Individual Income Taxation Chapter 5

Which of the following statements regarding related party expenses is true? a.If both parties are accrual basis taxpayers, there is no problem with reporting income and expenses between related parties. b.If an accrual basis taxpayer accrues an expense payable to a cash basis related party, the expense is deductible immediately. c.Related party rules prevent abuse by requiring a cash basis taxpayer to use an accrual method of accounting for expenses. d.If an accrual basis taxpayer accrues an expense payable to a cash basis related party, he or she has choices as to when to deduct the expense.

a.If both parties are accrual basis taxpayers, there is no problem with reporting income and expenses between related parties.

Which of the following statements regarding related party rules is true? a.Related parties are members of an individual's family and business entities in which the person directly or constructively owns more than a 50% interest. b.The tax law does not limit the timing of the deduction of accrued expenses payable to a related cash basis taxpayer. c.Related party rules restrict the timing of a deduction for a cash basis taxpayer to an accrual basis related party. d.The objective of the related party limitations is to accelerate accrued expenses from transactions that lack economic substance.

a.Related parties are members of an individual's family and business entities in which the person directly or constructively owns more than a 50% interest.

Which of the following statements regarding deductible business expenses is true? a.To be deductible, an expenditure must be for the taxpayer's benefit or be a payment of the taxpayer's obligation. b.Direct or indirect payments to any person of an amount that constitutes an illegal bribe or kickback are tax deductible. c.A payment of another person's obligation is tax deductible by the person for whom the payment is made. d.Premiums paid for life insurance by the insured taxpayer are deductible.

a.To be deductible, an expenditure must be for the taxpayer's benefit or be a payment of the taxpayer's obligation.

The capital recovery concept a.limits the amount of a deduction to the amount of the expenditure or the taxpayer's investment in an asset. b.requires all entities to report the results of their operations on a quarterly basis. c.does not acknowledge the basis of an asset (since estimation must be used). d.is one of the many alternatives that may be used to deduct the cost of an asset over its useful life.

a.limits the amount of a deduction to the amount of the expenditure or the taxpayer's investment in an asset.

Which of the following statements regarding the cash method is true? a.When a property or service is used to pay an expense, payment occurs when the taxpayer gives the property or renders the service to the creditor; however, it is discounted by 10% if it is a personal service. b.A cash basis taxpayer may claim a deduction in the year an expense is paid, and when a property or service is used to pay an expense, payment occurs when the taxpayer gives the property or renders the service to the creditor. c.A cash basis taxpayer may claim a deduction in the year an expense is paid, even if he or she does not have the funds to honor the check in the current period. d.If a taxpayer transfers property to a creditor and the property has a fair market value equal to its basis, the transfer will result in a realized gain or loss.

b.A cash basis taxpayer may claim a deduction in the year an expense is paid, and when a property or service is used to pay an expense, payment occurs when the taxpayer gives the property or renders the service to the creditor.

Which of the following statements regarding the home office deduction is true? a.The only requirement for classifying a portion of one's home as deductible is that the home office area must be regularly used as the principal place to conduct a trade or business belonging to the taxpayer or as a place to meet or deal with customers in the ordinary course of business. b.A specific part of the home must be used exclusively for carrying on a trade or business, and the home office area must be regularly used as the principal place to conduct a trade or business belonging to the taxpayer or as a place to meet or deal with customers in the ordinary course of business. c.Any part of the home may be used for carrying on a trade or business, and it need not be specified. For example, because Leah carries her laptop from room to room to use, she may choose which room in her home to allocate to home office expenses. d.If a structure on the taxpayer's property is detached and used for business, it is never deductible since it is hard to trace costs to the separate structure.

b.A specific part of the home must be used exclusively for carrying on a trade or business, and the home office area must be regularly used as the principal place to conduct a trade or business belonging to the taxpayer or as a place to meet or deal with customers in the ordinary course of business.

Which of the following statements regarding the amendment of Section 162 to disallow certain categories of payments is true? a.Congress found that deduction for expenditures for fines and penalties were frustrating public policy by encouraging lawful conduct. b.A taxpayer can deduct the legal ordinary and necessary expenses related to carrying on an illegal trade or business; however, contributions to political campaigns and expenditures to influence public opinion about legislation are not deductible. c.A taxpayer can deduct the legal ordinary and necessary damage payments for violation of antitrust laws. d.In 1970, Congress declared that any payments related to a sexual harassment case, where such payments are subject to a nondisclosure agreement, are nondeductible.

b.A taxpayer can deduct the legal ordinary and necessary expenses related to carrying on an illegal trade or business; however, contributions to political campaigns and expenditures to influence public opinion about legislation are not deductible.

