REG Mock Exam 1

Bill received $15,000 cash and a capital asset with a basis and fair market value of $35,000 in a proportionate liquidating distribution. His basis in his partnership interest was $65,000 prior to the distribution. How much gain or loss does Bill recognize, and what is his basis in the capital asset received in the distribution? a. $15,000 gain; $35,000 basis. b. $0 gain or loss; $50,000 basis. c. $15,000 loss; $35,000 basis. d. $15,000 gain; $50,000 basis.

*$0 gain or loss; $50,000 basis.* Explanation Choice "2" is correct. The *general rule* is that there is *no gain or loss on the liquidation of a partnership interest*. The basis of the asset is calculated as follows: Partnership basis $65,000 Less: Cash withdrawal (15,000) Remaining basis 50,000 Basis allocated to asset (*zero out to get out*) 50,000 Partnership basis $ 0

White Company acquires a machine (seven-year property) on January 10 of the current year, at a cost of $1,950,000. It was the only purchase of machinery White made in the current year. White makes the election to expense the maximum amount under Section 179. No election is made to use the straight-line method. Determine the total Section 179 deduction related to the machine for the current year assuming White has taxable income of $1,700,000 and assuming the rules in effect for the year 2020: a. $0 b. $1,040,000 c. $500,000 d. $1,950,000

*$1,040,000* Explanation Choice "2" is correct. 2020 maximum allowable Section 179 deduction $1,040,000 Reduction: Purchases $1,950,000 2020 max. allowed (2,590,000) Excess 0 Allowable Section 179 deduction $1,040,000 Choices "3" and "1" are incorrect. They are a distractor. Choice "4" is incorrect. *The maximum Section 179 deduction is $1,040,000 (2020)*.

Red, Inc. provides group term life insurance to the employees of the corporation. Susan, a manager, received $200,000 of coverage for the year at a cost to Red, Inc. of $2,800. The Uniform Premiums (based on Susan's age) are $9 a year for $1,000 protection. How much of the premiums must Susan include in gross income this year? a. $2,800 b. $1,800 c. $1,350 d. $0

*$1,350* Explanation Choice "3" is correct. Premiums for coverage in excess of $50,000 of coverage are taxable to the employee. Total coverage $200,000 -Maximum nontaxable coverage (50,000) =Excess taxable 150,000 Units ÷ 1,000 =Taxable units 150 Taxable cost per unit × 9 =Taxable benefit $ 1,350

Mitch, who is age 69, single, and has no dependents, had AGI of $100,000 during the year. His potential itemized deductions were as follows: Medical expenses (after percentage of AGI floor) $5,000 State income taxes 3,000 Real estate taxes 7,000 Mortgage (qualified housing and residence) interest 9,000 Cash contributions to various charities 4,000 What is the amount of Mitch's AMT adjustment for itemized deductions for the year? a. $10,000 b. $14,000 c. $25,000 d. $19,000

*$10,000* Explanation Choice "1" is correct. ................................Regular/ A.M.T./ A.M.T. Adjustment Medical ................$5,000/ $5,000/ $0 State taxes .............3,000/ 0....../ 3,000 R.E. taxes .................7,000/ 0......../ 7,000 Home mortgage 9,000/ 9,000/ 0 Charity ....................4,000/ 4,000/ 0 Total diff. ...................................................$10,000 *Note: State income taxes and real estate taxes are not allowable deductions* in calculating alternative minimum tax (*AMT*)and therefore *must be added back to taxable income*. *(Basically just calculate the difference between AMT and itemized deductions. The only two differences are the state and RE taxes that aren't counted as part of AMT.)*

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? a. $0 b. $12,500 c. $15,000 d. $25,000

*$12,500* Explanation 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

Tom and Suzan Cucinic, U.S. citizens, were married for the entire calendar year. During the year, Tom gave $48,000 cash to his cousin to aid in his legal defense. The Cucinics made two other gifts, one to Tom's niece and one to Suzan's cousin, each a painting with a fair market value of $5,000. Both Tom and Suzan signed a timely election to treat the $48,000 gift as made one-half by each spouse. Disregarding the applicable credit and estate tax consequences, what amount of the current year gifts are taxable to the Cucinics? a. $15,000 b. $0 c. $28,000 d. $18,000

*$18,000* Explanation Choice "4" is correct. The election to treat the $48,000 gift as made one-half by each spouse means that each person gave a $24,000 gift. *For 2020, the allowable tax-free amount is $15,000 per recipient*. Thus, both Tom and Suzan have a $9,000 taxable gift (total = $18,000). The fair market value of both paintings is below the $15,000 annual exclusion; therefore, they do not result in additional taxable gifts. Choice "1" is incorrect. This is the annual exclusion amount that is not subject to tax. Choice "2" is incorrect. In 2020, the annual minimum exclusion amount to be gifted tax free is $15,000 per donee per donor. The $48,000 cash gift, even though gift splitting was elected, exceeds that amount for both Suzan and Tom; therefore, the Cucinics do have taxable gifts in the year. Choice "3" is incorrect. This choice is the combination of the $18,000 taxable cash gift and the two $5,000 paintings. The annual exclusion applies per recipient—it is not an overall exclusion (combined).

Mr. Jones made a contribution to his self-employed retirement plan (SEP IRA plan). This contribution is: a. A deduction to arrive at adjusted gross income. b. A deduction from adjusted gross income, subject to a 2 percent AGI floor. c. Not deductible. d. A deduction from adjusted gross income.

*A deduction to arrive at adjusted gross income.* Explanation Choice "1" is correct. Amounts contributed to self-employed retirement plans are permitted as adjustments (for AGI).

Martha contributed fully depreciated, zero ($0) basis property valued at $16,000 to the MB Partnership in exchange for a 50% interest in partnership capital and profits. During the first year of partnership operations, MB had net taxable income of $5,000 and taxexempt income of $6,000. The partnership distributed $4,000 cash to Martha. Her share of partnership recourse liabilities on the last day of the partnership year was $1,500. Martha's adjusted basis for her partnership interest at year end is: a. $19,000 b. $0 c. $8,500 d. $3,000

*$3,000* Explanation Choice "4" is correct. Beginning capital account $ 0 Additions: +Net taxable income 5,000 +Tax-exempt 6,000 =$11,000 × 50% =$5,500 -Subtract: Distributions (4,000) =Ending capital account 1,500 +*ADD*: Martha's share of recourse liabilities 1,500 =*Ending basis $3,000* Choice "1" is incorrect. This answer assumes a partner's basis in the partnership interest equals the fair market value of property contributed ($16,000). A partner's basis in the partnership interest is the same basis as the property contributed. Choice "2" is incorrect. A partner's basis must be adjusted for her share of partnership income, separately stated items, distributions and her share of the partnership liabilities. Choice "3" is incorrect. This answer incorrectly assumes Martha is credited with a basis increase of 100% of net taxable income and tax-exempt income, not 50%.

Ken's AGI is $60,000. He contributed $52,000 in cash to a public charity. What is Ken's charitable contribution deduction for the year of contribution? a. $52,000 b. $31,200 c. $36,000 d. $60,000

*$36,000* Explanation Choice "3" is correct. *Cash donated to a public charity* is *limited to 60% of an individual's adjusted gross income*. ($60,000 × 60% = $36,000). Choice "1" is incorrect. $52,000 is the amount of cash contributed. The deduction for charitable contributions is limited to 60% of Ken's AGI and is not deductible in full. Choice "2" is incorrect. $31,200 is 60% of the contribution, not of Ken's AGI. Choice "4" is incorrect. The limitation on charitable contributions is 60% of AGI, not AGI itself. In addition, the contribution deduction cannot exceed the actual amounts contributed to qualified charities, unless the taxpayer has a carryover. The total deduction, whether current year contribution or carryover, is limited to 60% of AGI.

