Tax CH 6 Smartbook

Granite Corporation incurred $3.5 million of net interest expense in 2021. Granite had gross receipts of over $26 million for the past thee years. If Granite's adjusted taxable income is $7 million, Granite is permitted a current interest deduction of what amount?

$2.1 mil

Kolepp Corporation, an accrual basis taxpayer, performs consulting services. On November 1, 2020, Kolepp billed a client for $3,000 of services performed. Payment was received on January 5, 2021. Kolepp recognizes $______ of taxable income in 2020.

$3,000

Linguistic Specialists, an accrual basis taxpayer, offers language lessons for $40 per lesson. In 2020, they contracted to provide 50 Spanish lessons over the next 24 months. The lessons were provided as follows: 10 lessons in 2020, 25 in 2021, and 15 in 2022. Select the option that represents income recognition in 2020, 2021, and 2022 for tax purposes.

$400 in 2020; $1,600 in 2021; $0 in 2022 Reason: An accrual basis taxpayer may defer the prepayment up to one year. $400 is earned and reported in 2020. The remainder of the prepayment (or $2,000) must be recognized in 2021.

In 2023, Jeremy took a client to lunch to discuss business. The bill was $120. The amount and classification of the book tax difference is ______.

$60/permanent

In order for an expense to be deductible, the all-events test requires that

- the amount of the liability can be determined with reasonable accuracy - the amount of liability is fixed - economic performance has occurred

T/F: A change in accounting method from one permissible method of accounting to another (ex. from cash to accrual) does NOT require permission from the IRS

False

T/F: The QBI deduction increases the marginal tax rate of noncorporate businesses

Fasle

Which of the following statements about the accounting for bad debt is true?

the direct write-off method for tax purposes results in a temporary book/tax difference

Which of the following statements about constructive receipt is false?

the doctrine applies to both cash and accrual basis taxpayers

Last year, Tech-to-Go, an accrual basis taxpayer, wrote-off $10,000 in accounts as uncollectible. This year, Tech-to-Go received a check for $1,000 on one of these accounts. Which of the following statements is false?

the receipt has no affect on taxable income

Which of the following statements about accounting methods is false?

the same accounting method must be adopted for all related entities

Which of the following statements about tax preferences is false?

Tax preferences serve to simply the tax code

Which of the following statements about methods of accounting is false?

Taxpayers must use the same method of accounting to compute tax as they use to compute financial statement income.

Lyster and Mister Corporation enter into a business transaction. The two companies are considered related parties for tax purposes. Which of the following statements is true?

The IRS has the right to reallocate income from the transaction to prevent distortion of taxable income among the related parties

Which of the following statements about the all-events test is false?

an accrued expense is not deductible unless economic performance with respect to the liability has occurred

Which of the following statements is true about the principle of conservatism?

for tax purposes, it implies mitigating the tendency to under-report taxable income

Which of the following statements is true regarding an NOL deduction

in tax years after 2020, the deduction allowed for a post TCJA NOL is limited to 80% of taxable income before such deduction

Payment liabilities are deductible when the liability

is paid

Which of the following statements about the recurring item exception election is false?

it requires that economic performance occur before a deduction is permitted

Which of the following is not an example of a payment liability?

liabilities associated with purchases of inventory

The cash method of accounting

may not be used by corporations that average more than $26 million in annual gross receipts

An excess of deductible expenses over gross income is termed a

net operating loss

The Internal Revenue Code provides a deduction for "all ___ and ___ " expenses paid or incurred during the taxable year in carrying on any trade or business.

ordinary ; necessary

Municipal bond interest results in

permanent

Froggie Corp. reported $1,500,000 book income this year. Froggie reported $50,000 of unfavorable permanent differences and $200,000 of favorable temporary differences. Assume a 21% tax rate, which of the following statements is false?

permanent differences result in a deferred tax liability of $10,500 permanent differences do not create deffered tax assets or liabilities

The hybrid method of accounting

requires cash basis taxpayers to use accrual accounting for inventory

A change in accounting method ______.

requires permission from the IRS

The tax benefit rule associated with bad debts _____

requires that income be reported if an amount deducted in a previous year as an uncollectible account is later collected

Which of the following statements regarding the accounting for inventory is false?

service companies that have limited inventory sales must always use the accrual method for tax purposes to account for inventory

When excess business losses are not currently deductible

such losses carry forward and are treated as net operating losses in subsequent years

Proceeds paid to the beneficiary of a key-person life insurance policy are ______. As a result, the premiums paid are ______.

tax-exempt; non-deductible

A ___ difference between book income and taxable income results when an item of income is reflected on the books in a different period than when included in taxable income.

temporary

Which of the following statements about the net operating loss (NOL) deduction is true?

the NOL deduction reflects the idea that since a business pays taxes when profitable, they should also have some tax relief when they are not

Clunky Company has used a calendar year since incorporation. Clunky received permission to change to a May 31 fiscal year. Clunky must file a(n) ___ period tax return that covers the___ -month period, ____ 1 to _____ 31.

- short - five - January - May

An NOL results in a(n) ___ book/tax difference and generates a deferred tax ___.

- temporary - asset

A deferred tax asset is created when ______ differences create excess ______ income over ______ income.

- temporary - taxable - book

On December 27, 2020, Happy Holiday Company received a $2,500 check in the mail for services performed in December. The office closed December 24, 2020 for two weeks for the holiday break. Because of the ____ doctrine, Holiday will report $ ___ income related to these services on its 2020 tax return.

