2009 AICPA newly released questions – regulation

2009 AICPA Newly Released Questions – Regulation Following are multiple choice questions recently released by the AICPA These questions were released by the AICPA with letter answers only Our editorial board has provided the accompanying explanation Please note that the AICPA generally releases questions that it does NOT intend to use again These questions and content may or may not be representative of questions you may see on any upcoming exams © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation Under which of the following circumstances is trust property with an independent trustee includible in the grantor's gross estate? a b c d The trust is revocable The trust is established for a minor The trustee has the power to distribute trust income The income beneficiary disclaims the property, which then passes to the remainderman, the grantor's friend Solution: Choice "a" is correct If a revocable trust is created by a grantor, the trust assets may be returned to the grantor upon the grantor's "revocation" of the trust (i.e., no "complete" gift exists); thus, the assets never left the control (or possible ownership) of the grantor and remain includible in the gross estate of the grantor Choice "b" is incorrect When a trust is established for a minor, a complete gift is made to the trust, and the assets are no longer includible in the estate of the grantor Choice "c" is incorrect The trustee typically has the power to distribute trust income in various types of trusts; thus, this fact alone would not make the assets includible in the gross estate of the grantor Choice "d" is incorrect This type of arrangement has nothing to with the requirement of assets to be included in the gross estate of the grantor, as it could exist in an irrevocable trust or a revocable trust The beneficiary is simply passing his/her distribution to another party © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation Brisk Corp is an accrual-basis, calendar-year C corporation with one individual shareholder At year end, Brisk had $600,000 accumulated and current earnings and profits as it prepared to make its only dividend distribution for the year to its shareholder Brisk could distribute either cash of $200,000 or land with an adjusted tax basis of $75,000 and a fair market value of $200,000 How would the taxable incomes of both Brisk and the shareholder change if land were distributed instead of cash? a b c d Brisk's taxable income No change Increase No change Increase Shareholder's taxable income No change No change Decrease Decrease Solution: Rule: The taxable amount of a dividend to a shareholder from a corporation's earnings and profits is the amount received in cash or the fair market value of the property received Rule: The general rule is the payment of a dividend does not create a taxable event, unless the distribution is appreciated property When the distribution is of appreciated property, the corporation recognizes gain as if the property were sold at fair market value Choice "b" is correct If Brisk Corp were to distribute $200,000 of accumulated earnings and profits in cash as a dividend, the shareholder would recognize $200,000 in dividend income, and the corporation would reduce its earnings and profits by $200,000 If, instead, the dividend were the $200,000 FMV land with a basis of $75,000, the shareholder would still recognize $200,000 of dividend income (the FMV of the property received, as per the above rule), but the corporation would recognize a gain of $125,000 on the distribution ($200,000 FMV - $75,000 basis, per the above rule), the corporation's earnings and profits would increase $125,000, and the corporation would reduce its earnings and profits by the $200,000 dividend distribution Thus, Brisk's taxable income would increase if the land were distributed, but the shareholder's taxable income would not change Choice "a" is incorrect Per the above discussion and rules, Brisk's taxable income would increase $125,000 Choice "b" is incorrect Per the above discussion and rules, Brisk's taxable income would increase $125,000 and the shareholder would have no change in taxable income Choice "c" is incorrect Per the above discussion and rules, Brisk's taxable income would indeed increase ($125,000), but the shareholder would have no change in taxable income © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation Under the Negotiable Instruments Article of the UCC, which of the following parties has secondary liability on an instrument? a b c d An acceptor of a note An issuer of a cashier's check A drawer of a draft A maker of a note Solution: Choice "c" is correct The drawer of a draft is secondarily liable The drawer is liable only after the draft is presented to the drawee, the draft is dishonored, and the drawer is given notice of dishonor Choice "a" is incorrect because an acceptor is primarily liable When a drawee signs a draft, the drawee becomes an acceptor and is primarily liable Choice "b" is incorrect because with a cashier’s check, the bank is both the drawer and the drawee As the issuer the bank would be primarily liable Choice "d" is incorrect because the maker of a note is primarily liable © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation (Adapted) Train issued a note payable to Blake in payment of contracted services that Blake was to perform Blake endorsed the negotiable note "pay to bearer" and delivered it to Reed in satisfaction of a debt owed Reed Train refused to pay Reed on the note because Blake had not yet performed the services Reed was unaware of this failure when he took the note Under the Negotiable Instruments Article of the UCC, must Train pay Reed? a b c d No, Train does not have to pay Reed until the services are performed No, Train does not have to pay Reed because the note was issued to Blake Yes, Train has to pay Reed because the note was converted into bearer paper Yes, Train has to pay Reed because Reed was a holder in due course Solution: Choice "d" is correct Reed met all the requirements to be a holder in due course He was the holder of a negotiable instrument (the note) He gave value (taking a note as payment for debt constitutes value) Nothing in the facts indicates that Reed lacked good faith He was without notice of Blake's nonperformance of services Nonperformance of services is a personal defense and not a real defense A holder in due course takes free of personal defenses and is subject only to real defenses Thus, Train will have to pay Reed Choices "a" and "b" are incorrect because both indicate that Train will not have to pay Reed Train will have to pay Reed due to Reed's status as a holder in due course Choice "c" is incorrect Train must pay Reed because Reed was a holder in due course, not because the note was bearer paper © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation Assuming appropriate disclosure is made, which of the following fee arrangements generally would be permitted under the ethical standards of the profession? a b c d A fee paid to the client's audit firm for recommending investment advisory services to the client A fee paid to the client's tax accountant for recommending a computer system to the client A contingent fee paid to the CPA for preparing the client's amended income tax return A contingent fee paid to the CPA for reviewing the client's financial statements Solution: Choice "b" is correct There is no prohibition against paying a consulting fee to a tax accountant who recommends a computer system Choice "a" is incorrect A member in public practice shall not for a commission recommend or refer to a client any product or service when the member or the member's firm also performs for that client an audit of a financial statement Choices "c" and "d" are incorrect Contingent fees are specifically prohibited for audits and reviews of financial statements © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation Fox, the sole shareholder in Fall, a C corporation, has a tax basis of $60,000 Fall has $40,000 of accumulated positive earnings and profits at the beginning of the year and $10,000 of current positive earnings and profits for the current year At year end, Fall distributed land with an adjusted basis of $30,000 and a fair market value (FMV) of $38,000 to Fox The land has an outstanding mortgage of $3,000 that Fox must assume What is Fox's tax basis in the land? a b c d $38,000 $35,000 $30,000 $27,000 Solution: Choice "a" is correct Absent information to the contrary, we should assume this distribution is in the form of a dividend (especially because Fox is the sole shareholder) If the shareholder is an individual, the taxable amount of a property dividend from a corporation's earnings and profits is the fair market value of the property received (and the property's basis then becomes that fair market value) In this case, the shareholder is also taking on the responsibility for the mortgage on the property, but this affects only the amount of taxable income, as the debt is reported as a separate line item and does not affect the basis of the land The tax journal entry follows and indicates that the basis of the land is $38,000: Dr Land $38,000 Debt Taxable income Cr $ 3,000 $35,000 Choice "b" is incorrect This is the amount of the taxable income on the dividend ($35,000), not the basis in the land, as per the above journal entry Choice "c" is incorrect This amount of $30,000 is the basis of the land on the corporation's books In a dividend situation, assets are transferred from the corporation using the fair market value of the assets at the date of distribution Choice "d" is incorrect This amount of $27,000 was arrived at by using the basis of the land on the corporation's books ($30,000) and subtracting the mortgage assumed by the shareholder ($3,000) As is discussed in the explanation of the answer for item "a" (above), the fair market value should be used as the basis, and the debt does not have an effect on basis (debt affects taxable income, as shown in the journal entry above) © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation Dart, a C corporation, distributes software over the Internet and has had average revenues in excess of $20 million dollars per year for the past three years To purchase software, customers key-in their credit card number to a secure web site and receive a password that allows the customer to immediately download the software As a result, Dart doesn't record accounts receivable or inventory on its books Which of the following statements is correct? a Dart may use either the cash or accrual method of accounting as long as Dart elects a calendar year end b Dart may utilize any method of accounting Dart chooses as long as Dart consistently applies the method it chooses c Dart must use the accrual method of accounting d Dart