Edouard owns a 30% interest in the profits and losses of the EFG Partnership. Edouard acquired his interest by contributing land to the partnership that had an adjusted basis of $30,000 and a fair market value of $65,000 on the contribution date. Soon after forming the partnership, the land is sold by the partnership to a third party for $70,000. How much of the $40,000 tax gain from the sale will the partnership allocate to Edouard? a. $36,500 b. $1,500 c. $3,500 d. $40,000

*$36,500* Explanation Choice "1" is correct. FMV at date of contribution $65,000 Basis ( 30,000) =Gain allocable to Edouard $35,000 Sale by partnership $70,000 FMV at the date of contribution (65,000) =Gain 5,000 Edouard share × 30% =1,500 *Total gain allocated to Edouard = $35,000 + 1,500 = $36,500* Note: When a partner contributes property (which has a FMV that is higher or lower than the NBV) the built-in gain or loss with respect to that contributed property (when sold) must be allocated to the contributing partner. Any gain or loss in excess of that built-in amount would be shared by all partners. *(built-in [realized] gain from partner + partner's share of the company's [recognized] gain on sale)*

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? a. $79,000 b. $49,000 c. $48,500 d. $69,000

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

Gerald and Chaney would like to give as much as they can to their family without making a taxable gift. The donees will be their seven married children (including spouses) and 15 minor grandchildren. Presuming the election to split gifts is made, how much can be given? a. $435,000 b. $210,000 c. $870,000 d. $660,000

*$870,000* Explanation Choice "3" is correct. Children 7 Children's spouses 7 Grandchildren 15 =Total Recipients 29 x Gerald & Chaney Gifts [assumes each has $15,000] $30,000 =Total Gifts $870,000 *Rule*: For 2019, each person is entitled to an annual exclusion of $15,000 per donee per donor. A married couple can give $30,000 to each donee if gift splitting is elected. Choice "1" is incorrect. This amount only assumes a total of $15,000 per donee and does not take gift-splitting into account. Choice "2" is incorrect. This amount only assumes that the seven children are eligible gift recipients, so only seven gifts at $30,000 (gift-splitting) are included here. Choice "4" is incorrect. This amount assumes that the children's spouses are not eligible gift recipients, so only 22 gifts at $30,000 (gift-splitting) are included here.

a. For the current tax year, Tom and Karen, married taxpayers filing a joint tax return, qualified to itemize deductions. Their adjusted gross income was $90,000. Karen gave $1,000 for Christmas gifts directly to a needy family identified by her co-workers. Tom had $1,500 withheld from his payroll checks throughout the year to benefit the Children's Make-a-Wish Foundation. In addition, Tom and Karen donated to their church a piece of artwork valued at $2,000 that they purchased for $500 when they were married 10 years ago. There were no other contributions made throughout the year. Considering only to the information contained here, on their current year income tax return, Tom and Karen will claim: a. A charitable deduction of $3,500 and a capital gain of $0. b. A charitable deduction of $4,500 and a capital gain of $0. c. A charitable deduction of $3,500 and a capital gain of $1,500. d. A charitable deduction of $3,000 and a capital gain of $1,500.

*A charitable deduction of $3,500 and a capital gain of $0. * Explanation Choice "1" is correct. Considering only to the information contained here, on their current year income tax return, Tom and Karen will claim a charitable deduction of $3,500 [$1,500 from Tom's payroll deductions plus $2,000 for the painting] and capital gain of $0. Because the painting [a capital asset] was held over one year before being contributed, it qualified to be deducted at the higher FMV without capital gains being recognized on the difference between the FMV and tax basis. Although the 30% rule applies to such contributions, this case is below the threshold (i.e., 30% of $90,000 AGI equals $27,000, which would be the upper limit for deducting at the higher FMV). Deductions made directly to needy families that are not listed by the IRS as qualified organizations are not allowable itemized deductions and would be deemed a gift (and follow the gift tax rules). Choice "2" is incorrect. The $1,000 given to the needy family is not an allowable charitable deduction. Choice "3" is incorrect. *Capital gain is not recognized in this case.* Choice "4" is incorrect. This choice assumes one of two scenarios. In either case, the proper amounts of charitable contributions do not exist. In the first case [$1,000 + $1,500 + $500 = $3,000], the $1,000 given to a needy family is not deductible, and the painting is deductible at the higher FMV, not the lower purchase price. In the second case [$1,000 + $2,000 = $3,000], the $1,000 given to a needy family is not deductible, and the amount given to Make-a-Wish is not included when it should be. Further, recognized capital gain on the donation of the painting is zero.

The Social Security tax base is calculated on: a. An employee's taxable income. b. A self-employed person's net profit from self-employment. c. A self-employed person's gross income from self-employment. d. An employer's gross wages less the deduction permitted for contributions to an individual retirement account.

*A self-employed person's net profit from self-employment.* Explanation Choice "2" is correct. The Social Security tax is *based on a self-employed person's net profit* (subject to certain maximum limitations). For *employees, this tax is based on gross wages* (with some adjustments). The employer also pays the tax. Choice "1" is incorrect. The Social Security tax base is calculated on an employee's *gross income (limited), not taxable wages*. Choice "3" is incorrect. A self-employed person is allowed to deduct business expenses from self-employment gross income. The net amount is subject to self-employment tax. Choice "4" is incorrect. Contributions to an individual retirement account for an individual may qualify as an adjustment to gross income but are not deductible from an employer's gross wages.

Diana Kalyvas received a painting as a gift from her sister, Joanna, on April 1 of the current year. The painting had a fair market value of $5,000 at the date of gift, and Joanna had purchased the painting twenty years prior for an amount of $7,000. After holding the painting for three months, Diana realized that she would rather have the money for the value of the painting than the painting itself, so she sold the painting to her neighbor for $4,500 on July 4. On her current year income tax return, Diana should report: a. A short-term capital loss of $500. b. A long-term capital loss of $2,000. c. A short-term capital loss of $2,500. d.A long-term capital loss of $500.

*A short-term capital loss of $500.* Explanation Choice "1" is correct. The basis of the painting depended upon what Diana eventually sold the painting for. The gain basis of $7,000 would have applied if Diana had sold the painting above $7,000, but that did not happen in this case. The basis of $5,000 (FMV at the date of gift) applied because Diana sold the painting for less than the FMV at the date of gift and at the date of the gift the FMV of the gift was less than the donor's basis in the gift. Further, although the holding period for the donee typically includes the donor's holding period, this case is an exception to the rule. The holding period starts with the gift date when the FMV at the date of gift is used as the basis. Therefore, the sale resulted in a short-term capital loss of $500. Choice "2" is incorrect. The holding period began on April 1. Also Diana's basis in the painting was $5,000, due to the sale in the amount of $4,500. This answer incorrectly calculates the loss as the difference between Joanna's purchase price (the gain basis) and the FMV at the date of gift. Choice "3" is incorrect. Although the loss is a short-term capital loss, the basis of the painting on the date of sale was $5,000, not $7,000 (as discussed above). Choice "4" is incorrect. The holding period began on April 1 because the fair market value at the date of the gift was used as the basis.

Which one of the following types of organizations qualifies as an organization exempt from income tax? a. All "feeder" organizations, primarily conducting business for profit, but distributing 100% of their profits to organizations exempt from income tax. b. An organization whose purpose is to foster national or international amateur sports competition by providing athletic facilities and equipment. c. An "action" organization established for the purpose of influencing legislation pertaining to protection of animal rights. d. A social club organized and operated exclusively for the pleasure and recreation of its members, supported solely by membership fees, dues, and assessments.

*A social club organized and operated exclusively for the pleasure and recreation of its members, supported solely by membership fees, dues, and assessments.* Explanation Choice "4" is correct. A social club organized and operated exclusively for the pleasure and recreation of its members, supported "solely" by membership fees, dues, and assessments is exempt from income tax. Choice "1" is incorrect. An organization operated primarily for the purpose of carrying out a trade or business for profit cannot claim tax exemption on the ground that all its profits are payable to exempt organizations. It must rely on its own activities of an exempt nature to gain tax exemption. A feeder organization is taxable on its entire income, not just the portion it designates as its unrelated business income. Choice "2" is incorrect. An organization whose purpose is to foster national or international amateur sports competition may qualify as an exempt organization only if none of its activities involve the providing of athletic facilities or equipment. Choice "3" is incorrect. An "action" organization may lose its exempt status due to excessive lobbying. "Excess lobbying expenditures" are defined as the greater of the excess of lobbying expenditures over the lobbying nontaxable amount, or the excess of grass roots expenditures over 25% of the lobbying nontaxable amount.

