Becker: REG 1, Modules 3 & 4

A guaranteed payment by a partnership to a partner for services rendered, may include an agreement to pay: I. A salary of $10,000 monthly without regard to partnership income. II. A 30% interest in partnership profits. (1) I only (2) II only (3) Both I and II (4) Neither I nor II

Choice "1" is correct. I. A guaranteed payment is a salary or other payment to a partner that is not calculated with respect to partnership income. II. Since the 25% interest is calculated with respect to partnership profits, it is not a guaranteed payment.

The percentage-of-completion method is required for tax purposes for long-term contracts unless an exemption exists for the taxpayer. Which of the following situations does not describe an exemption from using the percentage-of-completion method for a long-term contract? (1) A Long-term construction contract that includes land with 20% of the contract cost for construction of property on the land (2) Services performed under a maintenance agreement (3) A project completed in an eighteen-month period by a contractor with average annual gross receipts of $8 million for the last five years (4) Services of an engineer contracted by a builder responsible for a two-year project

Choice "1" is correct. A long-term construction contract that includes land and less than 10% of the total contract cost relates to the actual construction of property on the land is exempt from the percentage-of-completion method reporting requirement. Because the contract has 20% of the cost related to construction of property, the contract is not exempt. Choice "2" is incorrect. Services performed under a maintenance agreement are exempt from percentage-of-completion reporting requirements. Choice "3" is incorrect. Projects that are expected to last no more than two years and are performed by a taxpayer with average annual gross receipts not exceeding $25 million for the three previous years are exempt from percentage-of-completion reporting requirements. Choice "4" is incorrect. The service of an engineer contracted by a builder on a long-term project is exempt from the percentage-of-completion reporting requirement.

Which of the following is considered a specified service trade or business (SSTB) for purposes of the qualifying business income deduction? (1) Accounting firm (2) Manufacturing company (3) Engineering firm (4) Architectural services

Choice "1" is correct. Accounting services are considered an SSTB for purposes of the qualified business income deduction. Choice "2" is incorrect. A manufacturing firm is a qualified trade or business (QTB) and not an SSTB. Choice "3" is incorrect. An engineering firm is specifically excluded from the definition of an SSTB. Choice "4" is incorrect. Architectural services are specifically excluded from the definition of an SSTB.

Aston and Becker are equal partners in AB Partnership. In the tax year, the ordinary income of the partnership is $20,000, and the partnership has a long-term capital gain of $12,000. Aston's basis inAB was $40,000, and he received distributions of $5,000 during the year. What is Aston's share of AB's ordinary income? (1) $10,000 (2) $15,000 (3) $16,000 (4) $18,500

Choice "1" is correct. Aston's share of ordinary income is $10,000 (50 percent partnership percentage × $20,000 partnership ordinary income). Choice "2" is incorrect. Ordinary income does not include distributions. Choice "3" is incorrect. Ordinary income does not include long-term capital gains. Choice "4" is incorrect. Ordinary income does not include distributions or long-term capital gains.

Bartlet owns a manufacturing business and participates in the business. Which of the following conditions would cause the business to be considered a nonpassive activity for Bartlet? (1) Bartlet participates in the business for more than 500 hours during a year (2) The business made a profit in any three of the last five years that preceded the current year (3) The business has at least 10 employees who, individually or collectively, work for the business more than 1,000 hours in a year (4) Bartlet files an election with the IRS postponing nonpassive activity classification

Choice "1" is correct. Bartlet's participation in the business would be considered nonpassive if he is considered to materially participate in the business. One test used for determining material participation in a business is if the individual participates in the activity for more than 500 hours during the year. Choice "2" is incorrect. Whether an activity made a profit in any three of the last five years preceding the current year is a test for determining if the activity is a business as compared to a hobby. Choice "3" is incorrect. This is not a test that would be used to determine if the activity is a nonpassive activity for Bartlet. Choice "4" is incorrect. This is not a test to determine whether an individual materially participates in a business.

Which of the following costs are subject to the Uniform Capitalization Rules of Code Sec. 263A for manufactured tangible personal property? (1) Off-site storage (2) Advertising (3) Research (4) Marketing

Choice "1" is correct. Costs required to be capitalized under the uniform capitalization rules include direct materials, direct labor, and applicable indirect costs. Applicable indirect costs include utilities, warehousing costs, repairs, maintenance, indirect labor, rents, storage, depreciation and amortization, insurance, pension contributions, engineering and design, repackaging, spoilage and scrap, and administrative supplies. Choice "2" is incorrect. Costs not required to be capitalized include selling, advertising, and marketing expenses, certain general and administrative expenses, research, and officer compensation not attributed to production services. Choice "3" is incorrect. Costs not required to be capitalized include selling, advertising, and marketing expenses, certain general and administrative expenses, research, and officer compensation not attributed to production services. Choice "4" is incorrect. Costs not required to be capitalized include selling, advertising, and marketing expenses, certain general and administrative expenses, research, and officer compensation not attributed to production services.

Rich is a cash basis self-employed air conditioning repairman with current year gross business receipts of $20,000. Rich's cash disbursements were as follows: Air-conditioning parts $2,500 Yellow pages listing 2,000 Estimated federal income taxes on self-employment income 1,000 Business long-distance telephone calls 400 Charitable contributions 200 What amount should Rich report as net self-employment income? (1) $15,100 (2) $14,900 (3) $14,100 (4) $13,900

Choice "1" is correct. Deductions to arrive at net self-employed income include all necessary and ordinary expenses connected with the business. Estimated federal income tax payments are not an expense. Charitable contributions by an individual are only deductible as an itemized deduction on Schedule A. This assumes the contribution was not made with the "expectation of commensurate financial return." Receipts 20,000 Parts (2,500) Listing (2,000) Telephone (400) Net self-employment income 15,100 Choice "2" is incorrect. Charitable contributions are an itemized deduction unless there is an expectation of commensurate financial return. Choice "3" is incorrect. Federal income taxes paid are not a deductible expense. Choice "4" is incorrect. Charitable contributions are an itemized deduction unless there is an expectation of commensurate financial return. Federal income taxes paid are not a deductible expense.

Under the uniform capitalization rules applicable to property acquired for resale, which of the following costs should be capitalized with respect to inventory if no exceptions are met? Repackaging costs; Off-site storage costs (1) Yes; Yes (2) Yes; No (3) No; Yes (4) No; No

Choice "1" is correct. Direct material, direct labor, and factory overhead (applicable indirect costs) are capitalized with respect to inventory under the uniform capitalization rules for property acquired for resale. Applicable indirect costs include depreciation and amortization, insurance, supervisory wages, utilities, spoilage and scrap, design expenses, repair and maintenance and rental of equipment and facilities (including offsite storage), some administrative costs, costs of bonus and other incentive plans, and indirect supplies and other materials (including repackaging costs).

Which of the following is true about the qualifying business income (QBI) deduction for taxpayers with taxable income above the taxable income limitations? (1) If the taxpayer is a specified service trade or business (SSTB), no QBI deduction is allowed (2) If the taxpayer is a qualified trade or business (QTB), W-2 wage and property limitations do not apply (3) If the taxpayer is a qualified trade or business (QTB), W-2 wage and property limitations are phased in (4) If the taxpayer is a specified service trade or business (SSTB), W-2 wage and property limitations apply

Choice "1" is correct. For a specified service trade or business (SSTB) over the taxable income limitation, no QBI deduction is allowed. Choice "2" is incorrect. For a qualified trade or business (QTB) over the taxable income limitation, W-2 wage and property limitations do apply. Choice "3" is incorrect. For a qualified trade or business (QTB) over the taxable income limitation, W-2 wage and property limitations apply in full and are not phased in. Choice "4" is incorrect. For a specified service trade or business (SSTB) over the taxable income limitation, no QBI deduction is allowed.

