining the business part of a residence for purposes of the home office expense deduction?

Number of rooms in the house used for business compared to total rooms in the house

Jim, a single taxpayer, sells Section 1244 stock for a $250,000 loss during the tax year. The stock had been held for two years. Which one of the following is CORRECT regarding the treatment of the loss?

$50,000 is treated as an ordinary loss; $200,000 is treated as long-term capital loss.

What is Bobby's total self-employment tax on his Schedule C net income of $50,000? Round your answer to the nearest dollar.

$7,065 Bobby's total self-employment tax is $7,065 ($50,000 × 0.9235 = $46,175; $46,175 × 0.1530 = $7,065).

Amanda's share of general partnership net income is $60,000 in 2022. In addition, her distributive share of S corporation income is $10,000. What is Amanda's self-employment tax, if any, for 2022? Round your answer to the nearest dollar.

$8,478

Which of the following businesses may be considered a specified service business (SSB) for purposes of the qualified business income (QBI) deduction?

A medical practice

Which of the following forms does a C corporation file?

Form 1120

All of the following are examples of self-employment income for purposes of the self-employment tax except

salary paid to an S corporation shareholder.

Ron has the following income for the current tax year: Schedule C net income: $12,000 Flow-through of general partnership operating income: $15,000 Wages: $80,000 Net income from rental of real estate: $10,000 What is the amount of Ron's self-employment tax?

$3,815 The total of these items is $27,000. This is then reduced by 7.65% of this amount, and then multiplied by 15.3% to give us $3,815. Remember, the 7.65% subtraction always applies. Because the total of the self-employment income and the wages received are less than the wage base, no special computation is necessary.

What percentage, if any, of a taxpayer's self-employment tax may be deductible as an adjustment to income?

50%

Your client, Mary, is contemplating the formation of an S corporation for her small manufacturing business. What can you accurately tell Mary about forming an S corporation? Mary would have limited liability. The number of shareholders is limited to 100. Mary's death would require reorganization of the corporation. The corporation's items of income, deductions, and tax credits would flow through to Mary's income tax return.

I, II, and IV

Alisha, a CFP® certificant and fee-only financial planner, has assisted Roger, a self-employed physician, in income tax return preparation and investment planning during the year. On which of the following schedules may Alisha's fee 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

II only The investment planning fees are not deductible. This expense may not be added to the basis of securities. The tax preparation fee is partly nondeductible (the portion attributable to the individual return), and the portion of the fee for completing the Schedule C is a business expense that would be deducted on the Schedule C.

Mark operates a sole proprietorship from his apartment. His gross income for the current tax year is $61,000. Business expenses not associated with his home office total $63,000. Expenses associated with the home office total $4,200. How much of the home office expense, if any, may Mark deduct for the current year?

$0 The home office expense deduction is limited to the earned income from the business. In other words, the home office expense deduction can generally neither create nor add to a loss. In this situation, the $61,000 of gross income is reduced by the $63,000 of business expenses not associated with the home office, to leave no earned income. Thus, of the $4,200 of home office expenses, none would be deductible in the current year. Note that the entire $4,200 of home office expenses would be subject to a carryforward.

Irwin, a young financial planner, operates his practice as an LLC. His LLC net income is $100,000, and the taxable income on his single return is $140,000. The LLC paid no wages, and has no depreciable property. What is the amount of Irwin's qualified business income (QBI) deduction?

$20,000 For a specified service business (SSB), if the taxpayer's taxable income is below the phaseout range of $170,050 to $220,050 (Single 2022), the QBI deduction is fully available. An SSB involves performance of services in the fields of health, law, accounting, actuarial science, performing arts, veterinary services, consulting, athletics, financial services, or brokerage services. For pass-through entities, the owner/taxpayer may be allowed a deduction equal to 20% of the lesser of the QBI, or 20% of the taxpayer's taxable income (reduced by net capital gain). Thus, the available deduction is 20% of the QBI of $100,000, or $20,000.

A small business with under $20 million in gross receipts and no inventory should most likely use which accounting method?

Cash

Which of the following is NOT an advantage of the cash basis method of accounting?

Constructive receipt serves to defer income.

Which one of the following types of investors derives the greatest tax benefit from investing in preferred stocks?

Corporate investors Because 50% of the preferred dividends received by a corporation are exempt from federal income taxes, a corporation gains a tax advantage. The government and nonprofit organizations pay no income taxes. Mutual funds are also exempt from taxation.

Harriet builds remote-control cars as a hobby. Which hobby expenses must she deduct from hobby income first?

Cost of goods sold

Which of the following statements about S corporations is CORRECT?

S corporations are prohibited from having more than one class of stock.

Which of the following forms of business would file a Schedule C to report the income or loss from the business?