Which of the following statements is/are correct? I. Guaranteed payments represent taxable income to the receiving partner and are reported separately on the partner's form K-1. II. Guaranteed payments are allowable tax deductions to the partnership, provided they are payments for services rendered or the use of capital without regard to partnership income or profit and loss sharing ratios. a. Neither I nor II is correct. b. II only is correct. c. I only is correct. d. Both I and II are correct.

*Both I and II are correct. * Explanation Choice "4" is correct. Guaranteed payments represent taxable income to the receiving partner and are reported separately on the partner's form K-1 AND are allowable tax deductions to the partnership, provided they are payments for services rendered or the use of capital without regard to partnership income or profit and loss sharing ratios.

Which of the following are capital assets? I. Interest in a partnership. II. Accounts receivable. III. Stocks and bonds. IV. Literary compositions held by the original artist. a. II only. b. Both I and III. c. I, II, and III. d. I, III, and IV.

*Both I and III.* Explanation Choice "2" is correct. A capital asset includes property (real and personal) held by the taxpayer for investment or for personal use. *Capital assets include:* -Personal automobile of the taxpayer. -Furniture and fixtures in the taxpayer's home. -Stock and bonds. -Real and personal property not used in a trade or business. -Interest in a partnership. -Goodwill of a corporation. -Purchased (as opposed to created) copyrights, literary, musical, or artistic compositions. -Musical compositions held by the original artist. -Other assets held for investment. *Non-capital assets include:* -Property normally included in inventory or held for sale. -Depreciable personal and real property used in a business. -Accounts and notes receivable arising from sales or services in a business. -Copyrights, literary, musical, or artistic compositions held by the original artist. -Treasury stock.

Which of the following is true regarding the required tax year of trusts and estates? a. Both trusts and estates must adopt a calendar year end. b. Only estates are allowed to elect a calendar or fiscal year end; trusts must have a calendar year end. c. Only trusts are allowed to elect a calendar or fiscal year end; estates must have a calendar year end. d. Both trusts and estates may elect to have either a calendar or a fiscal year end.

*Only estates are allowed to elect a calendar or fiscal year end; trusts must have a calendar year end.* Explanation Choice "2" is correct. Only estates are allowed to elect a calendar or fiscal year end; trusts must have a calendar year end. An easy way to memorize this is that "people can die at any time," so estates may elect a calendar year or a fiscal year. Another way to memorize this is that "estates" may "elect." Choices "1", "4", and "3" are incorrect, based on the above explanation.

Which of the following statements is correct with respect to fraud penalties? a. For the IRS to prevail in a case with a criminal penalty, the IRS must prove beyond a reasonable doubt that the taxpayer willfully and deliberately attempted to evade tax. b. Fraud penalties and civil penalties cannot apply at the same time. c. For the IRS to prevail in a case with a civil penalty, the IRS must prove by a preponderance of the evidence that the taxpayer willfully and deliberately attempted to avoid tax. d. The civil penalty for fraud can be as much as 50% of the understatement of tax due to the fraud.

*For the IRS to prevail in a case with a criminal penalty, the IRS must prove beyond a reasonable doubt that the taxpayer willfully and deliberately attempted to evade tax.* Explanation Choice "1" is correct. For the IRS to prevail in a case with a criminal penalty, the IRS must prove beyond a reasonable doubt that the taxpayer willfully and deliberately attempted to evade tax. Choice "2" is incorrect. Both civil penalties and fraud penalties can apply at the same time. Choice "3" is incorrect. For the IRS to prevail in a case with a civil penalty, the IRS must prove by a preponderance of the evidence that the taxpayer willfully and deliberately attempted to *evade, not avoid, tax*. The *preponderance of the evidence standard is a lesser standard than beyond a reasonable doubt* standard. Choice "4" is incorrect. The civil penalty for fraud is at least 75% of the understatement of tax due to the fraud.

Which of the following statements is correct regarding the filing of a voluntary petition under Chapter 7? a. Couples may not file a joint petition. b. If the petitioner is an individual consumer debtor, his case may be dismissed or converted to a Chapter 13 case if he does not pass the means test or the general abuse test. c. The petitioner must owe at least $15,775 in unsecured debt. d. The automatic stay stopping collection efforts is not available.

*If the petitioner is an individual consumer debtor, his case may be dismissed or converted to a Chapter 13 case if he does not pass the means test or the general abuse test.* Explanation Choice "2" is correct. If an individual files a voluntary petition under Chapter 7, the case may be dismissed or converted to a Chapter 13 case *if abuse is found*. Abuse may be found *under the means test or the general abuse test*. Choice "1" is incorrect. Couples may file a joint petition under Chapter 7. Choice "3" is incorrect. A voluntary petition is not subject to the $15,775 floor. The floor is only applicable to involuntary petitions. Choice "4" is incorrect. The automatic stay applies to any bankruptcy proceeding.

Which of the following qualifies as a like-kind exchange? a. Inventory of a retail hardware store for inventory of a plumbing wholesaler. b. Investment land for building to be used in a trade or business. c. General partnership interest for a limited partnership interest. d. Rental house for a house to be used as a principal residence.

*Investment land for building to be used in a trade or business.* Explanation Choice "2" is correct. *Investments in business assets* such as *land and building* qualify for like-kind exchange treatment. Choices "1" and "3" are incorrect. Like-kind business exchange is *not available for inventory*, investments in *bonds*, partnerships and corporation *stock*. Choice "4" is incorrect. *Personal use property is not eligible* for the deferral that is part of a like-kind exchange.

In a common law action against an accountant, lack of privity is a viable defense if the plaintiff: a. Is the accountant's client. b. Is the client's creditor who sues the accountant for negligence. c. Bases the action upon fraud. d. Can prove the presence of gross negligence that amounts to the reckless disregard for the truth.

*Is the client's creditor who sues the accountant for negligence.* Explanation Choice "2" is correct. A CPA's duty to act with reasonable care generally runs only to clients and, under the majority rule, to any person or limited foreseeable class of persons whom the CPA knows will be relying on the CPA's work. It does not extend to other parties. This is the so-called "privity defense." Thus, privity is a viable defense to an action against the accountant by a client's creditor. The CPA would not be in privity of contract with the creditor and owes the creditor no duty. Choice "1" is incorrect. An accountant, by definition, is in privity of contract with a client. Choices "4" and "3" are incorrect. Privity is not a defense to fraud and constructive fraud (gross negligence). It is only a defense to negligence actions by third parties.

Sly has serious financial problems and is unable to meet current unsecured obligations of $65,000 to 19 creditors who are demanding immediate payment. Sly owes Kane $10,500 and Kane has decided to file an involuntary petition in bankruptcy against Sly. Which of the following is necessary in order for Kane to validly petition Sly into bankruptcy? a. Kane must be a secured creditor. b. Sly must have committed an act of bankruptcy within 120 days of filing. c. Kane must be joined by at least two other creditors and, in the aggregate, be owed at least $16,750. d. Kane must allege and establish that Sly's liabilities exceed the fair market value of Sly's assets.

*Kane must be joined by at least two other creditors and, in the aggregate, be owed at least $16,750.* Explanation Choice "3" is correct. To file an involuntary petition, if there are 12 or more creditors, at least 3 of the creditors who are owed in the aggregate at least $16,750 in unsecured debt, must join in the petition. Choice "1" is incorrect. Only unsecured debt may be used to reach the $16,750 total; the debt owed to secured creditors, to the extent of the value of the security, does not count. Choice "2" is incorrect because committing an act of bankruptcy (whatever that might be) is not a prerequisite to filing an involuntary petition. Choice "4" is incorrect. The test for filing an involuntary petition is whether the debtor is not paying debts as they become due. There is no requirement that the debtor's debts exceed the debtor's assets.