Which of the following statements regarding the classification of business expenses is true? a.The Supreme Court (SCOTUS) has a very vague and broad definition of what it means to be engaged in a trade or business. b.A taxpayer may deduct all the ordinary and necessary expenses of operating a trade or business according to the Internal Revenue Code. c.A corporation's business expenses are always classified as trade or business expenses, regardless of the underlying business purpose. d.Classification of an activity as either a trade or business or for the production of income is a very vague and ambiguous categorization.

b.A taxpayer may deduct all the ordinary and necessary expenses of operating a trade or business according to the Internal Revenue Code.

Conduit entities separately report which of the following? a.Charitable contributions, investment interest expense, and ordinary income b.Charitable contributions, moving expenses, and personal expenses c.Charitable contributions, Section 179 expenses, and nondeductible expenses d.Charitable contributions, self-employed health insurance deductions, and HSA deductions

c.Charitable contributions, Section 179 expenses, and nondeductible expenses

Which of the following statements regarding financial and taxable income differences is true? a.Federal income tax expense is a common temporary timing difference. b.Depreciation charges are common temporary timing differences, and federal income tax expense is a common permanent timing difference. c.Depreciation charges are an example of common permanent timing differences. d.Financial accounting allows 50% of business meals to be written off against net income, while provisions in the tax law allow 100%, thereby creating a temporary timing difference.

b.Depreciation charges are common temporary timing differences, and federal income tax expense is a common permanent timing difference.

Which of the following statements regarding financial and taxable income is true? a.Tax accounting rules allow estimation, a concept that speaks to the fact that estimates may be employed. b.Financial accounting rules differ from tax reporting rules, and the all-events test and economic performance test create temporary differences between financial accounting and taxable income. c.Financial accounting rules dictate the use of absolutism, a concept that speaks to the fact that estimates may not be employed. d.All-events and economic performance tests create permanent differences between book and taxable income.

b.Financial accounting rules differ from tax reporting rules, and the all-events test and economic performance test create temporary differences between financial accounting and taxable income.

Which of the following must be true for an expense to be ordinary and reasonable? a.It must be deducted in totality; in other words, to be ordinary an expense cannot be allocable between a reasonable amount and an unreasonable (nondeductible) amount. b.It must be of a kind commonly incurred in the particular income-earning activity; it must be normal, common, and accepted under the circumstances of the business community, and it must be reasonable in amount. c.It must be of a recurring nature. d.Ordinary expenses must occur frequently.

b.It must be of a kind commonly incurred in the particular income-earning activity; it must be normal, common, and accepted under the circumstances of the business community, and it must be reasonable in amount

Which of the following statements regarding profit-motivated expenditures is true? a.Tax law encourages deductions that are motivated solely by the expected tax benefits (savings). b.Only expenses that satisfy the requirement that profit be the dominant motive are classified as business expenses, and tax law prohibits deductions that are motivated solely by the expected tax benefits (savings). c.Personal expenses are never deductible. d.It is not required to identify a profit motive when considering whether an expenditure is deductible or not.

b.Only expenses that satisfy the requirement that profit be the dominant motive are classified as business expenses, and tax law prohibits deductions that are motivated solely by the expected tax benefits (savings).

Which of the following statements regarding related party transactions is true? a.The tax law does not address the matching of deductions with the related reporting of income in order to avoid potential tax avoidance. b.The objective of the related party rules is to defer accrued expenses from transactions that lack economic substance, and the tax law requires a matching of the deduction with the related reporting of income to avoid potential tax avoidance. c.The objective of the related party rules is to accelerate accrued expenses from transactions that lack economic substance. d.Related party rules do not apply if one taxpayer is cash basis and the other is accrual basis.

b.The objective of the related party rules is to defer accrued expenses from transactions that lack economic substance, and the tax law requires a matching of the deduction with the related reporting of income to avoid potential tax avoidance.