Sole proprietorship

Jena owns and operates a string of retail electronics stores with approximately $30 million of sales annually. Approximately 20% of her sales are with extended credit terms. What method of tax accounting is most appropriate for Jena's business?

The accrual method, because inventory is such a large component of the business

John, an accountant, is considering forming an S corporation for his practice. He will be the sole employee of the corporation. Which of the following statements accurately describes the income tax consequences of the proposed arrangement?

The corporation would not be considered a personal service corporation (PSC), and the income would be subject to John's personal income tax rates. The personal service corporation (PSC) classification for a C corporation was effectively repealed with the Tax Cuts and Jobs Act (TCJA). S corporations do not have corporate income tax rates. As an S corporation, all income would flow through to John to be taxed at his individual rates.

Kappa Corporation has the following items of income and expense: Taxable income: $310,000 Federal income tax paid: $80,000 Dividends paid: $20,000 Accumulated earnings and profits at the end of the preceding year: $90,000 Kappa is an engineering firm with 100% of the stock owned by its three employee-shareholders. The corporation cannot establish a valid business purpose for excess accumulations. How much accumulated earnings tax is payable by Kappa?

$30,000 For a personal service corporation (PSC), the accumulations limit is $150,000. Engineering is one of the personal services specifically listed for determining a PSC. Expenses otherwise not allowed in computing the corporate income tax are allowed in computing the accumulated earnings tax, as is summarized here. (Note that the accumulated earnings credit of $60,000 is the difference between the $150,000 safe harbor and the $90,000 of accumulations at the beginning of the year.) The accumulated earnings tax rate is 20%, the highest rate that may apply to qualified dividends.

Glen and Debbie both have significant net worth and are currently in the highest marginal income tax bracket. They have developed a process that allows them to neutralize toxic chemical waste. They want to form a business that will protect their net worth in case the business fails or it becomes involved in lawsuits. They expect the business to produce significant profits immediately, as they have agreements in the works with several large chemical companies. Also, they would like to share ownership with other family members as they get closer to retirement. Which business form would be most appropriate for Glen and Debbie at this time?

C corporation The S corporation (and the partnership entities) are conduits, and would cause the income to be added to their other significant individual income. The use of the C corporation would allow for protection from lawsuits or business failure. Also, the general partnership and the limited partnership both would cause a flow-through of the income, and the general partnership would not provide protection from personal liability. There is no indication that either party wants to be a general partner in a limited partnership. The use of a C corporation would be appropriate since it is a separate taxable entity, and the profits would not flow through. They could receive a reasonable salary, and the qualified dividends that are paid out would be subject to long-term capital gain rates.

Mike is involved in the business of breeding show horses on a part-time basis as a sole proprietor. He has shown a significant net loss in this business every year for the last six years, and he has used these losses to reduce the tax liability on the salary he has earned from his law practice. With which one of the following potential tax traps should Mike be most concerned?

Hobby loss

In 2022, which of the following is a method in calculating total self-employment tax, where net income from self-employment is above the taxable wage base? Calculate self-employment income; multiply by 0.9235 (1 − 0.0765); subtract the taxable wage base, and from that, multiply the excess over the taxable wage base by 2.9% (Medicare portion of the tax). Multiply the taxable wage base by 15.3%, and add the results of the previous two steps together to arrive at the total self-employment tax. Calculate self-employment income; multiply by 0.9235 (1 − 0.0765); and multiply the result by 15.3%. Calculate self-employment income; multiply by 14.13%. Calculate self-employment income; multiply by 15.3%; multiply the excess over the taxable wage base by 2.9% (Medicare portion of the tax); and add the results of the previous two steps together to arrive at the total self-employment tax.

I only

Which of the following statements is CORRECT regarding a minority non-employee shareholder in an S corporation? Reports income when the corporation has net income for a tax year Votes for the board of directors at the annual shareholders meeting Receives a K-1 annually to prepare a personal income tax return Reports on a personal income tax return a pro rata share of corporate profit or loss

I, II, III, and IV

Carol owns and operates a retail electronics store with annual sales of approximately $2 million. The store also specializes in repairing computers and other small electronics. Approximately 30% of her sales are with extended credit terms. What method of tax accounting may be used for Carol's business? The accrual method, because inventory is such a large component of the business The cash method, because it provides flexibility in the timing of income and expenses The hybrid method, because the business involves both inventory and service The installment sale method, to spread the gain over a longer time frame

I, II, and III The cash method may be used because average annual gross receipts are under $27 million for the prior tax years. The accrual method may always be used. The hybrid method may be used because the business involves both inventory and service. The installment method may not be used, as dealers are not allowed to use the installment method.

Which of the following is subject to the self-employment tax? Distributive share of limited partnership operating income Flow-through of S corporation income Distributive share of general partnership operating income Interest or dividends from investments

III only The general partnership operating income is self-employment income. By definition, the other items of income are not subject to the self-employment tax.