The Roz Trust had distributable net income for the year of $10,000 of which $5,000 is from tax-exempt bonds, and the remainder is ordinary income. Under the terms of the trust instrument, the trustee must distribute $10,000 to Roger. After paying this amount, the trustee is empowered to make additional distributions at his discretion. Exercising this authority, the trustee distributes an additional $15,000 to Roger. What is the character of the amounts distributed to Roger? Ordinary Income/ Tax-exempt Income a. $5,000/ $5,000 b. $25,000/ $0 c. $15,000/ $15,000 d. $10,000/ $20,000

*a. $5,000/ $5,000* Explanation Choice "1" is correct. Amounts distributed to beneficiaries by a trust retain the same character (i.e., ordinary income or tax-exempt income) as they had at the trust level. The additional $15,000 distributed to Roger is a distribution of principal or corpus and is non-taxable.

Bluebird Corporation has a deficit in accumulated E&P of $180,000. For the current year, it has current E&P of $120,000. On July 1 of the current year, Bluebird Corporation distributes $135,000 to its sole shareholder, Mike. Mike has a basis of $60,000 in his stock in Bluebird Corporation. What is the effect to Mike? a. Mike has dividend income of $60,000 and reduces his stock basis to zero. b. Mike has dividend income of $120,000 and reduces his stock basis to $45,000. c. Mike has dividend income of $135,000. c. Mike has no dividend income, reduces his stock basis to zero, and has a capital gain of $75,000.

*Mike has dividend income of $120,000 and reduces his stock basis to $45,000.* Explanation Choice "2" is correct. Dividend income is determined by the amount of both current and accumulated (positive) E&P. The corporation had current E&P (by year end) of $120,000, even though the corporation has a deficit in accumulated E&P. Therefore, only $120,000 of the distribution is a dividend. The *additional $15,000 distribution ($135,000 − $120,000) is a "return of capital" and reduces his basis from $60,000 to $45,000*. Choice "1" is incorrect. The amount of the distribution to be characterized as a dividend is equal to all accumulated (positive) or current earnings and profits. Any amount in excess is then a return of basis. Choice "3" is incorrect. The entire amount would only be taxable as a dividend if Bluebird had earnings and profits (current and/or accumulated) of $135,000 or more. Choice "4" is incorrect. The first step in characterizing a distribution as a dividend is earnings and profits. This answer would be correct if the current and accumulated earnings of Bluebird were $0 or a deficit.

Stable Corp. offered in a signed writing to sell Mix an office building for $350,000. The offer, which was mailed by Stable on April 1, indicated that it would remain open until July 9. On July 5, Stable mailed a letter revoking the offer. On July 6, Mix sent a fax to Stable accepting the original offer. Mix received the letter of revocation on July 8 and the fax of acceptance was received by Stable on July 6. Which of the following is correct? a. Stable was not entitled to withdraw its offer until after July 9. b. Mix's fax resulted in the formation of a valid contract. c. Stable's letter of July 5 terminated Stable's offer when mailed. d. Although Stable's offer on April 1 was a firm offer under the UCC it will only remain open for three months.

*Mix's fax resulted in the formation of a valid contract.* Explanation Choice "2" is correct. Although an offeror generally can revoke an offer at any time (unless consideration was paid to keep the offer open or the offer is a firm merchant's offer), the offeror must revoke the offer before it is accepted. A revocation is only effective when it is received. Stable's May 5 letter attempting to revoke was too late. The offer had already been accepted because, under the mailbox rule, an acceptance is effective on dispatch. Here, the acceptance was dispatched (i.e., faxed) on July 6 and Mix did not receive the letter of revocation until July 8. Thus, the acceptance was effective and the attempted revocation was not effective because it was received after acceptance. Choice "1" is incorrect. An offeror may generally revoke an offer any time before it is accepted. This is true even if the offeror promises to keep the offer open unless consideration was paid to keep the offer open or the offer is a firm merchant's offer. Here, no consideration was paid to keep the offer open and the offer could not be a firm merchant's offer because such offers can be made only with respect to the sale of goods, and the offer here involved the sale of land. Choice "3" is incorrect for the reasons stated above. Revocations are only effective when received, not when the revocation is mailed, but acceptances are effective upon dispatch. Because the attempted revocation was received after the acceptance was dispatched, a valid acceptance had been made and it was too late to revoke. Choice "4" is incorrect. As discussed above, the firm offer rule only applies to sale of goods by a merchant. This UCC rule does not apply to the sale of real estate

Do the following business entities offer all of their owners protection from personal liability for contracts entered into by the business? Sole Proprietorship/ Partnership/ Limited Partnership a. No Yes No b. No No Yes c. Yes No No d. No No No

*No No No* Explanation Choice "4" is correct. None of the business entities listed offer its owner(s) protection from personal liability for contracts entered into by the business. A sole proprietorship is a business owned and run by one person, and that person is personally liable for all the obligations of the business. A partnership is an association of two or more persons to run a business for profit. All partners are personally liable for obligations of the partnership. *A limited partnership has at least one general partner who is liable for obligations of the partnership* and at least one limited partner who has no personal liability for obligations of the partnership.

Allen paid an attorney $500 to prepare his will. This expenditure is: a. A deduction from adjusted gross income. b. Not deductible. c. A deduction to arrive at adjusted gross income. d. A deduction from adjusted gross income, subject to a 2% AGI Floor.

*Not deductible.* Explanation Choice "2" is correct. Legal fees for preparation of a will are not deductible.

Susan paid $1,500 of interest on credit card charges. The charges were for items purchased for personal use. The interest is: a. A deduction to arrive at adjusted gross income. b. A tax credit. c. A deduction from adjusted gross income. d. Not deductible.

*Not deductible.* Explanation Choice "4" is correct. Consumer (personal) interest is not deductible

In the filing of a consolidated tax return for a corporation and its wholly owned subsidiaries, intercompany dividends between the parent and subsidiary corporations are: a. Included in taxable income to the extent of 80%. b. Not taxable. c. Included in taxable income to the extent of 20%. d. Fully taxable.

*Not taxable* Explanation Choice "2" is correct. Dividends received from other group members are eliminated from the parent's taxable income in consolidation; no dividends received deduction is allowed. Since the parent eliminates the subsidiary dividends in consolidation, they are effectively not taxable. Choices "3", "1", and "4" are incorrect. The regulations require elimination of intercompany dividends in consolidation.

Troy and Edie are married and under 65 years of age. During the current year, they furnish more than half of the support of their 20-year old daughter, Jobeth, who lives with them. Jobeth earns $15,000 from a part-time job, most of which she sets aside for future college expenses. Troy and Edie also provide more than half of the support of Troy's cousin who does not live with them. Edie's father is 80 years old and fully supported by Troy and Edie. He lives in an apartment down the street from Troy and Edie. How many individuals meet the definition of dependent for Troy and Edie? a. One b. Three c. Zero d. Two

*One* Explanation Choice "1" is correct. One individual qualifies as a dependent: Edie's father. An individual is a dependent of a taxpayer if he/she meets either the qualifying child or relatives rules. Jobeth does not meet either qualifying child or qualifying relative criteria. She fails the age requirement of qualifying child because she is over the age of 19 and not a full-time student. Her income is too high for the qualifying relative rules. *Troy's cousin does not meet the relationship test for either qualifying child or relative*. Edie's father meets the criteria for qualifying relative. A dependent parent is not required to live with the taxpayer to be deemed a dependent.

On January 1, Year 1, Marin, Riley, and Trevor form a general partnership in which they are all equal partners for ownership and profit and loss allocation. Marin and Riley each contribute $100,000 in cash for their 1/3 interests and Trevor contributes land with a FMV of $100,000 and a tax basis prior to contribution of $25,000. At the end of the year, the partnership reported annual ordinary income of $120,000. It also sold the land on November 30, Year 1, for $130,000. What amount of income/gain would Trevor report on his Year 1 income tax return? a. Ordinary income of $40,000 and capital gain of $85,000. b. Ordinary income $50,000 and capital gain of $75,000. c. Ordinary income of $75,000. d. Ordinary income of $40,000 and capital gain of $35,000.