may utilize the cash basis method of accounting until it incurs an additional $10 million to develop additional software Solution: Choice "c" is correct While the cash basis of accounting is used by most taxpayers for tax purposes, the accrual basis method of accounting for tax purposes is required for the following: The accounting for purchases and sales of inventory, Tax shelters, Certain farming corporations, and C corporations, trusts with unrelated trade or business income, and partnerships having a C corporation as a partner provided the business has greater than $5 million average annual gross receipts for the three-year period ending with the tax year The information in the facts tells us that Dart does not maintain inventory, so the first item that requires accrual method of accounting does not apply However, the facts also tell us that Dart is a C corporation with average annual gross receipts in excess of $20 million for the last three years (all of its sales are via credit card, which is turned into cash immediately; thus, gross receipts for the year are over $20 million) The fourth requirement above indicates that accrual method of accounting for tax purposes is required if a C corporation has annual average gross receipts in excess of $5 million for the three-year period ending with the tax year-thus, Dart must use the accrual method of accounting for tax purposes Choice "a" is incorrect, per the above explanation Choice "b" is incorrect, per the above explanation Choice "d" is incorrect, per the above explanation © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation Spinner, CPA, had audited Lasco Corp.'s financial statements for the past several years Prior to the current-year's engagement, a disagreement arose that caused Lasco to change auditing firms Lasco has demanded that Spinner provide Lasco with Spinner's working papers so that Lasco may show them to prospective auditors to help them prepare their bids for Lasco's audit engagement Spinner refused and Lasco commenced litigation Under the ethical standards of the profession, will Spinner be successful in refusing to turn over the working papers? a Yes, because Spinner is the owner of the working papers b Yes, because Lasco is required to direct prospective auditors to contact Spinner to make arrangements to view the working papers in Spinner's office c No, because Lasco has a legitimate business reason for demanding that Spinner surrender the working papers d No, because it was Lasco's financial statements that were audited Solution: Choice "a" is correct Work papers belong to the accountant who prepares them, not the client Thus, as the owner of the workpapers, Spinner does not have to disclose them to the client, Lasco Choice "b" is incorrect because it indicates Spinner would have to disclose if Lasko directed the new auditors to contact Spinner to view the workpapers in Spinner’s office Spinner does not have to disclose the workpapers Choices "c" and "d" are incorrect Both indicate that Spinner must disclose to Lasco and Spinner is not required to disclose the workpapers © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation The Simone Trust reported distributable net income of $120,000 for the current year The trustee is required to distribute $60,000 to Kent and $90,000 to Lind each year If the trustee distributes these amounts, what amount is includible in Lind's gross income? a b c d $0 $60,000 $72,000 $90,000 Solution: Rule: The income distribution deduction is the LESSER of DNI or the actual amount distributed to the beneficiary Choice "c" is correct Distributable net income is the maximum amount of income from the trust that may be taxed (passed through) to the beneficiary and be deductible by the trust as "the income distribution deduction." [The reason is that the beneficiary will report this amount of taxable income on his/her personal income tax return.] However, while DNI is the maximum amount of the income distribution deduction, the income distribution deduction is the LESSER of DNI or the actual amount distributed to the beneficiary The amount of the income distribution deduction to the beneficiary is the amount of income that is taxed to the beneficiary Typically, we see a situation in which DNI exceeds the amount distributed to the beneficiary; thus, the income distribution deduction would be the amount distributed In this case, the examiners are truly testing the candidate's ability to understand the concept of DNI, distributions, and the amount that can be deducted by the trust (and thus taxed to the beneficiary) because actual (and required) distributions exceed DNI Further, the examiners are requiring candidates to make a calculation based on the prorated amount of actual distributions required to be made Kent is required to receive $60,000 and Lind is required to receive $90,000 per year (for a total of $150,000) The applicable pro-rata portion of the income distribution deduction ($120,000 in this case) for Lind and the amount that would subsequently be includible in Lind's gross income is calculated as follows: $90,000/$150,000 * $120,000 = $72,000 Choice "a" is incorrect The amount includible in Lind's gross income is calculated per the above explanation Choice "b" is incorrect The answer ($60,000) is the amount of actual distributions to Kent While the question asks about Lind, we can take this option one step further for illustrative purposes