Briana has various items of income as follows: W-2 wages $24,000 Interest and dividends $3,000 Sole proprietorship income on Schedule C $98,000 Income from an S corporation from Schedule K-1 $12,000 Income as a limited partner from a limited partnership from Schedule K-1 $10,000 For purposes of self-employment tax, what are the net earnings from self-employment? (Note: Please answer before the required 92.35% calculation on Schedule SE.) (1) $98,000 (2) $22,000 (3) $27,000 (4) $10,000

Choice "1" is correct. Income subject to self-employment includes amounts from an unincorporated sole proprietorship (Schedule C) and general partnerships. It does not include W-2 wages, interest, dividends, income from an S corporation, or income as a limited partner from a limited partnership. The only amount here that qualifies is the $98,000 sole proprietorship income.

Harry has various items of income as follows: W-2 wages $24,000 Interest and dividends $3,000 Rental real estate on Schedule E $8,000 Income from an S corporation from Schedule K-1 $12,000 Income from a general partnership from Schedule K-1 $10,000 For purposes of the self-employment tax, what are the net earnings from self-employment? (Note: Please answer before the required 92.35% calculation performed on Schedule SE.) (1) $10,,000 (2) $22,000 (3) $30,000 (4) $57,000

Choice "1" is correct. Income subject to self-employment includes amounts from an unincorporated sole proprietorship (Schedule C) and general partnerships. It does not include W-2 wages, interest, dividends, rental real estate income, or income from an S corporation. The only amount here that qualifies is the $10,000 from the general partnership.

IRC Section 263A requires the capitalization of certain indirect costs related to inventory when a qualifying business is manufacturing tangible personal property. Which of the following costs is not required to be capitalized as part of this adjustment? (1) Marketing (2) Recruiting (3) Payroll (4) Securities services

Choice "1" is correct. The general rule is that product costs are capitalized, such as direct materials, indirect materials, and factory overhead. Period expenses are not capitalized, including G&A, selling, and R&D. Marketing is a period expense that is not capitalized. Choices "2", "3", and "4" are incorrect. These are all factory overhead items related to product costs that would be capitalized.

During a major sports event, a taxpayer rented his primary residence to spectators for 10 days. The taxpayer's rental income and expenses were as follows: Rental income $10,000 Prorated mortgage interest and taxes 1,000 Advertising 500 Commissions 1,000 How much net rental income must the taxpayer report on his income tax return? (1) $0 (2) $7,500 (3) $8,500 (4) $10,000

Choice "1" is correct. The taxpayer rented his primary residence for less than 15 days during the year, so he is not required to include the rental income on his income tax return, nor is he allowed to deduct the commissions and advertising expenses related to the rental activity. He is still allowed to deduct the mortgage interest and real estate taxes as itemized deductions. Choice "2" is incorrect. The net income from rental of the taxpayer's residence, including a prorated portion of mortgage interest and real estate taxes, is $7,500. However, the taxpayer is not required to include the rental income on his income tax return because he rented his residence for less than 15 days during the year. Choice "3" is incorrect. The net income from rental of the taxpayer's residence, excluding the prorated portion of mortgage interest and real estate taxes, is $8,500. However, the taxpayer is not required to include the rental income on his income tax return because he rented his residence for less than 15 days during the year. Choice "4" is incorrect. The taxpayer is not required to include the $10,000 of rental income on his income tax return because he rented his residence for less than 15 days during the year.

Which of the following costs is not included in inventory under the Uniform Capitalization rules for goods manufactured by the taxpayer? (1) Research (2) Warehousing costs (3) Quality control (4) Taxes excluding income taxes

Choice "1" is correct. Uniform Capitalization rules provide guidelines with respect to capitalizing or expensing certain costs. With regard to inventory, direct materials, direct labor, and factory overhead should be capitalized as part of the cost of inventory. Warehousing costs, quality control, and taxes, excluding income taxes, are all considered factory overhead items. The research should be expensed.

Vale is a 50% partner in Ball Partnership. Vale's tax basis in Ball on January 2, year 1, was $60,000. Ball did not have unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. On December 31, year 1, Ball made a $10,000 non-liquidating cash distribution to each partner. The Ball Partnership income tax return reported the following items for yea: Tax-exempt interest income $80,000 Dividend income 12,000 What total amount of gross income from Ball should be included in Vale's year 1 adjusted gross income? (1) $6,000 (2) $16,000 (3) $36,000 (4) $46,000

Choice "1" is correct. Vale includes only his share of dividend income from the partnership ($12,000 × 50% = $6,000) in adjusted gross income. Choice "2" is incorrect. Adjusted gross income does not include cash distributions if the distributions do not exceed the partner's tax basis in the partnership interest prior to distribution. Choice "3" is incorrect. Adjusted gross income does not include tax-exempt interest income because it is not taxable. Cash distributions decrease the partner's tax basis in the partnership interest, and do not decrease adjusted gross income. Choice "4" is incorrect. Adjusted gross income does not include tax-exempt interest income because it is not taxable.

Baker, a sole proprietor CPA, has several clients that do business in Spain. While on a four-week vacation in Spain, Baker took a five-day seminar on Spanish business practices that cost $700. Baker's round-trip airfare to Spain was $600. While in Spain, Baker spent an average of $100 per day on accommodations, local travel, and other incidental expenses, for total expenses of $2,800. What amount of total expense can Baker deduct on Form 1040 Schedule C, "Profit or Loss From Business," related to this situation? (1) $700 (2) $1,200 (3) $1,800 (4) $4,100

Choice "2" is correct. Baker can deduct $1,200 in total expense on Form 1040 Schedule C, calculated as follows: Direct educational expenses 700 [cost of the course] Daily expenses for 5-day seminar 500 [$100 per day × 5] Total educational expenses 1,200 Rule: If foreign travel is primarily personal in nature (e.g., a vacation), none of the travel expenses (e.g., round-trip airfare) incurred will be allowable business deductions, even if the taxpayer was involved in business activities while in the foreign country. Choice "1" is incorrect, as the expenses for the five-day period Baker attended the seminar were directly related to being in Spain for the additional period of time and are allowable business deductions.

The Groves own a beach house as a second home. This year, the Groves used the beach house personally for 4 months. For 14 days during the summer, the Groves rented out their beach house for $5,000 total to friends. Which statement is true regarding the taxability of the Groves' beach house? (1) 5,000 is included in gross income (2) Mortgage interest paid on the beach house is deductible (3) All repair expenses on the beach house are deductible (4) Depreciation expense on the beach house is deductible.

Choice "2" is correct. Because the Groves rented their cabin for fewer than 15 days, it is treated as a personal residence. Therefore, the rental income is excluded from gross income and mortgage interest and real estate taxes are deductible as itemized deductions on schedule A (subject to limitations). Choice "1" is incorrect. Because the Groves rented their cabin for fewer than 15 days, it is treated as a personal residence. Mortgage interest and real estate taxes are deductible as itemized deductions on schedule A (subject to limitations). Choices "3" and "4" are incorrect. Because the Groves rented their cabin for fewer than 15 days, it is treated as a personal residence. Therefore, repairs, utilities, depreciation, and other allowed rental expenses are not deductible.