*Ordinary income of $40,000 and capital gain of $85,000.* Explanation Choice "1" is correct. *Trevor will report 1/3 of the ordinary income earned by the partnership, or $40,000 [$120,000 × 1/3]*, plus a portion of the capital gain on the land, which includes 100% of the difference between the FMV and the basis at the date of contribution ("built-in gain") plus 1/3 of the gain related to the increase in FMV subsequent to the date of contribution, or $85,000, calculated as follows: Sales price of land $130,000 Basis of land (25,000) = Capital gain to partnership $105,000 *Allocated as follows:* FMV at date of contribution $100,000 -Basis at date of contribution (25,000) =100% of gain at date of contribution allocated to Trevor 75,000 +Plus: 1/3 of remaining gain* 10,000 =Trevor's capital gain $85,000 *Remaining gain = $105,000 - 75,000 = $30,000 x 1/3 =$10,000

Attachment under Article 9 of the UCC applies primarily to the rights of: a. Warehousemen. b. Third party creditors. c. Holders in due course. d. Parties to secured transactions.

*Parties to secured transactions* Explanation Choice "4" is correct. Attachment establishes a secured party's right to take possession of collateral from a debtor when there is a default on a secured transaction. Choice "1" is incorrect. Warehousemen are relevant to Documents of Title under Article 7 of the UCC. Attachment has nothing to do with the rights of warehousemen. Choice "2" is incorrect. Perfection establishes a secured party's rights to collateral securing an obligation as against third parties who also might have an interest in the collateral after a debtor defaults on the secured obligation. Choice "3" is incorrect. Holders in due course are relevant to commercial paper under Article 3 of the UCC. Attachment has nothing to do with holders in due course.

Mern Corp is in the business of selling computers and computer software to the public. Mern sold and delivered a personal computer to Whyte on credit. Whyte executed and delivered to Mern a promissory note for the purchase price and a security agreement covering the computer. If Whyte purchased the computer for personal use and Mern fails to file a financing statement, which of the following statements is correct? a. Mern does not have a perfected security interest because it failed to file a financing statement. b. The computer was a consumer good while in Mern's possession. c. Perfection of Mern's security interest occurred at the time of attachment. d. Mern's security interest is not enforceable against Whyte because Mern failed to file a financing statement.

*Perfection of Mern's security interest occurred at the time of attachment.* Explanation Choice "3" is correct. A purchase money security interest in consumer goods is automatically perfected at the time of attachment. Mern is a purchase money security interest creditor because Mern sold the collateral to Whyte on credit and retained a security interest in the collateral. The collateral is consumer goods because Whyte purchased it for personal use. Choice "1" is incorrect. Filing is just one method of perfection. Perfection can also occur by possession or, as is this case, automatically. Choice "2" is incorrect. Consumer goods are goods used for personal or household purposes. When the computer was in Mern's possession, it was being held for sale. Goods held for sale are inventory. Thus, while the computer was in Mern's possession it was inventory, not consumer goods. Choice "4" is incorrect. To have a security interest enforceable against Whyte, it must have attached to the collateral. Filing relates to perfection, not attachment. Mern's interest did attach to the computer because there was a written security agreement, Mern gave value (the computer), and Whyte had rights in the computer (ownership).

A plaintiff wishes to recover damages from the issuers of securities for losses resulting from material misstatements in a securities registration statement. In order to be successful, one of the elements the plaintiff must prove is that the: a. Issuer acted fraudulently. b. Issuer acted negligently. c. Plaintiff was in privity of contract with the issuer or that the issuer knew of the plaintiff. d. Plaintiff acquired the securities.

*Plaintiff acquired the securities.* Explanation Choice "4" is correct. Under Section 11 of the 33 Act, the plaintiff must prove that there was a material misstatement and they suffered damages by acquiring the securities. The plaintiff need not prove intent, fraud, negligence or reliance.

In which of the following situations will a controlled foreign corporation located in Ireland be deemed to have subpart F income? a. Services are provided by an Irish company in England under a contract entered into by its U.S. parent. b. Property is produced in Ireland by the Irish company and sold outside its country of incorporation. c. Services are performed in Ireland by the Irish company under a contract entered into by its U.S. parent. d. Property is bought from the controlled foreign corporation's U.S. parent and is sold by an Irish company for use in an Irish manufacturing plant.

*Services are provided by an Irish company in England under a contract entered into by its U.S. parent.* Explanation Choice "1" is correct. *Subpart F income* is taxable income includable by a U.S. taxpayer from a controlled foreign corporation. It generally includes income that has *no economic connection to the country of origin*. This choice describes subpart F income, because the contract is entered into by the U.S. parent and has no economic connection to Ireland. Choices "2", "3", and "4" are incorrect, because *all of these transactions do have an economic connection to Ireland*.

Which of the following defenses will release a gratuitous surety from liability to a creditor? a. The creditor and debtor enter into a binding agreement to extend the debtor's time for payment without the surety's consent. b. Release of the principal debtor's obligation by the creditor but with the reservation of the creditor's rights against the surety. c. Fraud by the debtor which induced the surety to enter into the contract and the creditor was unaware of the fraud. d. Filing of an involuntary petition in bankruptcy against the principal debtor.

*The creditor and debtor enter into a binding agreement to extend the debtor's time for payment without the surety's consent.* Explanation Choice "1" is correct. A *gratuitous surety will be released* when the *creditor commits fraud*, when there is *duress or breach*, when the *surety lacks capacity or goes bankrupt*, or when there is a *material change (e.g., an extension of time) without the surety's consent*. (*Note*: A *compensated surety* would be released *only to the extent harmed*.) Choice "2" is incorrect. Release of the debtor does not release a gratuitous surety if the creditor reserves the right to pursue the surety. The surety will have recourse against the debtor directly for reimbursement. Choice "3" is incorrect. The creditor does not trust the debtor (for whatever reason) to pay back the loan. That is the creditor's reason for requiring the surety. In this case, the debtor was dishonest. It is the responsibility of the surety to know the character of who they are signing on with. The surety will remain liable to the creditor and will have to bring an action against the debtor for the fraud. Choice "4" is incorrect. The creditor understands that the debtor may be a bad credit risk, including the possibility of a bankruptcy by the debtor. Hence the reason for the surety. The debtor's bankruptcy, whether voluntary or involuntary, does not release the surety from the obligation.

Terrence has been Pauline's agent in the liquor business for ten years and has made numerous contracts on Pauline's behalf. Under which of the following situations could Terrence continue to have the power to bind Pauline? a. The passage of a federal constitutional amendment making the sale or purchase of alcoholic beverages illegal. b. The death of Pauline without Terrence's knowledge. c. The bankruptcy of Pauline with Terrence's knowledge. d. The firing of Terrence by Pauline.

*The firing of Terrence by Pauline.* Explanation Choice "4" is correct. When a *principal terminates* an agent's actual authority, the *agent will continue to have apparent authority* to perform *until the principal notifies 3rd parties* who might have known of the agency. Thus, even after being fired, Terrence would continue to have apparent authority to bind Pauline until Pauline gives proper notice. Choice "1" is incorrect. If the subject matter of an agency becomes illegal, the agency is terminated immediately by operation of law. Thus, Terrence's power to bind Pauline to contracts for the sale of alcoholic beverages would terminate when such contracts became illegal. Choice "2" is incorrect. *Death of the principal terminates an agent's actual or apparent authority* by operation of law, regardless of notice. Choice "3" is incorrect. *Bankruptcy of the principal terminates an agent's actual or apparent authority*, regardless of notice by operation of law.