Kent received $60,000 in actual distributions, but the maximum income distribution for Kent (and the amount that will show up on Kent's K-1 from the trust) is $48,000 [$60,000/$150,000 * $120,000] Choice "d" is incorrect Lind received $90,000 in actual distributions, but the maximum income distribution for Lind (and the amount that will show up on Lind's K-1 from the trust) is $72,000 [$90,000/$150,000 * $120,000] 10 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 26 George and Suzanne have been married for 40 years Suzanne inherited $1,000,000 from her mother Assume that the annual gift-tax exclusion is $12,000 What amount of the $1,000,000 can Suzanne give to George without incurring a gift-tax liability? a b c d $12,000 $24,000 $500,000 $1,000,000 Solution: Rules: Every transfer of money or property, whether real or personal, tangible or intangible, for less than adequate or full consideration is a gift A donor may exclude the maximum allowable amount of gifts according to the tax law each year made to each donee In addition, there are four items that qualify for unlimited exclusion from gift tax: (1) payments made directly to an educational institution for a donee's tuition, (2) payments made directly to a health care provider for medical care, (3) charitable gifts, and (4) marital transfers Relationship of the donee to the donor is not of consequence Choice "d" is correct Per the above rule, marital transfers are excluded from gift tax In this case, Suzanne inherited $1,000,000 Suzanne can give the entire $1,000,000 to George without incurring a gift tax liability Choice "a" is incorrect The answer option is the annual exclusion amount given in the question of $12,000 As per the above rule, marital transfers are excluded from gift tax Choice "b" is incorrect This answer option incorrectly assumes a gift-split of the two spouses (using the $12,000 annual exclusion amount) [$12,000 * = $24,000.] Per the above rule, marital transfers are excluded from gift tax Choice "c" is incorrect This answer option incorrectly assumes that 50% of the $1,000,000 (probably trying to trick you into applying the "joint" property rules) is the maximum amount that can be transferred to George without Suzanne incurring gift tax liability Per the above rule, marital transfers are excluded from gift tax 27 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 27 Kant, a cash-basis individual, owns and operates an office building Kant received the following payments during the current year: Current rents Advance rents for the next year Security deposits held in a segregated account Lease cancellation payments $30,000 10,000 5,000 15,000 What amount is included in gross income? a b c d $30,000 $40,000 $55,000 $60,000 Solution: 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 Net rental income 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 "c" is correct The calculation of gross income for the year follows: Current rents Advance rents for the next year Security deposits held in a segregated account Lease cancellation payments $30,000 10,000 -15,000 Gross income from the rental activity $55,000 Choice "a" 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 "b" 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 "d" 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 28 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 28 Webster, a C corporation, has $70,000 in accumulated and no current earnings and profits Webster distributed $20,000 cash and property with an adjusted basis and fair market value of $60,000 to its shareholders What amount should the shareholders report as dividend income? a b c d $20,000 $60,000 $70,000 $80,000 Solution: Rules: Distributions from corporations to shareholders are taxable to such shareholders if the distributions are classified as dividends A dividend is defined by the IRC as a distribution of property by a corporation out if its earnings and profits An individual shareholder will be taxed on dividends in cash for the amount received and on dividends of property for the fair market value of the property received Distributions are deemed to come from earnings and profits first Any distribution in excess of earnings and profits ("E&P," accumulated and current) is treated as a nontaxable return of capital that reduces the shareholder's basis in the stock Distributions in excess of basis are capital gain distributions taxable as capital gains instead of dividends Choice "c" is correct Per the above rules, an individual shareholder will be taxed on dividends in cash for the amount received and on dividends of property for the fair market value of the property received, but any distribution in excess of earnings and profits (accumulated and current) is treated as a nontaxable return of capital that reduces the shareholder's basis in the stock The corporation has $70,000 in current and accumulated earnings and profits Therefore, the shareholders will be taxed on the $20,000 in cash received plus the $60,000 in FMV of the property received ($80,000), but only to the extent there is E&P, and that means a taxable amount of dividends of $70,000 The remaining $10,000 will either be a nontaxable return of capital (assuming basis exists), a taxable capital gain (assuming no basis exists), or something in between (assuming basis is positive but less than $10,000) [Note: The question indicates that the basis of the property equals the