Dr. Merry, a self-employed dentist, incurred the following expenses: Investment expenses $700 Custodial fees related to Dr. Merry's Keogh plan $40 Work uniforms for Dr. Merry and Dr. Merry's employees $320 Subscriptions for periodicals used in the waiting room $110 Dental education seminar $1,300 What is the amount of expenses the doctor can deduct as business expenses on Schedule C, Profit or Loss from Business? (1) $1,620 (2) $1,730 (3) $1,770 (4) $2,430

Choice "2" is correct. Business expenses include work uniforms for the taxpayer and taxpayer's employees, subscriptions for periodicals for patient use, and continuing education expenses. Choice "1" is incorrect. Business expenses include subscriptions for periodicals for patient use. Choice "3" is incorrect. Business expenses do not include custodial fees for retirement accounts. Choice "4" is incorrect. Business expenses do not include investment expenses

On December 1 of the current taxable year, Krest, a self-employed cash basis taxpayer, borrowed $200,000 to use in her business. The loan was to be repaid on November 30 of the following year. Krest paid the entire interest amount of $24,000 on December 1 of the current year. What amount of interest was deductible on Krest's current year income tax return? (1) $0 (2) $2,000 (3) $22,000 (4) $24,000

Choice "2" is correct. Cash basis taxpayers deduct interest in the year paid or the year to which the interest relates, whichever is later. Even though all of the interest on this loan was paid on December 1, of the current year, only the interest relating to December of the current year can be deducted in the current year. The question does not give an interest rate, but because the loan is to be repaid in a lump sum at maturity, 1/12 of the interest, or $2,000 applies to each month. Choice "1" is incorrect. Because $2,000 of the interest relates to the current year, this amount is deductible in the current year. Choice "3" is incorrect. This is the amount that cannot be deducted until the following year, the year to which the interest relates. Be sure to read questions like this very carefully, because if you had simply misread the question as seeking the amount deductible in the following year, you would get the question wrong despite understanding the rule. Choice "4" is incorrect. Cash basis taxpayers can deduct interest in the year paid or the year to which the interest relates, whichever is later, thus 11 months of the interest will not be deductible until next year.

Miyasyke, Inc., a calendar year S corporation, has 5 equal shareholders at the end of the tax year. Miyasyke had $75,000 of taxable income. Miyasyke made distributions to its shareholders of $32,000 each, for a total of $160,000. Each shareholder's basis in the S corporation is $100,000 at the beginning of the tax year. What amount from Miyasyke should be included in each shareholder's gross income? (1) $0 (2) $15,000 (3) $32,000 (4) $47,000

Choice "2" is correct. Each shareholder reports his/her pro rata share of the S corporation's taxable income in his or her gross income. The distributions are not taxable to the extent the shareholders' basis exceeds the distribution (and increased for any income reported by them during the year). Choice "1" is incorrect. Each shareholder's share of taxable income (non-separately stated) is reported in the shareholder's gross income. Choices "3" and "4" are incorrect. Choice "3" only includes the distribution, which is not taxable in this case as the shareholder's basis exceeds the distribution. Choice "4" includes both the shareholder's pro rata share of the taxable income and the distribution. The distribution is not taxable in this situation.

Juan recently started operating a flower shop as a proprietorship. In its first year of operations, the shop had a taxable income of $60,000. Assuming that Juan had no other employment-related earnings: (1) The flower shop must withhold FICA taxes from Juan's earnings (2) Juan must pay self-employment tax on the earnings of the business (3) Juan will be exempt from self-employment taxes for the first three years of operations (4) Juan will be exempt from the Medicare tax because the business earnings are below the threshold amount

Choice "2" is correct. Earnings from self-employment are subject to the income tax as well as to the federal self-employment tax. Thus, Juan must pay self-employment tax on the earnings of the business. Choice "1" is incorrect. Because Juan is the proprietor of a sole proprietorship (as opposed to an employee of an employer), the flower shop will not pay Juan a wage, and thus will not withhold either income taxes or FICA taxes from that wage. Choice "3" is incorrect. There is no provision exempting a proprietorship from self-employment taxes for its first three years of operations. Choice "4" is incorrect. No self-employment tax is owed if self-employment income, after multiplying by 92.35 percent, is less than $400. However, Juan's self-employment income exceeds this threshold, and thus Juan is not exempt from either of the two components of the self-employment tax (the Medicare tax and the Social Security tax).

Gena, an unmarried individual, had an adjusted gross income of $125,000 in the current year before any IRA deduction, taxable social security benefits, or passive activity losses. Gena incurred a loss of $30,000 in the current year from rental real estate in which she actively participated. What amount of loss attributable to this rental real estate can be used in the current year as an offset against her income from non-passive sources? (1) $0 (2) $12,500 (3) $15,000 (4) $25,000

Choice "2" is correct. Gena may use $12,500 of the loss attributable to her rental real estate activities as an offset to her income from non-passive sources in the current year. RULE: Rental real estate activities are passive activities, and losses from them are generally not allowed to be used as an offset against income from any non-passive activities. However, there is a limited exception to this general rule in the case where a taxpayer actively participates in rental real estate. Under this exception, up to $25,000 of passive losses may be used to offset income from non-passive sources. This $25,000 allowance is reduced (not below zero) by an amount equal to 50% of the amount by which the taxpayer's modified AGI exceeds $100,000 (becoming fully phased-out at modified AGI of $150,000). In this case, modified AGI of $125,000 is $25,000 higher than the $100,000 floor. The allowance of the $25,000 exception (which would apply in Gena's case) is reduced by 50% of the difference (or $12,500). Therefore, the amount allowable to be used to offset against non-passive sources is $12,500. Note that MFS filers are not allowed any loss deduction amount unless they lived apart the entire year. If MFS filers do live apart for the entire year, they each can claim a maximum deduction of $12,500 before the phase-out, which begins when MAGI exceeds $50,000. Choice "1" is incorrect. Gena actively participates in the rental real estate activity and her modified AGI does not exceed $150,000, therefore, she is entitled to a deduction. Choice "3" is incorrect. This answer represents 50% of the loss from rental real estate activities, which is not the proper calculation. Choice "4" is incorrect. This is the entire loss from rental real estate activities, which is limited based upon Gena's modified AGI.

The Jacksons, who file a joint return, actively participate in a solely-owned rental real estate activity that produces a $30,000 loss during the current year. Their adjusted gross income was $120,000 before considering the rental activity. How much of the rental loss, if any, are the Jacksons entitled to deduct? (1) $0 (2) $15,000 (3)$25,000 (4) $30,000

Choice "2" is correct. Generally, passive losses are only deductible against other passive income, and there is no passive income in the facts of this question. However, the "mom and pop" exception will apply because the Jacksons actively participate in the activity. This exception allows up to $25,000 of passive losses to be deducted against other nonpassive income. There is a phase-out over an adjusted gross income (AGI) range of $100,000 to $150,000. The Jacksons' AGI is $120,000, and that is 40% into the phase-out range. Therefore, 40% of the $25,000 exception amount is phased out, and the deduction is $15,000 [$25,000 - ($25,000 × 40%)]. Choice "1" is incorrect. $0 would be correct if the "mom and pop" exception did not apply or was completely phased out. Choice "3" is incorrect. $25,000 would be the correct answer if the entire "mom and pop" exception applied. Choice "4" is incorrect. $30,000 would only be correct if at least that amount of other passive income existed.

Pat has various items of income as follows: W-2 wages $24,000 Interest and dividends $3,000 Sole proprietorship income on Schedule C $8,000 Income from an S corporation from Schedule K-1 $12,000 Income from a general partnership from Schedule K-1 $10,000 For purposes of the self-employment tax, what are the net earnings from self-employment? (Note: Please answer before the required 92.35% calculation performed on Schedule SE.) (1) $10,000 (2) $18,000 (3) $22,000 (4) $57,000

Choice "2" is correct. Income subject to self-employment includes amounts from an unincorporated sole proprietorship (Schedule C) and general partnerships. It does not include W-2 wages, interest, dividends, or income from an S corporation. The only amounts here that qualify are the $8,000 sole proprietorship income and the $10,000 from the general partnership.

Nan, a cash basis taxpayer, borrowed money from a bank and signed a 10-year interest-bearing note on business property on January 1 of the current year. The cash flow from Nan's business enabled Naan to prepay the first three years of interest attributable to the note on December 31 of the current year. How should Nan treat the prepayment of interest for tax purposes? (1) Deduct the entire amount as a current expense (2) Deduct the current year's interest and amortize the balance over the next two years (3) Capitalize the interest and amortize the balance over the 10-year long period (4) Capitalize the interest as part of the basis of the business property

Choice "2" is correct. Interest paid in advance by a cash basis taxpayer on business loans cannot be deducted until the tax period to which the interest relates. In other words, the interest must be both paid and incurred in order to be deducted.