A requirement of a private action to recover damages for violation of the registration requirements of the Securities Act of 1933 is that: a. The securities be purchased from an underwriter. b. A registration statement be filed. c. The issuer or other defendants commit either negligence or fraud in the sale of the securities. d. The plaintiff has acquired the securities in question.

*The plaintiff has acquired the securities in question.* Explanation Choice "4" is correct. To recover damages under Section 11 of the 1933 Act, the *plaintiff must have acquired the securities*. Note that the plaintiff need not have been the initial purchaser. Choice "1" is incorrect. Underwriters are not required under the 1933 Act. Because underwriters are not required, the securities do not need to be purchased from an underwriter. Choice "2" is incorrect. Under Section 12 of the 1933 Act, issuers have civil liability for damages if a required registration statement was not filed. Thus, damages are available even if a registration statement was not filed. Choice "3" is incorrect. Under Section 11 of the 1933 Act the plaintiff need only show he acquired the stock, he suffered a loss and there was a material misrepresentation of material omission of fact in the registration statement. That is all the plaintiff has to prove. There is *no requirement to prove fraud or negligence*.

With respect to Circular 230 requirements for written advice: a. The practitioner must take into account the possibility that a tax return will not be audited. b. The practitioner may not base written advice on legal assumptions as to future events. c. The practitioner must consider only the relevant facts and circumstances explicitly told to the practitioner by the taxpayer. d. The practitioner must use reasonable efforts to identify and ascertain the facts relevant to written advice on each federal tax matter.

*The practitioner must use reasonable efforts to identify and ascertain the facts relevant to written advice on each federal tax matter.* Explanation Choice "4" is correct. The practitioner must use reasonable efforts to solicit the necessary information to identify and ascertain the facts relevant to written advice. The practitioner has a responsibility to ask the client the appropriate questions to obtain those facts. The practitioner must determine if the information provided by the client seems incomplete or incorrect; if it does, additional inquiries must be made. Choice "1" is incorrect. The practitioner must not, in evaluating a federal tax matter, take into account the possibility that a tax return will not be audited or that a matter will not be raised on audit. Choice "2" is incorrect. The practitioner must base the written advice on reasonable factual and legal assumptions, including assumptions as to future events. Choice "3" is incorrect. The practitioner must consider all relevant facts and circumstances that the practitioner knows or reasonably should know.

Which of the following acts is most likely to cause a court to pierce the corporate veil? a. Using corporate assets for the owner's personal purposes. b. Retention of excess capital. c. Failure to designate a registered agent in the articles of incorporation (Charter). d. Failure to conduct a significant portion of business in the chartering state.

*Using corporate assets for the owner's personal purposes. * Explanation Choice "1" is correct. The corporate veil of limited liability may be pierced and the personal assets of the shareholders may be reached to satisfy corporate obligations if the shareholder commingles personal assets with his own. This includes using corporate assets to pay personal debts. Choice "2" is incorrect. Retention of excess capital may be a ground for imposing extra taxes on the corporation, but it is not a ground for piercing the corporate veil. Choice "3" is incorrect. Failure to designate a registered agent in the articles makes the articles faulty in most states and is a ground for seeking dissolution of the corporation, but in and of itself, it is not a ground for piercing the corporate veil to reach shareholders' personal assets to satisfy corporate obligations. Choice "4" is incorrect. Failure to conduct a significant portion of business in the chartering state has absolutely no impact on corporate obligations. Many corporations are incorporated in states with favorable tax structures and corporate laws (e.g., Delaware) even though they carry on little or no business in the state of incorporation.

On May 8, Westar Corp. sold 20 computers to Saper for use in Saper's business. Saper paid for the computers by executing a promissory note secured by the computers and a security agreement. On May 9, Saper filed a petition in bankruptcy and a trustee was appointed. On May 16, Westar filed a financing statement covering the computers. Westar insists that their perfected security interest takes priority over the trustee in bankruptcy's interest. The trustee in bankruptcy disagrees. Who is correct? a. The trustee, because filing a bankruptcy petition cuts off Westar's rights as of the filing date. b. Westar, because it perfected its security interest within 30 days after Saper took possession. c. The trustee, because the petition was filed prior to Westar's filing of the financing statement. d. Westar, because its security interest was automatically perfected upon attachment.

*Westar, because it perfected its security interest within 30 days after Saper took possession.* Explanation Choice "2" is correct. Because Westar sold the computers to Saper on credit and retained a security interest in the computers, it has a purchase money security interest (PMSI). A PMSI in non-inventory collateral has priority over the interest of a trustee in bankruptcy if the PMSI is perfected under state law and within the permissible time after the debtor receives possession of the collateral. Here, the collateral is non-inventory collateral (specifically, equipment) because it was being used in Saper's business rather than being held for sale. Moreover, Westar perfected its security interest by filing within seven days after Saper received possession of the computers. Every state allows at least a 10-day grace period from the time a debtor receives possession of collateral in which to perfect a PMSI in equipment that will have superpriority over an intervening lien creditor such as a trustee in bankruptcy. Thus, because Westar's security interest was properly perfected under state law and within the permissible time after Saper took possession of the computers, Westar's security interest is superior to the interest of the trustee in bankruptcy

Under the Sales Article of the UCC, in an auction announced in explicit terms to be *without reserve*, when may an auctioneer withdraw the goods put up for sale? I. At any time until the auctioneer announces completion of the sale. II. If no bid is made within a reasonable time. a. II only. b. I only. c. Either I or II. d. Neither I nor II.

*a. II only.* Explanation Choice "1" is correct. In an auction without reserve, the goods must be sold if an offer is made. Of course, if no offer is made within a reasonable time, the goods need not be sold. *Item I describes a sale with reserve.*

Cash gifts to four sisters of $7,000 each (gift made before death) a. Not includable in Remsen's gross estate b. Deductible from Remsen's final individual tax return c. Fully includable in Remsen's gross estate d. Fully deductible in Remsen's gross estate

*a. Not includable in Remsen's gross estate* The cash gifts to his sisters were made before he died, so they are *not included in his estate*. The gifts were *within the annual $15,000-per-donee gift exclusion*.

Tuition payment directly to university on grandchild's behalf (gift made before death) a. Not includable in Remsen's gross estate b. Deductible from Remsen's final individual tax return c. Fully includable in Remsen's gross estate d. Fully deductible in Remsen's gross estate

*a. Not includable in Remsen's gross estate* This gift was *made before Remsen died, so it is not part of his gross estate*. There is an unlimited exclusion from gift tax for gifts made directly to an educational institution on behalf of a donee.

Robert Corp. granted an incentive stock option for 200 shares to Beverly, an employee, on March 14, Year 12. The option price and FMV on the date of grant was $150. Beverly exercised the option on August 2, Year 14, when the FMV was $180 per share. She sold the stock on September 20, Year 15, for $250 per share. How much *gross income* did Beverly *recognize in Year 12*? a. $150 b. $0 c. $30,000 d. $20,000

*b. $0* Explanation Choice "2" is correct. Due to the fact that this is a *qualified stock option*, there is *no recognition of income in the year of grant*. (PAY ATTENTIONTO THE DATES!!) Choice "1" is incorrect. This is simply the option price per share on the date of grant. Choice "3" is incorrect. This is the purchase price of the stock upon exercise of 200 shares at $150 per share. It is not income in the year of grant as per the above explanation. Choice "4" is incorrect. This is the gain Beverly will recognize upon the sale of the stock. The purchase was 200 shares at $150 per share, or $30,000. The sale was 200 shares at $250 per share, or $50,000. *This gain is not recognized until the sale occurs in Year 15.*

Donner Corporation, an S corporation, had an ordinary loss of $73,000 for the current year ended December 31. At January 1 of the current year, Cracraft, an individual, owned 50% of Donner's stock. Cracraft held the stock for 90 days during the year before selling the entire 50% interest to an unrelated third party. Cracraft's properly-calculated basis for the stock on the date of sale was $20,000, and Cracraft sold the stock for $10,000. Cracraft was a full-time employee of Donner until the stock was sold. Cracraft's share of Donner's current year loss was: a. $10,000 b. $9,000 c. $18,000 d. $36,500