fair market value This avoids the impact on the E&P on the corporation's books for the gain on the dividend to the shareholders and keeps the E&P at $70,000.] Choice "a" is incorrect This answer option incorrectly includes only the cash received ($20,000) as the dividend and excludes the property received Choice "b" is incorrect This answer option incorrectly includes only the fair market value of the property received ($60,000) as the dividend and excludes the cash received Choice "d" is incorrect This answer option includes both the $20,000 cash received and the $60,000 fair market value of the property received [$20,000 + $60,000 = $80,000], but it (incorrectly) does not limit the dividend income to the total amount of corporate E&P, which is $70,000 29 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 29 Under the Secured Transactions Article of the UCC, for which of the following types of collateral must a financing statement be filed in order to perfect a purchase money security interest? a b c d Stock certificates Promissory notes Personal jewelry Inventory Solution: Choice "d" is correct By definition a purchase money security interest in inventory can only occur in two ways First, the creditor sells inventory to the debtor on credit and retains a security interest for the purchase price Second, the creditor loans money to the creditor to purchase the inventory In either case, filing is the only way to perfect The debtor has possession of the inventory, not the creditor Thus, the creditor cannot perfect by possession or control The creditor cannot be automatically perfected with a purchase money security interest in inventory Only a purchase money security interest in consumer goods is automatically perfected Thus, the only way to perfect a purchase money security interest in inventory is to file a financing statement Choices "a" and "b" are incorrect With stocks, bonds and negotiable instruments (like promissory notes), the creditor can only perfect by possession or control Choice "c" is incorrect because personal jewelry is consumer goods collateral, and a purchase money security interest in consumer goods can be automatically perfected without filing 30 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 30 Under the Secured Transactions Article of the UCC, what secured transaction document must be signed by the debtor? a b c d Statement of assignment Security agreement Release of collateral Termination statement Solution: Choice "b" is correct The security agreement must be signed or authenticated by the debtor Choice "a" is incorrect The Secured Transaction Article permits a creditor to assign all or part of his rights under a security agreement A statement of assignment must be signed by the creditor, not the debtor Choice "c" is incorrect The Secured Transaction Article permits a creditor to release all or part of his rights to collateral described in a security agreement A release of collateral must be signed by the creditor, not the debtor Choice "d" is incorrect A termination statement terminates a security interest in collateral It must be signed by the creditor, not the debtor 31 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 31 Ames and Roth form Homerun, a C corporation Ames contributes several autographed baseballs to Homerun Ames purchased the baseballs for $500, and they have a total fair market value of $1,000 Roth contributes several autographed baseball bats to Homerun Roth purchased the bats for $5,000, and they have a fair market value of $7,000 What is Homerun's basis in the contributed bats and balls? a b c d $0 $5,500 $6,000 $8,000 Solution: Rules: There is no gain or loss to the corporation issuing stock in exchange for property for the issuance of stock The general rule is that the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation A shareholder recognizes gain when at least 80% of the voting stock is not owned by the shareholders immediately after the transaction and there is no taxable boot (cash is withdrawn or cancellation of debt exists) on the transaction Choice "b" is correct The general rule is that the basis of the property received from the transferor/shareholder is the greater of: (1) adjusted net book value of the transferor/shareholder plus any gain recognized by the transferor/shareholder or (2) debt assumed by the corporation Applying the information in the fact pattern and that above rules, there is no "shareholder gain" on this transaction Further, there is not indication of any debt being assumed by the corporation Thus, Homerun's basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors Choice "a" is incorrect Homerun's basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors Choice "c" is incorrect This answer option incorrectly adds the fair market value of the baseballs ($1,000) to the basis of the bats ($5,000) Homerun's basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors Choice "d" is incorrect This answer option incorrectly adds the fair market value of the baseballs ($1,000) to the fair market value of the bats ($7,000) Homerun's basis in the contributed bats and balls is $5,500 [$500 for the baseballs plus $5,000 for the bats], which is the adjusted net book value of the transferors 32 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 32 Sandy is the sole shareholder of Swallow, an S corporation Sandy's adjusted basis in Swallow stock is $60,000 at the beginning