Which of the following is the overall limitation to the qualifying business income (QBI) deduction? (1) Lesser of: 50 percent of combined QBI or 20 percent of the taxpayer's taxable income in excess of net capital gain (2) Lesser of: combined QBI or 20 percent of the taxpayer's taxable income in excess of net capital gain (3) Lesser of: 50 percent of W-2 wages or 25 percent of W-2 wages plus 2.5 percent of the unadjusted basis of qualified property (4) Taxable income limitations based on filing status

Choice "2" is correct. Once the QBI deduction is calculated based on the taxpayer's eligibility, the overall deduction is limited to the lesser of combined QBI or 20 percent of the taxpayer's taxable income in excess of net capital gain. Choice "1" is incorrect. Once the QBI deduction is calculated based on the taxpayer's eligibility, the overall deduction is limited to the lesser of combined QBI (not 50 percent of the combined QBI) or 20 percent of the taxpayer's taxable income in excess of net capital gain. Choice "3" is incorrect. The wage and property limitation determines the calculation of the QBI deduction but is not the overall limitation to the QBI deduction. Choice "4" is incorrect. Taxable income limitations based on filing status determine the calculation of the QBI deduction. The overall limitation to the deduction, however, is the lesser of combined QBI or 20 percent of the taxpayer's taxable income in excess of net capital gain.

On December 1 of the prior year, Michaels, a self-employed cash basis taxpayer, borrowed $100,000 to use in her business. The loan was to be repaid on November 30 of the current year. Michaels paid the entire interest of $12,000 on December 1 of the prior year. What amount of interest was deductible on Michaels' current year income tax return? (1) $12,000 (2) $11,000 (3) $1,000 (4) $0

Choice "2" is correct. Prepaid interest must be prorated over the time for which payment is made. This is true for both cash and accrual basis taxpayers. The loan is for 1 month in Year 1 and 11 months in Year 2. Therefore, 1/12 of the interest is deductible in Year 1 and 11/12, or $11,000 is deductible in Year 2. Choices "1", "3", and "4" are incorrect. Prepaid interest must be prorated over the time for which payment is made. This is true for both cash and accrual basis taxpayers.

Which of the following statements regarding the self-employment tax is true? (1) Income and expenses from self-employment is reported on Schedule D (Form 1040) (2) Self-employment income is subject to both federal income tax and self-employment tax (3) One half of self-employment tax is deductible as an itemized deduction (4) All self-employment income is subject to both Medicare and Social Security tax

Choice "2" is correct. Self-employment income is subject to federal income tax and self-employment tax. The self-employment tax is made up of Social Security (12.4%) and Medicare (2.9%), for a total of 15.3%. Choice "1" is incorrect. Income from self-employment is reported on Schedule C of Form 1040. Choice "3" is incorrect. One half of self-employment tax is deductible as an AGI deduction. Choice "4" is incorrect. All self-employment income is subject to the 2.9% Medicare tax, but Social Security tax is subject to the 12.4% tax only up to a certain threshold.

Tom and Sharlene had the following items of income and expense during the taxable year: Self-Employment Activity Gross Income $35,000 Business license fees 500 Marketing Expenses 2,000 Salary paid to Sharlene 10,000 Tom's wages from his job 67,000 Interest from money market 1,500 Gain from sale of securities owned for 3 months 15,000 What is Tom & Sharlene's gross income before adjustments? (1) $106,000 (2) $116,000 (3) $128,500 (4) $131,500

Choice "2" is correct. Tom & Sharlene's gross income is calculated as follows: Net self-employment income 32,500 Tom's wages 67,000 Interest 1,500 Gain from sale 15,000 Total gross Income 116,000 Note: Sharlene's salary is not included as income as 100% of the net self-employment activity is taxable to her. Her salary is considered a draw and is not an allowable business deduction against the gross income of the self-employment activity.

The Morgan Trust, a complex trust, had distributable net income (DNI) in Year 4 of $10,000. Of the $10,000 of DNI, $4,000 was distributed to trust beneficiaries. Of the $4,000 distributed, which taxpayer(s), if any, are responsible for the tax liability on the $4,000 distribution? (1) The Morgan Trust (2) The trust beneficiaries (3) The Morgan Trust and the trust beneficiaries (4) Neither the Morgan Trust nor the trust beneficiaries

Choice "2" is correct. Trusts are separate income tax-paying entities. Distributions made by trusts are deductible by the trust, but taxable to the recipient. This avoids double taxation of trust income. Choice "1" is incorrect. Distributions by trusts of income are deductible by the trust but taxable to the recipient. Choice "3" is incorrect. Double taxation is avoided on trust income due to the distribution deduction for trust income paid to trust beneficiaries. Choice "4" is incorrect. All income in a trust is subject to taxation. Income retained in the trust will be taxed at the trust level only, while income distributed by the trust will be deductible at the trust level, but taxable to the beneficiaries.

Angela, a real estate broker, had the following income and expenses in her schedule C business: Commissions income $100,000 Expenses: Commissions paid to non-brokers for referrals (illegal under state law and subject to criminal penalties) 20,000 Commissions paid to other real estate brokers for referrals (not illegal under state law) 10,000 Travel and transportation 12,000 Supplies 4,000 Office and phone 5,000 Parking tickets 500 How much net income must Angela report from this business? (1) $48,500 (2) $49,000 (3) $69,000 (4) $79,000

Choice "3" is correct. Commission income 100,000 Less: Legal commissions 10,000 Less: Travel 12,000 Less: Supplies 4,000 Less: Office and phone 5,000 Total expenses (31,000) Net income 69,000 Choice "1" is incorrect. Illegal payments ($20,000) and fines and penalties ($500) are not deductible expenses on Schedule C. Choice "2" is incorrect. Illegal payments ($20,000) are not deductible expenses on Schedule C. Choice "4" is incorrect. Legal commissions are deductible on Schedule C.

Which of the following is both an item that is an allowable tax deduction to the partnership, reported separately on the individual partner's Schedule K-1, and then included on the partner's individual tax return? (1) Salaries paid to non-partner employees (2) Advertising expeditures (3) Guaranteed payments paid to partners (4) Depreciation on equipment used in the business

Choice "3" is correct. A partnership calculates net ordinary business income or loss and passes each partner's distributive share through on Schedule K-1. Guaranteed payments paid to partners for services provided or for the use of capital, without regard to partnership income or profit and loss sharing ratios, are an allowable deduction to the partnership and are also separately reported on Schedule K-1 for inclusion on the partner's tax return. Choice "1" is incorrect. Salaries paid to non-partner employees are deducted from revenues to arrive at net ordinary business income or loss at the partnership level. Each partner's distributive share of the net income or loss is then reported on Schedule K-1. Choice "2" is incorrect. Advertising expenditures incurred by the partnership are deducted from revenues to arrive at net ordinary business income or loss at the partnership level. Each partner's distributive share of the net income or loss is then reported on Schedule K-1. Choice "4" is incorrect. Depreciation of assets used in the business is deducted from revenues to arrive at net ordinary business income or loss at the partnership level. Each partner's distributive share of the net income or loss is then reported on Schedule K-1.

Ben Flood, attorney at law, is a sole proprietor and files Schedule C with his federal Form 1040. Which of the following is not a deductible expense on Schedule C? (1) $30 business tax payable to the city in which he practices (2) Salaries paid to the paralegal who works for him (3) Health insurance for him and his family (4) Depreciation on the computer used by his assistant

Choice "3" is correct. A rule of thumb is that personal expenses are not allowed as deductions on the Schedule C. For instance, personal use of an automobile is considered a personal expense, not a deductible expense on Schedule C. Schedule C items should be only those related to the operation of the business itself. Health insurance for himself and his family is actually an adjustment to arrive at adjusted gross income. Choice "1" is incorrect. Business tax items are deductible expenses which should be reported on Schedule C. Choice "2" is incorrect. Salaries and commissions paid to others as part of the business are expenses allowed on Schedule C. Choice "4" is incorrect. Depreciation on business assets is an allowable deduction.