*b. $9,000* Explanation Choice "2" is correct. *If ownership interests in an S corporation change within the taxable year*, the income and/or loss to be *allocated among the various shareholders will be made on a "per share/per day" basis*. S corporation loss for the year $(73,000) Divided by 365 days in a year ÷ 365 =Losses per day during the year (200) Number of days Cracraft was a shareholder × 90 =Loss allocated to 90 days (18,000) Cracraft's ownership interest × 50% =Loss allocated to Cracraft for the year $(9,000) *S corporation ordinary loss for the year x (Number of days [Cracraft] was a shareholder / 365) = Loss allocated to days spent as shareholder x [Cracraft's] ownership interest = Loss allocated to [Cracraft] for the year* Choice "1" is incorrect. This amount represents Cracraft's capital loss on the sale of Donner's stock [$10,000 selling price − $20,000 basis]. The allocated losses of $9,000 would already have been included in the basis calculation to arrive at the $20,000. Choice "3" is incorrect. This amount represents 100% of Donner's losses for the 90 days Cracraft held the stock. Cracraft only owned 50% of the stock for those 90 days. Choice "4" is incorrect. This amount represents 50% of Donner's total loss for the year. Cracraft only held the stock for 90 days during the year, and the losses must be allocated based on the number of days he held the stock during the year (as well as the percentage ownership).

Sky Corp. was a wholly-owned subsidiary of Jet Corp. Both corporations were domestic C corporations. Jet received a liquidating distribution of property in cancellation of its Sky stock when Jet's tax basis in Sky stock was $100,000. The distributed property had an adjusted basis of $135,000 and a fair market value of $250,000. What amount of taxable gain did Jet, the parent corporation, recognize on the receipt of the property? a. $250,000 b. $150,000 c. $0 d. $35,000

*c. $0* Explanation Choice "3" is correct. *No gain is recognized by* Jet Corporation, *the parent, upon the liquidation of Sky* Corporation. *Rule*: No gain or loss is generally recognized in connection with the complete liquidation of a controlled subsidiary (e.g., Sky Corp.) into its parent corporation (e.g., Jet Corp.). (Note: In addition, any unused net operating loss carryovers or charitable contribution carryovers would be transferred to the successor parent corporation.) *Explanation*: Sky Corporation was a wholly-owned subsidiary of Jet Corporation; therefore, it was a controlled subsidiary. This was a liquidating distribution in cancellation of Jet's investment in Sky Corporation; therefore, it was a complete liquidation.

Which of the following tax credits *may result in a refund* even if the taxpayer had *no income tax liability*? a. Elderly and permanently disabled credit. b. Dependent care credit. c. Additional child tax credit. d. Adoption credit.

*c. Additional child tax credit.* Explanation Choice "3" is correct. The additional child tax credit may result in a refund to the extent of the lesser of (1) excess child tax credit over the tax liability or (2) earned income less certain thresholds. Choices "4", "2", and "1" are incorrect. These allowable credits are personal tax credits that are not deemed "refundable" credits, which means that they can reduce the total tax liability to zero, but may not result in a cash refund in excess of the liability

Which of the following claims would have the highest priority in the distribution of a bankruptcy estate in an involuntary proceeding under Chapter 7 of the Bankruptcy Code filed on June 1, Year 1, with the order for relief granted on June 30, Year 1? a. Employee wages of $3,500 due on March 30, Year 1. b. Consumer deposit of $4,500 for goods ordered, but not received. c. Alimony payment due. d. A claim occurring in the ordinary course of business on June 5, Year 1, prior to the order for relief or appointment of a trustee.

*c. Alimony payment due.* Explanation Choice "3" is correct. After secured creditors are paid, the unsecured creditors entitled to a priority are paid. Claims for alimony have the *first priority* among unsecured creditors. Choice "1" is incorrect. Employees with claims for wages earned within 180 days prior to the filing receive the fourth priority among unsecured creditors. Choice "2" is incorrect. Consumer deposits for goods ordered but not received have the seventh priority among unsecured creditors. Choice "4" is incorrect. Claims that accrue in the ordinary course of business after an involuntary petition is filed, but before the order for relief or appointment of a trustee (involuntary case gap claims), receive third priority among unsecured creditors.

Marketable securities owned at date of death (bequeathed to spouse) a. Not includable in Remsen's gross estate b. Deductible from Remsen's final individual tax return c. Fully includable in Remsen's gross estate d. Fully deductible in Remsen's gross estate

*c. Fully includable in Remsen's gross estate* The fair market value of the marketable securities are fully includable in the gross estate. Since they were bequeathed to his wife, they will *qualify for the unlimited marital deduction*, a *deduction from the gross estate to arrive at the taxable estate*.

Cash owned at date of death (bequeathed to son) a. Not includable in Remsen's gross estate b. Deductible from Remsen's final individual tax return c. Fully includable in Remsen's gross estate d. Fully deductible in Remsen's gross estate

*c. Fully includable in Remsen's gross estate* The full amount of cash is includable in the gross estate (although there will be deductions from the gross estate to arrive at the taxable estate for certain amounts of cash paid out).

Life insurance policy proceeds (son named as beneficiary) a. Not includable in Remsen's gross estate b. Deductible from Remsen's final individual tax return c. Fully includable in Remsen's gross estate d. Fully deductible in Remsen's gross estate

*c. Fully includable in Remsen's gross estate* The full fair market value of the life insurance policy is includable in the gross estate because the *decedent was the owner of the policy at the time of his death*.

Lincoln Corp., a calendar-year C corporation, made a nonliquidating cash distribution of $1,500,000 to its shareholders with respect to its stock. At that time, Lincoln's current and accumulated earnings and profits totaled $825,000 and its total paid in capital for tax purposes was $10,000,000. Lincoln had no corporate shareholders. Which of the following statements is(are) correct regarding Lincoln's cash distribution? I. The distribution was taxable as $1,500,000 in ordinary income to its shareholders. II. The distribution reduced its shareholders' adjusted bases in Lincoln stock by $675,000. a. Both I and II. b. I only. c. II only. d. Neither I nor II.

*c. II only.* Explanation Choice "3" is correct. The distribution reduced the shareholders' adjusted bases in Lincoln Corporation Stock by $675,000. Rule: Non-liquidating cash distributions (deemed dividends) are ordinary dividends to the shareholder to the extent of current and accumulated earnings and profits (retained earnings). Any portion paid in excess of current and accumulated earnings and profits is considered a return of capital to the shareholder, to the extent of the shareholder's basis (anything in excess of basis, which includes paid-in-capital and common stock, is capital gain to the shareholder). *Note*: The distinction of *whether the shareholders were corporate shareholders or individuals is a distractor* for purposes of this question. It would make a difference for taxation of the dividends due to the corporate dividends received deduction, but this is not asked in the question. Current and accumulated earnings and profits $ 825,000 -Less: Non-liquidating cash distribution (1,500,000) =Reduction in bases of shareholders $ (675,000)

An employee who has had social security tax withheld in an amount greater than the maximum for a particular year may claim: a. Reimbursement of such excess from his employer, if the excess resulted from correct withholding by two or more employers. b. The excess as a credit against income tax, provided the excess was over-withheld by one employer. c. The excess as a credit against income tax, if that excess was correctly withheld by two or more employers. d. An itemized deduction for the excess or a credit against income tax, if the excess resulted from correct withholding by two or more employers.

*c. The excess as a credit against income tax, if that excess was correctly withheld by two or more employers.* Explanation Choice "3" is correct. An employee who has had social security tax withheld in an amount greater than the maximum for a particular year may claim the *excess as a credit against income tax*, if that excess was correctly *withheld by two or more employers*.

Dent is an agent for Wein pursuant to a written agreement with a three-year term. After two years of the term, Wein decides that he would like to terminate the relationship with Dent. Wein may terminate the relationship: a. Only if Dent breaches the fiduciary duties owed to Wein. b. Without cause, but may be held liable for the intentional interference with an existing contract. c. Without cause, but may be held liable for breach of contract. d. Even if Dent is an agent coupled with an interest.