Which of the following statements regarding mixed-use assets and expenditures is true? a.An expense allocated to personal use cannot be deducted unless it qualifies as a specifically allowed itemized deduction. b.The portion of expenses reasonably allocated to business use is treated the same as other expenses related to the profit-motivated activity, and an expense allocated to personal use cannot be deducted unless it qualifies as a specifically allowed itemized deduction. c.Mixed-use expenditures are not subject to special treatment. d.Tax law does not address mixed-use assets and expenditures.

b.The portion of expenses reasonably allocated to business use is treated the same as other expenses related to the profit-motivated activity, and an expense allocated to personal use cannot be deducted unless it qualifies as a specifically allowed itemized deduction.

Which of the following statements regarding deductions is true? a.They are identified in tax law by exception (i.e., everything is deductible except for specific items that are exempted). b.They are a part of Congress's approach to implementing the ability-to-pay concept and are a matter of legislative grace. c.They are broadly categorized expenses, suspensions, credits, losses, and other itemized deductions. d.A taxpayer may identify a deduction that seems fair and equitable to him or her and may use that expenditure to reduce income.

b.They are a part of Congress's approach to implementing the ability-to-pay concept and are a matter of legislative grace.

Which of the following statements regarding the business purpose concept is true? a.If the secondary purpose of a transaction is tax savings, it will not be allowed as a deduction. b.To be deductible, the business purpose concept requires an expenditure to have a bona fide business reason other than tax avoidance. If the sole purpose of a transaction is tax savings, it will not be allowed as a deduction. c.The only test for deductibility vis-a-vis the business purpose concept is that an expenditure must directly create profit. d.The dominant motive for incurring a business expense need not be to earn a profit independent of any tax savings.

b.To be deductible, the business purpose concept requires an expenditure to have a bona fide business reason other than tax avoidance. If the sole purpose of a transaction is tax savings, it will not be allowed as a deduction.

Which of the following statements regarding cash basis taxpayers is true? a.Payment of an expense by charging it to a credit card is treated as payment on the date the taxpayer pays the credit card bill. b.Cash basis taxpayers may deduct prepaid expenses in the year paid, regardless of how long the benefit of the asset that was created extends. c.Cash basis taxpayers may deduct prepaid expenses in the year paid if the prepayment does not create an asset that extends substantially beyond the year of payment. d.If a cash basis taxpayer deducts prepaid taxes in the year paid, he or she does not need to report a subsequent refund as income.

c.Cash basis taxpayers may deduct prepaid expenses in the year paid if the prepayment does not create an asset that extends substantially beyond the year of payment.

Which of the following statements regarding economic performance is true? a.Economic performance occurs when the taxpayer disposes of property. b.The purpose of the economic performance test is to allow a current deduction for costs that will not be paid in the near future. c.Economic performance occurs when services or property are provided to the taxpayer. d.Economic performance testing for income taxes does not contrast with financial accounting and the matching principle.

c.Economic performance occurs when services or property are provided to the taxpayer.

Which of the following statements regarding an ordinary expense is true? a.It is a regularly recurring item for the taxpayer. b.It is a normal and regularly recurring item for the taxpayer. c.It is normal, common, and accepted under the circumstances in the business community. d.It is irrelevant how the business community treats the type of expenditure in question; rather, it is how the executive management team treats the expense when defining "ordinary."

c.It is normal, common, and accepted under the circumstances in the business community.

Which of the following statements regarding mixed-use expenditures is true? a.Mixed-use expenditures are allocated to trade or business expenses but not to personal use. b.Mixed-use expenditures are not subject to special treatment. c.Mixed-use expenditures are incurred both for profit and personal reasons. d.The law is very hazy as to how to allocate mixed-use expenditures.

c.Mixed-use expenditures are incurred both for profit and personal reasons.