Adams owns a second residence that is used for both personal and rental purposes. During the current year, Adams used the second residence for 50 days and rented the residence for 200 days. Which of the following statements is correct? (1) Depreciation may not be deducted on the property under any circumstances (2) A rental loss may be deducted if rental-related expenses exceed rental income (3) Utilities and maintenance on the property must be divided between personal and rental use (4) All mortgage interest and taxes on the property will be deducted to determine the property's net income or loss

Choice "3" is correct. Because the second property was personally used more than 14 days, any net loss from the rental of the property will be disallowed. All related expenses must be prorated between the personal use portion and the rental activity portion. Prorated depreciation is permitted for the rental activity.

Bob is a farmer and is required to use the accrual method. At the beginning of the year, Bob has inventory, including livestock held for resale, amounting to $10,000. During the year, Bob purchased livestock totaling $3,000. Bob's ending inventory was $4,000. Bob's net sales for the year totaled $17,000. What is Bob's gross profit for the current year? (1) $9,000 (2) $17,000 (3) $8,000 (4) $13,000

Choice "3" is correct. Bob's beginning inventory 10,000 + purchases 3,000 - 4,000 ending inventory = 9,000 cost of sales. If net sales totaled $17,000, then $17,000 sales - $9,000 cost of sales = $8,000 gross profit. Choice "1" is incorrect. This is equal to Bob's cost of sales based on the change in inventory. Choice "2" is incorrect. This is the amount of Bob's net sales. Gross profit is calculated as sales minus cost of sales. Choice "4" is incorrect. This amount is equal to Bob's net sales less the amount of the ending inventory rather than the change inventory or cost of sales.

Garner is a 25 percent partner in Classic General Partnership. On February 3, Garner's tax basis in Classic was $10,000 when she received a nonliquidating distribution of $5,000 cash. Classic had no unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. Classic reported the following for the same year: U.S. Treasury interest $30,000 Ordinary business income 120,000 What amount of income from Classic should Garner include in her gross income for that year? (1) $7,500 (2) $30,000 (3) $37,500 (4) $42,500

Choice "3" is correct. Garner's 25 percent share of the partnership's $120,000 ordinary business income is $30,000. Her 25 percent share of the partnership's $30,000 U.S. Treasury interest is $7,500. These are both included in Garner's gross income for the year. A nonliquidating cash distribution is a nontaxable return of capital to the extent that the partner has basis in his or her partnership interest. Because Garner's basis in her partnership interest is more than the $5,000 cash distribution, the distribution is nontaxable. Garner's total gross income for the year is $30,000 + $7,500 = $37,500. Choice "1" is incorrect. Garner's gross income also includes her 25 percent share of the partnership's ordinary business income of $30,000. Choice "2" is incorrect. Garner's gross income also includes her 25 percent share of the partnership's U.S. Treasury interest income of $7,500. Choice "4" is incorrect. Garner's gross income includes her 25 percent share of the partnership's ordinary business income and U.S. Treasury interest income, but not the $5,000 nonliquidating cash distribution.

Freeman, a single individual, reported the following income in the current year: Guaranteed payment from services rendered to a partnership $ 50,000 Ordinary income from an S corporation 20,000 What amount of Freeman's income is subject to self-employment tax? (1) $0 (2) $20,000 (3) $50,000 (4) $70,000

Choice "3" is correct. Guaranteed payments are reasonable compensation paid to a partner for services rendered (or use of capital) without regard to his ratio of income. Earned compensation is subject to self-employment tax. Payments not guaranteed are merely another way to distribute partnership profits. The ordinary income reported from an S corporation is taxable income to the individual or their own individual tax return but is not subject to self-employment tax. The ordinary income reported from a partnership may be subject to self-employment tax (if to a general partner).

Guaranteed payment by a partnership to a partner for services rendered may include an agreement to pay: I. A salary of $5,000 monthly without regard to partnership income II. A 25% interest in partnership profits (1) I only (2) II only (3) Both I and II (4) Neither I nor II

Choice "3" is correct. Guaranteed payments to partners are deductible on Form 1065 to arrive at partnership ordinary income. On Schedule K-1, guaranteed payments are shown as income and flow through as ordinary income.

Evan, an individual, has a 40% interest in EF, an S corporation. At the beginning of the year, Evan's basis in EF was $2,000. During the year, EF distributed $100,000 and reported operating income of $200,000. What amount should Evan include in gross income? (1) $38,000 (2) $40,000 (3) $80,000 (4) $118,000

Choice "3" is correct. Like partnerships, S corporations report both separately and non-separately stated items of income and/or loss. Allocations to shareholders are made on a per-share, per-day basis in accordance with ownership percentage. Shareholders in an S corporation must include on their personal income tax return their distributive share of each separate "pass-through" item. Shareholders are taxed on these items, regardless of whether or not these items have been distributed to them during the year. EF's operating income 200,000 x Evan's ownership % 40% Gross income for Evan 80,000 Choice "1" is incorrect. This answer option incorrectly assumes that Evan's gross income is calculated as 40% of the distribution for the year ($100,000 x 40% = $40,000) less the basis of $2,000 as of the beginning of the year ($40,000 - $2,000 = $38,000). Choice "2" is incorrect. This answer option incorrectly assumes that Evan's gross income is calculated as 40% of the distribution for the year ($100,000 x 40% = $40,000). Choice "4" is incorrect. This answer option incorrectly assumes that Evan's gross income is 1 - 40%, or 60%, of the corporation's operating income for the year ($200,000 x 60% = $120,000), less the basis of $2,000 as of the beginning of the year ($120,000 - $2,000 = $118,000).

What are the treatment options for a net operating loss occurring in tax years after December 31, 2017? (1) Two-year carryback and 20-year carryforward (2) No carryback and 20-year carryforward (3) No carryback and indefinite carryforward (4) Two-year carryback and indefinite carryforward

Choice "3" is correct. Net operating losses may not be carried back (for tax years beginning after December 31, 2017), but can be carried forward indefinitely. Also, note that the net operating loss utilized in one tax year is limited to 80 percent of taxable income.

The Griffins own a mountain cabin that is used for both personal and rental purposes. In the current year, the Griffins rented the cabin out for 150 days and used it personally for 50 days. Assume that the Griffins itemize their deductions. Which of the following statements regarding the treatment of the mountain cabin on the Griffin's tax return is true? (1) 100% of the utilities for the mountain cabin for the entire year are deductible (2) Depreciation is deductible under all rental circumstances (3) Real estate taxes are deductible under all rental circumstances (4) The rental income received is not included in gross income

Choice "3" is correct. Real estate taxes and mortgage interest are either deducted on the rental schedule E or as an itemized deduction (subject to limitations). Therefore, real estate taxes will be deductible whether the Griffins rent their cabin or not. Choice "1" is incorrect. Only the rental portion of the utilities is deducted on Schedule E. Because the Griffins rented their cabin for more than 15 days and used the cabin for the greater of (1) 14 days or (2) more than 10% of the rental days, their cabin is treated as a personal/rental residence. The rental portion is deducted on Schedule E. The personal use portion of the utilities expense is not deductible. Choice "2" is incorrect. Depreciation is only deductible as a rental expense on Schedule E. If the Griffins had rented their cabin out for fewer than 15 days, then the cabin would be treated as a personal residence. As a personal residence, depreciation is not deductible. Therefore, depreciation is not deductible under all rental circumstances. Choice "4" is incorrect. Because the Griffins rented their cabin for more than 15 days and used the cabin for the greater of (1) 14 days or (2) more than 10% of the rental days, their cabin is treated as a personal/rental residence. The Griffins would include the rental income received in their gross income on Schedule E.