- constructive - receipt - $2500

The QBI deduction ______.

- effectively lowers the marginal tax rate on business income earned through sole proprietorships, partnerships, and S corporations - generally equals 20% of qualified business income

The IRS ______. (Select all that apply.)

- more closely scrutinizes income recognition of related party transactions relative to unrelated parties - under Section 482, has the right to reallocate income and deductions between related parties

Which of the following statements about municipal bond interest are correct?

- municipal bond interest is a tax preference - municipal bond interest is recognized as income for financial reporting purposes

Sky Inc. is an accrual basis, calendar year taxpayer. Sky contracts with Guardian Company to provide their security services and pays $6,000 every 6 months. Full payment of $6,000 was made on November 15, 2020 to cover the 6-month period beginning December 1, 2020. Which of the following statements is true? (Select all that apply.)

- If the recurring items election is adopted, Sky may deduct the full $6,000 in 2020. - Under general rules for accrual accounting, Sky may deduct $1,000 in 2020.

Which of the following statements is true regarding transactions between related parties?

- a taxpayer may be required to defer a deduction in a related party transaction until income is recognized by the other party to the transaction - when transacting parties use different accounting methods, the two sides (income/deduction) may not be reported in the same year

Which of the following statements best describes a permanent book/tax difference?

- an income item reported on the income statement but never included as taxable income on the tax return - an expenditure that is reported on the current income statement but for tax purposes is only %50 deductible

Temporary differences ______.

- can cause taxable income to exceed book income in a given year - can cause book income to exceed taxable income in a given year - result from differences in the timing for recognition of income or deductions for book and tax purposes

Which of the following taxpayers is subject to the excess business loss limitation?

- partner in partnership operating a business - individual operating a business as a sole proprietorship - shareholder in an S corporation operating a business

Which of the following statements are TRUE with respect to the deductibility of the following business expenditures?

- the costs to settle a civil lawsuit is NOT deductible - a penalty paid to the bank for a late payment on a loan is deductible - the cost of a business lunch at a local restaurant during 2021 is fully deductible

Richard's Rentals is an accrual basis taxpayer. On October 15, 2020, Richard's Rentals received a $24,000 rent check to cover the 12-month period November 1, 2020 to October 31, 2021. In 2020, Richards must report $ ___ of book income and $ ___ of taxable income.

4,000 24,000

In 2020, Charlie's Customs Cakes sold 100 cakes at a cost of $100 each. At the end of the year, 20 of those cakes had been invoiced, but the payment was not yet received. Payment was received in January 2021. As a cash basis business taxpayer, Charlie should report $ of taxable income in 2020.

8,000

Which of the following statements about deductions is true?

A deduction is permitted for the cost of long-term assets, but this deduction is generally spread over several years.

Which of the following statements is inconsistent with the federal tax definition of gross income?

Gross income does not include increases in wealth unless it is accompanied by the receipt of cash.

Elite Company has used a calendar year since incorporation. The company has a strong business reason to support changing to a March 31 fiscal year-end. Which of the following statements is true?

If Elite changes to a fiscal year-end, it must file a short-period return in the year of the change for the 3-month period, January 1 to March 31.

Plato Corporation operates a business with a natural annual operating cycle ending February 28. Which of the following best describes Plato's options for adopting a taxable year?

Plato is permitted to adopt a calendar year or any fiscal year

T/F: Contrasting principles of conservatism between tax law and GAAP lead to many book/tax differences

True

Which of the following statements is false regarding NOLs?

a NOL carryforward results in a deferred tax liability

Which of the following statements about the cash method of accounting is true?

a cash basis taxpayer who is in constructive receipt of an income item must recognize that income currently

Which of the following best describes the reason a deduction is disallowed for a fine or a penalty paid to a government?

a deduction would essentially be a government subsidy for bad or illegal behavior

Assume Zippy Motors is a Fortune 500 firm that manufactures and sells sports cars. Which method of accounting must Zippy use?

accrual

Regardless of when payment is received, the ___ method of accounting is intended to match expenses against revenue in the year the liability for the expense is incurred.

accrual

Regardless of when payment is received, the _____ method of accounting is intended to match expenses against revenue in the year the liability for the expense is incurred

accrual

If a taxpayer is involved in multiple businesses, the excess business loss limitation

applies to aggregate deductions from the taxpayers businesses over income and gains plus a threshold amount

If a taxpayer is involved in multiple businesses, for post-2020 tax years the excess business loss limitation ______.

applies to the aggregate of deductions from all businesses over income and gains from all businesses

In general, business managers prefer to report ______.

as much income as possible for book purposes, but as little taxable income as possible

Tax expense per books is based on

before-tax book income adjusted for permanent differences

The firm's choice of a calendar or fiscal year is usually dictated ______.

by the operating cycle of the firm

If financial records are ket for a 12-month period ending December 31, the firm has adopted a ___ year. If the financial records are kept on a 12-month period ending on any other date, the firm has adopted a ____ year

calendar ; fiscal

If some portion of a company's business interest expense is not currently deductible as a result of the business interest limitation, the nondeductible interest ______.

can be carried forward to succeeding taxable years as business interest

A permanent book/tax difference

can relate to both the deductibility of expenses and the recognition of income

Under the general rules for the ___ method of accounting, income is recognized when payment is received

cash

T/F: In applying the excess business loss limitation, a taxpayer involved in multiple businesses is allowed to net losses from one business against profits from another

true

Which of the following statements about the cash method of accounting is false?

under the cash method, annual taxable income always equals annual net cash flow