of the year During the year, Swallow reports the following income items: Ordinary income Tax-exempt income Capital gains $30,000 5,000 10,000 In addition, Swallow makes a nontaxable distribution to Sandy of $20,000 during the year What is Sandy's adjusted basis in the Swallow stock at the end of the year? a b c d $60,000 $70,000 $80,000 $85,000 Solution: Rules: The rules for determining a shareholder's basis in S corporation stock follow: + + - Initial basis (or beginning of year) Income items (separately and non-separately stated items) Additional shareholder investments in corporation stock Distributions to shareholders Loss or expense items Ending basis Choice "d" is correct Initial basis (or beginning of year amount) Income items (separately and non-separately stated items) Additional shareholder investments in corporation stock Distributions to shareholders Loss or expense items Ending basis $ 60,000 45,000 -(20,000) $ 85,000 Choice "a" is incorrect This is only the amount of Sandy's basis at the beginning of the year ($60,000) The income items and distributions also affect Sandy's basis as of the end of the year Choice "b" is incorrect This answer option includes the $60,000 basis at the beginning of the year plus the $10,000 in capital gains during the year, but it incorrectly excludes the ordinary and tax-exempt income from the year and the effect of the distributions during the year Choice "c" is incorrect This answer option incorrectly excludes the $5,000 of tax-exempt income received by Swallow during the year 33 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 33 A $100,000 increase in partnership liabilities is treated in which of the following ways? a b c d Increases each partner's basis in the partnership by $100,000 Increases the partners' bases only if the liability is nonrecourse Increases each partner's basis in proportion to their ownership Does not change any partner's basis in the partnership regardless of whether the liabilities are recourse or nonrecourse Solution: Rule: The partner's original basis is increased by the portion of the liabilities assumed by the partner, and this amount is equal to the partner's percentage ownership in the partnership Choice "c" is correct A $100,000 increase in partnership liabilities generally increases each partner's basis in proportion to their ownership percentage [Thus, a 25% partner will generally have a basis increase of $25,000 for an increase in partnership debt of $100,000.] Choice "a" is incorrect This incorrectly says that each partner will have a basis increase of $100,000 for a total partnership debt increase of $100,000 A partner is only responsible for debt in the proportion of his/her ownership interest Choice "b" is incorrect Partnership basis will increase in proportion to the partner's economic loss percentage (risk) if the debt is recourse Partnership basis may increase if the debt in nonrecourse, but there are limitations (beyond the scope of the exam) Choice "d" is incorrect A $100,000 increase in partnership liabilities generally increases each partner's basis in proportion to their ownership percentage Partnership basis will increase in proportion to the partner's economic loss percentage (risk) if the debt is recourse Partnership basis may increase if the debt in nonrecourse, but there are limitations (beyond the scope of the exam) 34 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 34 Under the Secured Transactions Article of the UCC, all of the following are needed to create an enforceable security interest, except: a b c d A security agreement must exist The secured party must give value The debtor must have rights in the collateral A financing statement must be filed Solution: Choice "d" is correct Attachment is the process whereby a security interest is created giving the creditor rights against the debtor There are three requisites for attachment First, there must be an agreement between the creditor and the debtor Second, the creditor must give value Third, the debtor must have rights in the collateral Filing a financing statement is not a requirement for creating a security interest Filing is one of the methods of perfecting a security interest against third parties Choices "a", "b", and "c" are incorrect because they are all requisites for attachment 35 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 35 An individual received $50,000 during the current year pursuant to a divorce decree A check for $25,000 was identified as annual alimony, checks totaling $10,000 as annual child support, and a check for $15,000 as a property settlement What amount should be included in the individual's gross income? a b c d $50,000 $40,000 $25,000 $0 Solution: Rules: Payments for the support of a spouse are income to the spouse receiving the payments and are deductible to arrive at adjusted gross income by the contributing spouse Child support is not taxable Property settlements are not taxable Choice "c" is correct Only the $25,000 in alimony is included in the gross income of the receiving spouse Choice "a" is incorrect This answer option incorrectly includes all of the payments received in the year The child support ($10,000) and the property settlement ($15,000) are NOT included in the gross income of the receiving spouse Choice "b" is incorrect This answer option incorrectly includes the payments received in the year for alimony and property settlement for the year [$25,000 + $15,000 = $40,000] The property settlement ($15,000) is NOT included in the gross income of the receiving spouse Choice "d" is incorrect The amount received for alimony ($25,000) is included in the gross income of the receiving spouse 36 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 36 Bluff purchased equipment for business use for $35,000 and made $1,000 of improvements to the equipment After deducting depreciation of $5,000, Bluff gave the equipment to Russett for business use At the time the gift was made, the equipment had a fair market value of $32,000 Ignoring gift tax consequences, what is Russett's basis in the equipment? a b c d $31,000 $32,000 $35,000 $36,000 Solution: Rule: Property acquired as a gift generally retains the rollover cost basis as it had in the hands of the donor at the time of the gift Basis is increased by any gift tax paid attributable to the appreciation in the value of the gift (but the facts in this case indicate to ignore gift tax consequences) There is an exception to the general rule: if the fair market value at the date of gift is greater than the roll-over cost basis from the donor, the basis for the donee depends upon the donee's future selling price of the asset The asset may sell for (1) greater than the donor's basis, (2) between the donor's basis and the lower FMV at the date of gift, and (3) less than the FMV at the date of gift Choice "a" is correct The first step is to determine the donor's basis in the asset at the gift date In this case, the basis is $31,000 ($35,000 + $1,000 - $5,000) The fair market value of the asset is $32,000 at the date of gift, which is greater than the donor's basis, so the general rule applies Property acquired as a gift generally retains the rollover cost basis as it had in the hands of the donor at the time of the gift Thus, Russett's basis in the equipment is $31,000 Choice "b" is incorrect The first step is to determine the donor's basis in the asset at the gift date In this case, the basis is $31,000 ($35,000 + $1,000 - $5,000) The fair market value of the asset is $32,000 at the date of gift, which is greater than the donor's basis, so the general rule applies Property acquired as a gift generally retains the rollover cost basis as it had in the hands of the donor at the time of the gift Thus, Russett's basis in the equipment is $31,000 (the cost basis of the donor), not the $32,000 fair market value at the date of gift Choice "c" is incorrect This answer option incorrectly assumes the basis is only the $35,000 purchase price of the asset and ignores the $1,000 in improvements and the basis reduction for the $5,000 in accumulated depreciation Choice "d" is incorrect This answer option incorrectly assumes the basis is only the $35,000 purchase price of the asset plus the $1,000 in improvements and ignores the basis reduction for the $5,000 in accumulated depreciation 37 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 37 Dale was a 50% partner in D&P Partnership Dale contributed $10,000 in cash upon the formation of the partnership D&P borrowed $10,000 to purchase equipment During the first year of operations, D&P had $15,000 net taxable income, $2,000 tax-exempt interest income, a $3,000 distribution to each partner, and a $4,000 reduction of debt At the end of the first year of operation, what amount would be Dale's basis? a b c d $16,500 $17,500 $18,500 $21,500 Solution: Rule: The partnership basis formula follows: Basis = Capital Account + Partner's Share of Liabilities Choice "c" is correct Dale's basis at the end of the first year of operations is calculated as follows: Initial contribution at formation Net taxable income Tax exempt income Distributions Increase in debt responsible for Reduction in debt responsible for Basis at year end $ 10,000 7,500 1,000 (3,000) 5,000 (2,000) $ 18,500 [$15,000 * 50%] [$2,000 * 50%] [to each partner] [$10,000 * 50%] [$4,000 * 50%] Choice "a" is incorrect There are a few ways to have miscalculated the basis by $2,000 The proper calculation of the basis at year end is shown above Choice "b" is incorrect The most likely error made if this answer option were chosen is that the tax exempt income of $1,000 was omitted from being an increase in the partner's basis in the partnership All income (including tax free income) increases a partner's basis Choice "d" is incorrect The most likely error made if this answer option were chosen is that the distributions of $3,000 were omitted from being a decrease in the partner's basis in the partnership; although, several other miscalculations could have been made The proper calculation of the basis at year end is shown above 38 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 38 The adjusted basis of Smith's interest in EVA partnership was $230,000 immediately before receiving the following distribution in complete liquidation of EVA: Cash Real estate Basis to EVA $150,000 120,000 Fair market value $150,000 146,000 What is Smith's basis in the real estate? a b c d $146,000 $133,000 $120,000 $80,000 Solution: Rule: In a complete liquidation of a partnership, the partner's basis in the distributed property is the same as the adjusted basis of his partnership interest (the partner is essentially exchanging his partnership interest for assets of the partnership), reduced by any monies received The partner recognizes gain only to the extent that money received exceeds the partner's