Carson owned 40% of the outstanding stock of a C corporation. During a tax year, the corporation reported $400,000 in taxable income and distributed a total of $70,000 in cash dividends to its shareholders. Carson accurately reported $28,000 in gross income on Carson's individual tax return. If the corporation had been an S corporation and the distributions to the owners had been proportionate, how much income would Carson have reported on Carson's individual return? (1) $28,000 (2) $132,000 (3) $160,000 (4) $188,000

Choice "3" is correct. S Corporations work in a similar fashion to partnerships. The income is passed through to the shareholder and included in taxable income whether or not it is actually distributed. Therefore, Carson will report 40% of the $400,000 taxable income, or $160,000. The $28,000 distribution will not affect the taxable income, but will reduce Carson's basis in the S Corporation stock. Choice "1" is incorrect. This is simply the same answer as if the corporation were a C Corporation. Choice "2" is incorrect. This is the correct answer of $160,000 reduced by the $28,000 distribution. The $28,000 will not reduce taxable income, but will reduce Carson's basis in the S Corporation stock. Choice "4" is incorrect. This is the correct answer of $160,000 increased by the $28,000 distribution. The $28,000 will not increase taxable income, but will reduce Carson's basis in the S Corporation stock.

Which of the following types of expenditures is not subject to uniform capitalization (UNICAP) rules? (1) Compensation for manufacturing labor (2) Cost of direct materials (3) Administrative expenditures (4) Compensation for production supervisors

Choice "3" is correct. Selling, advertising, marketing, general, administrative, and research and development costs are not subject to UNICAP. Direct materials, direct labor, and factory overhead costs are capitalized as inventory under the UNICAP rules. Choice "1" is incorrect. Compensation for manufacturing labor is a direct labor cost and is required to be capitalized under UNICAP. Choice "2" is incorrect. The cost of direct materials must be capitalized under UNICAP. Choice "4" is incorrect. Compensation for production supervisors is a factory overhead cost and therefore must be capitalized under UNICAP.

Perle, a dentist, billed Wood $600 for dental services. Wood paid Perle $200 cash and built a bookcase for Perle's office in full settlement of the bill. Wood sells comparable bookcases for $350. What amount should Perle include in taxable income as a result of this transaction? (1) $0 (2) $200 (3) $550 (4) $600

Choice "3" is correct. The $200 cash received plus the $350 fair value of the bookcase received must be included in income by Perle, for a total of $550. The income is based on the value in money or fair value of property received by Perle, not the $600 billed. Choice "1" is incorrect. Perle must report taxable income as a result of this transaction. Choice "2" is incorrect. The $350 fair value of the bookcase received is also income for Perle. Choice "4" is incorrect. The income is based on the total value received by Perle, not the $600 billed.

Which of the following types of costs are required to be capitalized under the Uniform Capitalization Rules of Code Sec. 263A? (1) Marketing (2) Distribution (3) Warehousing (4) Office maintenance

Choice "3" is correct. The Uniform Capitalization Rules require the capitalization of certain costs related to inventory. They include direct materials, direct labor, and indirect overhead costs including warehousing. Choice "1" is incorrect. Marketing is a selling expense, which is not required to be capitalized under the Uniform Capitalization Rules. Choice "2" is incorrect. Distribution is a selling expense, which is not required to be capitalized under the Uniform Capitalization Rules. Choice "4" is incorrect. Office maintenance is a general and administrative expense, which is not required to be capitalized under the Uniform Capitalization Rules.

What is the basic deduction calculation for the qualifying business income deduction? (1) 30% x Qualifying business income (QBI) (2) 20% x W-2 wages (3) 20% x Qualifying business income (QBI) (4) 30% x W-2 wages

Choice "3" is correct. The basic calculation for the QBI deduction is 20% × QBI. The deduction is subject to limitations.

Mosh, a sole proprietor, uses the cash method of accounting. At the beginning of the current year, accounts receivable were $25,000. During the year, Mosh collected $100,000 from customers. At the end of the year, accounts receivable were $15,000. What was Mosh's gross taxable income for the current year? (1) $75,000 (2) $90,000 (3) $100,000 (4) $110,000

Choice "3" is correct. The facts state that cash collections from customers were $100,000 and as a cash basis taxpayer this is the amount of Mosh's gross taxable income for the year. Note that according to the formula BASE - we can determine the amount of sales = $90,000, but that would give us accrual, not cash basis, income. Beginning A/R 25,000 Add―Sales 90,000 accrual basis taxable income 115,000 Subtract―Cash collections (100,000) cash basis taxable income Ending A/R 15,000 Choices "1" and "4" are incorrect. See explanation above. Choice "2" is incorrect. $90,000 is the amount of sales that would be Mosh's taxable income if Mosh were an accrual basis taxpayer.

Which of the following types of property is not subject to the uniform capitalization (UNICAP) rules beginning in 2018? (1) Manufacturer's inventory (2) Retailer's inventory with annual average gross receipts of $30,000,000 (past three years) (3) Retailer's inventory with annual average gross receipts of $5,000,000 (past three years) (4) Tangible personal property produced by a taxpayer for use in the taxpayer's trade or business

Choice "3" is correct. UNICAP rules do not apply to a retailer's inventory if the retailer's average gross receipts for the preceding three tax years do not exceed $26,000,000 annually. Choice "1" is incorrect. Real or tangible personal property produced by the taxpayer for sale to his or her customers (manufacturer's inventory) are subject to the UNICAP rules. Choice "2" is incorrect. Real or tangible person property acquired by the taxpayer for resale (retailer's inventory) are all subject to the UNICAP rules. However, retailers with average gross receipts under $26,000,000 for the three preceding tax years are exempt. Choice "4" is incorrect. Real or tangible person property produced by the taxpayer for use in his or her trade or business is subject to the UNICAP rules.

Don Wolf became a general partner in Gata Associates on January 1, 2017, with a 5% interest in Gata's profits, losses, and capital. Gata is a distributor of auto parts. Wolf does not materially participate in the partnership business. For the year ended December 31, 2017, Gata had an operating loss of $100,000. In addition, Gata earned interest of $20,000 on a temporary investment. Gata has kept the principal temporarily invested while awaiting delivery of equipment that is presently on order. The principal will be used to pay for this equipment.Wolf's passive loss for 2017 is: (1) $0 (2) $4,000 (3) $5,000 (4) $6,000

Choice "3" is correct. Wolf's passive loss for the current year is $5,000 ($100,000 operating loss × 5% interest in partnership). Choice "1" is incorrect. Wolf did not materially participate in the partnership, so the loss was passive. Choice "2" is incorrect. Wolf's passive loss of $5,000 could not be reduced by his distributive share of the partnership's "interest income" totaling $1,000. Interest income is considered "portfolio income," and neither the partnership nor a partner can offset it against passive losses. Choice "4" is incorrect. No items of income or deduction from portfolio income or activities in which the taxpayer materially participates may be combined or offset with passive losses unless the activity generating the loss is completely disposed of in a taxable transaction.