*c. Without cause, but may be held liable for breach of contract.* Explanation Choice "3" is correct. Either party generally has the power to terminate the relationship at will, but they may be liable for damages if the termination breached the contract between the parties. Here, the contract was for three years. If Wein terminates the contract after only two years without cause he will be held to be in breach and thus may be held liable for damages. Choice "1" is incorrect. Generally, both the principal and the agent have the power (although not necessarily the right) to terminate the agency relationship at any time. There is no prerequisite that the agent must have breached a fiduciary duty. Choice "2" is incorrect. If a party to a contract breaches the contract, the party may be held liable for breach of contract but not for intentional interference with contractual relations. Intentional interference is a tort claim that may be brought by a party to a contract against a third party who wrongfully interferes with a contractual relationship. Choice "4" is incorrect. If the agency is coupled with an interest, the principal does not have the power to terminate the agent; only the agent has the power to terminate the agency

Incentive Stock Options (ISO) (7 requirements)

1. *Granted* under a plan, *approved* by the shareholders, sets out the total number of shares that may be issued and who may receive them 2. Must be granted *within 10 years* of the *earlier of the date* when the plan was *adopted* or *approved* 3. The options must be *exercisable within 10 years* of the grant date 4. The exercise price may *not* be *less than* the *FMV of the stock* at the date of *grant* 5. The employee *may not own more than 10% of the combined voting power* of the corp. as of the date of the grant 6. Once exercised, must be *held at least 2 years after grant date* and at least *one year after exercise* date 7. Employee *must remain employee* from date option is granted *until 3 months before* the option is *exercised*

Emerald Corporation, an accrual basis taxpayer, was formed and began operations on July 1, Year 1. The following expenses were incurred during the first tax year (July 1 to December 31, Year 1) of operations: Expenses of temporary directors and of *organizational meetings* $ 5,000 Fee paid to the *state of incorporation* 600 Accounting services *incident to organization* 1,200 *Legal services for drafting* the corporate charter and *bylaws* 2,800 Expenses incident to the printing and sale of *stock certificates* 1,000 Total $10,600 Assume Emerald Corporation makes an appropriate and timely election under §248(c) and the related regulations. What is the maximum organizational expense Emerald may write-off for the first tax year? a. $153 b. $5,187 c. $960 d. $5,153

*d. $5,153* Explanation Choice "4" is correct. Organizational meetings $5,000 +State incorporation fees 600 +Accounting for expenses incident to organization 1,200 +Legal fees drafting bylaws 2,800 =Qualified "start-up" expenses $9,600 -Expensed immediately (5,000) =Remainder $ 4,600 Amortization Period ÷ 180 months =Amortization expense/month $ 25.56 Months of operation (July − Dec.) × 6 =Total Amortization expense $153.36 *Total write-off:* Expense maximum $ 5,000 +Amortized amount 153 *=Total write-off $ 5,153* Organizational expenses are eligible for an immediate 5,000 deduction, with the remainder amortized over 180 months. (Note: The $5,000 is reduced as the total cost exceeds 50,000 for each item.) Note that expenses related to the issuance of the corporation's stock (the expenses for printing and sale of stock certificates, $1,000) are not amortizable.

Executor's fees to distribute decedent's property (deducted on fiduciary tax return) a. Not includable in Remsen's gross estate b. Deductible from Remsen's final individual tax return c. Fully includable in Remsen's gross estate d. Fully deductible in Remsen's gross estate

*d. Fully deductible from Remsen's gross estate* Executor's fees to distribute the decedent's property are allowable deductions from the decedent's gross estate to arrive at the decedent's taxable estate. They are not deductible on the decedent's final individual income tax return.

Decedent's funeral expenses a. Not includable in Remsen's gross estate b. Deductible from Remsen's final individual tax return c. Fully includable in Remsen's gross estate d. Fully deductible in Remsen's gross estate

*d. Fully deductible from Remsen's gross estate* Funeral expenses for the decedent are *allowable deductions from the decedent's gross estate* to arrive at the decedent's taxable estate. They are *not* deductible on the decedent's *final individual income tax return*.

Decedent's outstanding medical expenses a. Not includable in Remsen's gross estate b. Deductible from Remsen's final individual tax return c. Fully includable in Remsen's gross estate d. Fully deductible in Remsen's gross estate

*d. Fully deductible from Remsen's gross estate* The decedent's outstanding medical expenses are *allowable deductions* from the decedent's gross estate to arrive at the decedent's taxable estate. They can only be deducted on the decedent's final individual income tax return if they are paid within one year of the date of death. In this case, Remsen died on January 9, Year 1, and the medical expenses were paid on January 31, Year 2, so they were not paid within one year of the date of death.

Employee Stock Purchase Plans (ESPP) (8 requirements)

1. The plan must be *written and approved* by the shareholders 2. *Cannot* grant options to any employee who has *more than 5% of the voting power* of the corp. 3. Must include all full-time employees (except highly compensated employees) and those with < 2 years employment 4. Option exercise price may *not* be *less than (<)* the *lesser of 85% of FMV of stock* when *granted or exercised* (ex: stock price = $25/share and option price was $22/share; 85% of $25 = $21.25; $22 option > $21.25) 5. The options must be *exercisable within 10 years* of the grant date 6. *No employee* can acquire the *right to purchase > $25,000 of stock* per year. 7. Once exercised, must be *held at least 2 years after grant date* and at least *one year after exercise* date 8. The employee *must remain employee* of corp from date option is granted *until 3 months before* option is *exercised*

For the current year, Hammond Corporation reported book income of $2,300,000. Included in that amount was corporate bond interest income of $100,000, municipal bond interest income of $200,000, $80,000 for meals expense, $500,000 for corporate federal income tax expense, $150,000 state income tax expense, $75,000 of rental expense, and $20,000 for life insurance premiums on an officer's life (corporation is the beneficiary). Further, the company collected $50,000 in advance rents during the year. In Hammond's Schedule M-1 of Form 1120 for the current year, which reconciles book income to taxable income, what amount should be reported as taxable income? a. $2,710,000 b. $2,670,000 c. $2,660,000 d. $2,860,000

Explanation Choice "1" is correct. Taxable income of $2,710,000 is calculated as follows: Book income $ 2,300,000 Additions: +Federal income tax expense 500,000 +50% of meals 40,000 +Life insurance premiums 20,000 +Advance rents collected 50,000 Subtractions: -Municipal bond interest income (200,000) =Taxable income $2,710,000 *do not add/subtract corporate bonds - LEAVE IT ALONE!* Choice "2" is incorrect. This amount fails to make an adjustment to increase book income by 50% of the meals expenses paid, which are only 50% deductible. Choice "3" is incorrect. This amount neglects to include the $50,000 advance rents received as taxable income. Choice "4" is incorrect. This amount adds the state income tax paid back to the book income in error. State income taxes are deductible expenses on the federal corporate income tax return.

Amount of taxable estate before exclusion

Remsen's taxable estate is calculated as follows: Gross estate: Cash$ 650,000 +Marketable securities (FMV) 900,000 +Life insurance proceeds 500,000 =Total gross estate 2,050,000 Less: nondiscretionary deductions -Executor's fees (15,000) -Funeral expenses (25,000) -Medical expenses (10,000) =Adjusted gross estate 2,000,000 -*Less: unlimited marital deduction* (for transfers to spouse) (900,000) *=Taxable estate before exclusion $ 1,100,000* The taxable estate is *less than the transfer tax exclusion amount* of $11,400,000, so it is *not* subject to estate tax.

Schedule E (Income from rental real estate, royalties, S corporations, and partnerships)

includes: -Residential real estate rental unit -Share of S corp's/partnership's/LLP's *ordinary business income* (which must be calculated -Share of Section 179 depreciation (in the SIM example, the share of the LLP's (10% interest) loss was limited to the rental unit because they are passive activities. PALs are limited to PA gains)