basis in the partnership Choice "d" is correct Smith's basis in the real estate is calculated as follows: Smith's basis in EVA before liquidation $ 230,000 Cash received (150,000) Smith's basis in the real estate $ 80,000 Choice "a" is incorrect This answer option incorrectly uses the fair market value of the land ($146,000) at the date of distribution in complete liquidation In a complete liquidation of a partnership, the partner's basis in the distributed property is the same as the adjusted basis of his partnership interest (the partner is essentially exchanging his partnership interest for assets of the partnership), reduced by any monies received Choice "b" is incorrect This answer option incorrectly uses the average of the basis and the fair markets value of the real estate at the date of distribution [($120,000 + $146,000)/2 = $133,000] In a complete liquidation of a partnership, the partner's basis in the distributed property is the same as the adjusted basis of his partnership interest (the partner is essentially exchanging his partnership interest for assets of the partnership), reduced by any monies received Choice "c" is incorrect This answer option incorrectly uses EVA's basis of the land ($120,000) at the date of distribution in complete liquidation In a complete liquidation of a partnership, the partner's basis in the distributed property is the same as the adjusted basis of his partnership interest (the partner is essentially exchanging his partnership interest for assets of the partnership), reduced by any monies received 39 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 39 A CPA in public practice may not disclose confidential client information regarding auditing services without the client's consent in response to which of the following situations? a b c d A review of the CPA's professional practice by a state CPA society A letter to the client from the IRS An inquiry from the professional ethics division of the AICPA A court-ordered subpoena or summons Solution: Choice "b" is correct A CPA is required to disclosed confidential client information if the information is subpoenaed and relevant to a court case The IRS would have to more than request the information in a letter The IRS would have to subpoena the information and show that it was relevant to a court matter Choice "a" is incorrect because a CPA is required to reveal confidential client information to a state CPA society voluntary quality control review panel when requested Choice "c" is incorrect because a CPA is required to reveal confidential information in an official investigation of the AICPA/state trial board Choice "d" is incorrect because a CPA is required to reveal confidential client information if it is subpoenaed and relevant to a court case 40 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 40 An S corporation engaged in manufacturing has a year end of June 30 Revenue consistently has been more than $10 million under both cash and accrual basis of accounting The stockholders would like to change the tax status of the corporation to a C corporation using the cash basis with the same year end Which of the following statements is correct if it changes to a C corporation? a b c d The year end will be December 31, using the cash basis of accounting The year end will be December 31, using the accrual basis of accounting The year end will be June 30, using the accrual basis of accounting The year end will be June 30, using the cash basis of accounting Solution: Rule: While the cash basis of accounting is used by most taxpayers for tax purposes, the accrual basis method of accounting for tax purposes is required for the following: The accounting for purchases and sales of inventory, Tax shelters, Certain farming corporations, and C corporations, trusts with unrelated trade or business income, and partnerships having a C corporation as a partner provided the business has greater than $5 million average annual gross receipts for the three-year period ending with the tax year Choice "c" is correct The facts tell us that the shareholders would like to change the status to a C corporation using the same year end as the S corporation (June 30) Per the above rule, C corporations with greater than $5 million average annual gross receipts must use the accrual basis of accounting for tax purposes When this corporation changes to a C corporation status, therefore, it must report on the accrual basis of accounting for tax purposes It will be able to stay on the June 30 year end, as the shareholders desire Choice "a" is incorrect The year will be June 30 (not December 31) with the accrual (not cash) basis of accounting Choice "b" is incorrect The year will be June 30 (not December 31), but the accrual basis of accounting will be used Choice "d" is incorrect The year will be June 30, but the accrual (not cash) basis of accounting will be used 41 © 2009 DeVry/Becker Educational Development Corp All rights reserved ... They are not a promise to pay 12 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 12 Under Regulation D of the Securities Act... found in Rules 504, 505 or 506 of Regulation D 13 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 13 In April, A and B formed... identified in the rule, above 20 © 2009 DeVry/Becker Educational Development Corp All rights reserved 2009 AICPA Newly Released Questions – Regulation 20 According to the AICPA Code of Professional