Calculate the taxpayer's qualifying business income (QBI) deduction for a qualified trade or business (QTB): Filing status: Single Taxable income before QBI deduction: $185,800 Net capital gains: $0 Qualified business income (QBI): $80,000 QTB's W-2 wages: $20,000 (1) $16,000 (2) $10,000 (3) $2,700 (4) $13,300

Choice "4" is correct. Taxable income before the QBI deduction is within the phase-in range of $163,300 to $213,300 (single) for 2020, so the QBI deduction is reduced. Tentative QBI deduction: $80,000 (QBI) × 20% = $16,000 W-2 wage limitation: $20,000 × 50% = $10,000 $16,000 − $10,000 = $6,000 excess amount Calculation of phase-in percentage: $185,800 taxable income − $163,300 = $22,500 $22,500 / $50,000 (phase-in range) = 45% $6,000 excess amount × 45% phase-in percentage = $2,700 reduction amount $16,000 tentative QBI deduction − $2,700 reduction amount = $13,300 reduced QBI deduction

Calculate the taxpayer's qualifying business income deduction for a qualified trade or business: Filing status: Single Taxable income: $100,000 Net capital gains: $0 Qualified business income (QBI): $30,000 W-2 wages: $10,000 (1) $5,000 (2) $70,000 (3) $20,000 (4) $6,000

Choice "4" is correct. $30,000 QBI × 20% = $6,000. W-2 wage and property limits do not apply to qualified trade or businesses with income below the taxable income threshold (2020 threshold for single taxpayers = $163,300). Choice "1" is incorrect. The W-2 wage and property limitations do not apply to a qualified trade or business under the taxable income limitations. Therefore, the deduction for QBI is not limited to $5,000 (W-2 wages of $10,000 × 50% = $5,000). Choice "2" is incorrect. $30,000 QBI × 20% = $6,000 Choice "3" is incorrect. $30,000 QBI × 20% = $6,000

Calculate the taxpayer's qualifying business income deduction for a specified service trade or business: Filling status: Single Taxable income: $300,000 Net capital gains: $0 Qualified business income (QBI): $50,000 W-2 wages: $10,000 (1) $15,000 (2) $5,000 (3) $60,000 (4) $0

Choice "4" is correct. A specified service trade or business with taxable income over the $213,300 for 2020 is not eligible for the QBI deduction. Choice "1" is incorrect. A specified service trade or business with taxable income over the upper threshold $213,300 for 2020 is not eligible for the QBI deduction. Choice "2" is incorrect. A specified service trade or business with taxable income over the upper threshold $213,300 for 2020 is not eligible for the QBI deduction. Choice "3" is incorrect. A specified service trade or business with taxable income over the upper threshold $213,300 for 2020 is not eligible for the QBI deduction.

Hunter has a loss of $50,000 from his landscaping business in the current year. He reports the loss on Schedule C of his Form 1040. After deducting the loss against his other sources of income, he has a remaining business loss of $10,000. What are Hunter's options regarding the remaining $10,000 business loss? (1) He can carry the loss back four years and forward 20 years (2) He can carry the loss back two years and forward 20 years (3) He can choose to only carry the loss forward 20 years (4) He can carry the loss forward indefinitely

Choice "4" is correct. A taxpayer's deductible losses are limited each year to $250,000 (unmarried) and $500,000 (married). Hunter's $50,000 loss is under this limitation. The $10,000 remaining business loss may be carried forward indefinitely and is limited to offsetting up to 80 percent of taxable income each subsequent year. Choice "1" is incorrect. There is no four-year carryback for net operating losses. Choices "2" and "3" are incorrect. A taxpayer may carry a net business loss forward indefinitely and may offset up to 80 percent of taxable income in the subsequent years.

Baum, an unmarried optometrist and sole proprietor of Optics, buys and maintains a supply of eyeglasses and frames to sell in the ordinary course of business. In the current year, Optics had $350,000 in gross business receipts and its year-end inventory was not subject to the uniform capitalization rules. Baum's current year adjusted gross income was $90,000 and Baum qualified to itemize deductions. During the year, Baum recorded the following information: Business expenses: Optics cost of goods sold $35,000 Optics rent expense 28,000 Liability insurance premium on Optics 5,250 Other expenditures: Baum's self-employment tax $29,750 Baum's self-employment health insurance 8,750 Insurance premium on personal residence. In the current year, Baum's home was totally destroyed by fire. The furniture had an adjustment basis of $14,000 and a fair market value of $11,000. During the year, Baum collected $3,000 in insurance reimbursement and had no casualty gains during the year. 2,625 Qualified mortgage interest on a loan secured in 2016 to acquire a personal residence 52,500 Annual interest on a $70,000, 5-year home equity loan by a substantial amount. The proceeds were used to purchase a car for personal use 3,500 Points prepaid on January 2 of the current year to acquire the home equity loan 1,400 Real estate taxes on personal residence Estimated payments of current year federal income taxes 13,500 Local property taxes on the car value, used exclusively for personal use What about should Baum report as current year net earnings from self-employment? (1) $243,250 (2) $252,000 (3) $273,000 (4) $281,750

Choice "4" is correct. Baum should report $281,750 as current year net earnings from self-employment (line 12 of the Form 1040), calculated as follows: Gross business receipts 350,000 Cost of goods sold (35,000) Rent expense (28,000) Liability insurance premium (5,250) Net earnings on Schedule C 281,750 Choices "1", "2", and "3" are incorrect. Self-employment tax and self-employment health insurance expenses are adjustments from total gross income. They are not deducted from self-employment earnings. Note: There are many distracters in this question, all relating to items that are either deductible as part of itemized deductions or not deductible. Be careful to read the requirement of the question before spending unnecessary time on the question. The statement that Baum's year-end inventory was not subject to the uniform capitalization rules is a distracter as well. There is not enough information given in the facts to apply the rules if he had been subject to them.

John created a trust for the benefit of his son, Connor. John does not have the right to change any terms of the trust once established and has no right to income. All trust income is to be distributed to Connor on an annual basis. How should the trust income be reported? (1) To John, reported only on his Form 1040 (2) Reported on Form 1041, with a Schedule K-1 issued to John (3) To Connor, reported only on his Form 1040 (4) Reported on Form 1041, with a Schedule K-1 issued to Connor

Choice "4" is correct. Because the grantor (John) does not retain (1) beneficial enjoyment of the corpus or (2) the power to dispose of the trust income without the approval or consent of any adverse party, the trust is a separate entity for tax purposes. Therefore, the trust would be required to file a Form 1041. The 1041 would issue a schedule K-1 to the income beneficiary, in this case, Connor. Choice "1" is incorrect. Because the grantor did not retain any control or benefit from the trust, the grantor would not be taxed on the trust income. Choice "2" is incorrect. Although the trust would file a Form 1041, a Schedule K-1 would not be issued to John because he is not the income beneficiary. Choice "3" is incorrect. Although the income is reportable by Connor on his individual income tax return, Form 1040 is not the only reporting requirement. The trust will have to file a Form 1041 issuing a Schedule K-1 to Connor.

Which of the following items must be separately stated on Form 1120S, U.S. Income Tax Return for an S Corporation, Schedule K-1? (1) Mark-to-market income (2) Unearned revenue (3) Section 1245 Gain (4) Gain or loss from the sale of collectibles

Choice "4" is correct. Gain or loss from the S corporation's sale of collectibles is separately reported on the Schedule K-1 of IRS form 1120S. Choice "1" is incorrect. The S corporation's mark-to-market income is part of "ordinary business income (loss)," which is separately stated on the Schedule K-1 of IRS form 1120S. However, the various components of "ordinary business income," such as mark-to-market income, are not separately stated on the K-1 of IRS form 1120S. Choice "2" is incorrect. The S corporation's unearned revenue is not separately stated but is a component of "ordinary business income" or "net rental real estate income (loss)" or "other net rental income (loss)," each of which is separately stated on the Schedule K-1 of IRS form 1120S. However, the various components (such as unearned revenue) of "ordinary business income," "net rental real estate income (loss)," and "other net rental income (loss)" are not separately stated on the K-1 of IRS form 1120S. Choice "3" is incorrect. The S corporation's section 1245 gain (and section 1250 gain) is not separately stated but is a component of "ordinary business income" or "net rental real estate income (loss)" or "other net rental income (loss)," each of which is separately stated on the Schedule K-1 of IRS form 1120S. However, the various components (such as section 1245 gain) of "ordinary business income," "net rental real estate income (loss)," and "other net rental income (loss)" are not separately stated on the K-1 of IRS form 1120S.