Which of the following is an example of a permanent difference between financial income and taxable income? a.Executive compensation b.Calculation of depreciation c.The 50% meals and entertainment limitation required by tax law d.Warranty repair allowances

c.The 50% meals and entertainment limitation required by tax law

which of the following statements regarding "reasonable in amount" for deductible expenses is true? a. an expense may be ordinary and necessary even if it is not reasonable b. the portion of an expense that is not reasonable in amount will be deductible because it is part of an ordinary or necessary expense c. the issue of reasonableness is very rarely at question when parties are related d. according to the irs and the courts, an expense must be reasonable in amount to be ordinary and necessary

d. according to the irs and the courts, an expense must be reasonable in amount to be ordinary and necessary

Which of the following statements regarding mixed-use assets is true? a.For tax purposes, a mixed-use asset is always treated as a business asset. b.For tax purposes, a mixed-use asset is always treated as a personal use asset. c.A mixed-use asset is one that is used both to earn income and for personal reasons. d.A mixed-use asset is an asset that is used both to earn income and for personal purposes.

d.A mixed-use asset is an asset that is used both to earn income and for personal purposes.

Which of the following statements illustrates the business purpose concept? a.Claire is considering an expenditure that has a dual personal and business purpose; therefore, the tax deduction is appropriate. b.A sole proprietor can evaluate equally the business purpose for an expenditure and tax avoidance motives when deciding if a potential deduction is viable. c.Claire, a taxpayer who loves to travel and take beautiful photos, is going to the Andes and plans on deducting the cost of the trip in the hope that she can sell some of her photos. Because she is a realtor, this is a solid tax strategy. d.Claire has a deep appreciation of Impressionist art and is planning an extensive trip to France to do research at some its most famous museums. She hopes to use some of her research to become an illustrator. Because there is no profit-motivated transaction impending, she is unable to take a current-year deduction for the travel expenditures.

d.Claire has a deep appreciation of Impressionist art and is planning an extensive trip to France to do research at some its most famous museums. She hopes to use some of her research to become an illustrator. Because there is no profit-motivated transaction impending, she is unable to take a current-year deduction for the travel expenditures.

Which of the following statements regarding adjusted gross income is true? a.Deductions for adjusted gross income are always deductible in full, but deductions from adjusted gross income are subject to limitations. b.Adjusted gross income is unique to corporations' tax computations. c.AGI (adjusted gross income) is a tax concept that applies to individuals, corporations, and conduit entities. d.Deductions for adjusted gross income are more favorably treated than deductions from adjusted gross income.

d.Deductions for adjusted gross income are more favorably treated than deductions from adjusted gross income.

Which of the following statements regarding deductible business expenses is true? a.All start-up costs related to creating a new active trade or business are deductible business expenses. b.Fines and penalties are allowed as a deduction. c.Expenses incurred to earn tax-exempt income are allowed as a deduction. d.Expenses incurred for the cost of investigating, expanding, or establishing new locations for the same line of business are deductible business expenses.

d.Expenses incurred for the cost of investigating, expanding, or establishing new locations for the same line of business are deductible business expenses.

hich of the following statements regarding vacation homes is true? a.If a property is classified as rental property, all expenses are deducted, even those incurred for personal use. b.Vacation home mortgage interest and property taxes on the property may not be deducted as a personal itemized deduction. c.Under the administrative convenience concept, rental income is not reported but rental expenses are deducted for vacation homes. d.If a taxpayer's home is rented more than 14 days and the personal use is more than 14 days, or more than 10% of the number of days rented at fair market value (whichever is longer), then the property is considered a vacation home.

d.If a taxpayer's home is rented more than 14 days and the personal use is more than 14 days, or more than 10% of the number of days rented at fair market value (whichever is longer), then the property is considered a vacation home.

Sarah uses one room in her home as the primary location for her business. Her home is 2,400 square feet, and the office area is 300 square feet. For the current year, she has $10,000 in mortgage interest; $2,000 in real estate taxes; and $13,000 in insurance, repairs, and maintenance related to her home. She calculates depreciation on the home office portion of her home for the current year at $4,000 (do not multiply this by the percentage). She has $25,000 in income and $18,000 in other business expenses. Which of the following statements about her home office deduction is true? a.Sarah can deduct insurance, repairs, and maintenance, but not depreciation. b.Depreciation is never calculated as part of a home office deduction; therefore, Sarah may not deduct it. c.Sarah cannot deduct any of the depreciation, insurance, repairs, or maintenance. d.Mortgage interest and real estate taxes may exceed income from the related business.

d.Mortgage interest and real estate taxes may exceed income from the related business.

Conduit entities include a.both C corporations and S corporations. b.partnerships, C corporations, and S corporations. c.both individuals and corporations. d.partnerships and S corporations.

d.partnerships and S corporations.