Nare, an accrual-basis taxpayer, owns a building which was rented to Mott under a 10-year lease expiring August 31, Year 8. On January 2, Year 2, Mott paid $30,000 as consideration for canceling the lease. On November 1, Year 2, Nare leased the building to Pine under a 5-year lease. Pine paid Nare $10,000 rent for the two months of November and December, and an additional $5,000 for the last month's rent. What amount of rental income should Nare report in its Year 2 income tax return? (1) $10,000 (2) $15,000 (3) $40,000 (4) $45,000

Choice "4" is correct. Prepaid rent is income when received even for an accrual-basis taxpayer. The $30,000 received as consideration for canceling the lease is in substitution for rental payments and is thus rental income. The $5,000 prepaid for the last month's rent is also rental income. Choice "1" is incorrect. The $30,000 received as consideration for canceling the lease is in substitution for rental payments and is thus rental income. The $5,000 prepaid for the last month's rent is also rental income. Choice "2" is incorrect. The $30,000 is in substitution of rental payments and is thus rental income. Choice "3" is incorrect. The $5,000 prepaid for the last month's rent would also be rental income.

Jason is a cash basis, self-employed attorney. Which of the following expenses are deductible on his Schedule C? (1) Mrs. Jones was billed in February of the prior year, but has never paid. Jackson considers this to be bad debt (2) Jason made a $1,000 contribution to the Boys and Girls Club (3) Jason paid country club dues totaling $4,000 for the year. Jason meets potential and current clients at the country club (4) Jason paid$35,000 to his part-time assistant

Choice "4" is correct. Salaries and wages paid to employees are deductible business expenses on Schedule C of Form 1040. Choice "1" is incorrect. Because Jason is a cash basis taxpayer, he has not reported the income from Mrs. Jones. Therefore, the fact that she hasn't paid him does not create a deductible expense for Jason. Choice "2" is incorrect. Charitable contributions should be reported on Schedule A as an itemized deduction. Choice "3" is incorrect. Country club dues are not deductible business expenses.

Marty Smarty is a CPA in private practice. For the current year ended December 31, Marty had the following items of income and expenses with respect to his CPA practice: Gross Revenue $275,000 Rent Expense $24,000 Wages paid to employees $60,000 Wages paid to Marty $120,000 Payroll taxes for employees $5,000 Payroll taxes for Marty (estimates) $9,000 Supplies Expense $10,000 Insurance Expense $8,000 Depreciation Expense $15,000 Business Meals $4,000 Health Insurance for employees $5,000 Health insurance for Marty $2,000 Business bad debt loss (allowance) $3,000 State income taxes for the business $10,000 What is Marty's taxable income on Schedule C for the CPA practice for the current year? (1) $120,000 (2) $130,000 (3) $144,000 (4) $146,000

Choice "4" is correct. The answer is calculated as follows: Gross revenue 275,000 Rent expense (24,000) Wages paid to employees (60,000) Wages paid to Marty [considered a draw, not an expense] Payroll taxes for employees (5,000) Payroll taxes for Marty (estimates) [not deducted on Sch. C, 50% is an adjustment] Supplies expense (10,000) Insurance expense (8,000) Depreciation expense (15,000) Business meals (2,000) [only 50% deductible] Health insurance for employees (5,000) Health insurance for Marty [not deducted on Sch. C, 100% is an adjustment] Business bad debt loss (allowance) [direct write-off only for accrual basis taxpayers] State income taxes for the business [not deducted on Sch. C, an itemized deduction] Schedule C 146,000

The Uniform Capitalization Rules of Code Sec. 263A apply to retailers those average gross receipts for the preceding three years exceed what amount? (1) $1,000,000 (2) $5,000,000 (3) $10,000,000 (4) $26,000,000

Choice "4" is correct. The uniform capitalization rules do not apply to inventory acquired for resale if the taxpayer's average gross receipts for the preceding three tax years do not exceed $26,000,000.

Under the uniform capitalization rules applicable to property acquired for resale, which of the following costs should be capitalized with respect to inventory if no exceptions are met? Marketing costs; Off-site storage costs (1) Yes; Yes (2) Yes; No (3) No; No (4) No; Yes

Choice "4" is correct. Under the uniform capitalization rules, purchasers of inventory for resale may deduct their marketing costs but must capitalize their off-site storage costs. Choices "1", "2", and "3" are incorrect. Marketing costs are deductible, but off-site storage must be capitalized.

Which of the following is subject to the Uniform Capitalization Rules of Code Sec. 263A? (1) Editorial costs incurred by a freelance writer (2) Research and experimental expenditures (3) Mine development and exploration costs (4) Warehousing costs incurred by a manufacturing company with $12 million in annual gross receipts

Choice "4" is correct. Uniform capitalization rules apply to the following: (1) real or tangible personal property produced by the taxpayer for use in his or her trade or business; (2) real or tangible personal property produced by the taxpayer for sale to his or her customers; and (3) real or tangible personal property acquired by the taxpayer for resale, provided the taxpayer's annual average gross receipts for the preceding three years exceeds $26,000,000. Warehousing costs incurred by a manufacturing company (making inventory for sale to its customers) are subject to the Uniform Capitalization Rules. Further, they are the only item on the list that is real or tangible personal property. In this case, the inventory is not acquired for resale (it is produced by the taxpayer for sale to his or her customers), so the fact that the annual sales are $32,000,000 does not matter in this case. The sales could have been less than $26,000,000 annually, and the Uniform Capitalization Rules would still have applied.

Barkley owns a vacation cabin that was rented to unrelated parties for 10 days during the year for $2,500. The cabin was used by Barkley for three months and left vacant for the rest of the year. Expenses for the cabin were as follows: Real estate taxes $1,000 Maintenance and utilities $2,000 How much rental income (loss) is included in Barkley's adjusted gross income? (1) $0 (2) $500 (3) $(500) (4) $(1,500)

RULE: If a vacation residence is rented for less than 15 days per year, it is treated as a personal residence. The rental income is excluded from income, and mortgage interest (first or second home) and real estate taxes are allowed as itemized deductions. Depreciation, utilities, and repairs are not deductible. Choice "1" is correct. Applying the RULE above, if a vacation residence is rented for less than 15 days per year, it is treated as a personal residence. The rental income ($2,500 in this case) is excluded from income. A Schedule E is not filed for this property (i.e., no income is reported, the taxes are reported as itemized deductions, and the maintenance and utilities are not deductible), so the effect on AGI is zero. Choice "2" is incorrect. This assumes that the property taxes are reported as itemized deductions but that the rental income ($2,500) less the maintenance and utilities ($2,000) are reported net on Schedule E. Per the above RULE, the rental income is excluded from income, and the maintenance and utilities are not deductible. Choice "3" is incorrect. This assumes that all of the items shown are reported net on the Schedule E-$2,500 - $1,000 - $2,000 = ($500). Per the above RULE, the rental income is excluded from income, the maintenance and utilities are not deductible, and the property taxes are reported on Schedule A as an itemized deduction. Choice "4" is incorrect, per the above RULE and discussion.

Kant, a cash-basis individual, owns and operates an office building. Kant received the following payments during the current year: Current rents $30,000 Advance rents for the next year 10,000 Security deposits held in a segregated account 5,000 Lease cancellation payments 15,000 What amount is included in gross income? (1) $30,000 (2) $40,000 (3) $55,000 (4) $60,000

Rule: The basic formula for determination of net rental income or loss follows: · Gross rental income · Prepaid rental income · Rent cancellation payments · Improvements in lieu of rent · (Rental expenses) · Net rental income (loss) If security deposits are held separately and not available to be applied to last month's rent (as in a segregated account), they are a liability of the taxpayer and not included in income in the year received. Choice "3" is correct. The calculation of gross income for the year follows: Current rents 30,000 Advance rents for the next year 10,000 Security deposits held in a segregated account − Lease cancellation payments 15,000 Gross income from the rental activity 55,000 Choice "1" is incorrect. This answer option incorrectly includes only the current rents as part of gross income, when advance rents and lease cancellation payments also must be included. Choice "2" is incorrect. This answer option incorrectly includes only the current rents and the advance rents as part of gross income, when lease cancellation payments also must be included. Choice "4" is incorrect. This answer option incorrectly includes all of the payments collected for the rental activity in the year, when the security deposits that are held in a segregated account are excluded from gross income.