Lambers CPA review regulations

CPA CPAREVIEW REVIEW Financial Business Auditing & Regulation Accounting and Environment Attestation & Concepts Reporting by by Joseph R Lanciano, CPA, Vincent Lambers, MBA, CPA, Vincent W.W Lambers, CPA and MST, CPA, Michael F Farrell, J.D and ArthurMBA, E Reed, MBA, DonaldPaul T Hanson, Richard Delgaudio, MBA,CPA, CPA Debole,MBA, J.D William A Grubbs, MBA, CPA Regulation BUSINESS LAW & PROFESSIONAL RESPONSIBILITY (Chapters 1-13) FEDERAL INCOME TAXES (Chapters 1-13 plus Appendix) by Joseph R Lanciano, CPA Michael F Farrell, J.D Arthur E Reed, MBA, MST, CPA Paul DeBole, J.D Published by Copyright © 2012 by LearnForce Partners, LLC All rights reserved No part of this publication may be reproduced in any form without the written permission of the publisher Chapter Subjects of VOLUME 2—REGULATION BUSINESS LAW & PROFESSIONAL RESPONSIBILITIES Chapter One — CONTRACTS Chapter Two — SALES Chapter Three — SECURED TRANSACTIONS Chapter Four — NEGOTIABLE INSTRUMENTS Chapter Five — DOCUMENTS OF TITLE Chapter Six — AGENCY Chapter Seven — BANKRUPTCY Chapter Eight — SURETY AND DEBT COLLECTION REMEDIES Chapter Nine — NON-CORPORATE ENTITIES Chapter Ten — CORPORATIONS Chapter Eleven — SECURITIES ACTS AND ANTITRUST REGULATION Chapter Twelve — REGULATION OF EMPLOYMENT Chapter Thirteen — ACCOUNTANT’S LEGAL LIABILITY FEDERAL INCOME TAXES Chapter One — FILING STATUS AND EXEMPTIONS, FILING REQUIREMENTS AND PENALTIES Chapter Two — INCOME – INCLUSIONS AND EXCLUSIONS Chapter Three — DEDUCTIONS FOR ADJUSTED GROSS INCOME Chapter Four — DEDUCTIONS FROM ADJUSTED GROSS INCOME Chapter Five — ACCOUNTING METHODS & PERIODS, AND COMPUTATION OF TAX LIABILITY & TAX CREDITS Chapter Six — CAPITAL TRANSACTIONS Chapter Seven — PARTNERSHIPS Chapter Eight — C CORPORATIONS Chapter Nine — TAX COMPUTATION AND CONTROLLED GROUPS Chapter Ten — CORPORATE DISTRIBUTIONS AND OTHER MATTERS Chapter Eleven — S CORPORATIONS Chapter Twelve — TAXATION OF GIFTS, ESTATES AND FIDUCIARIES, AND EXEMPT ORGANIZATIONS Chapter Thirteen— PROFESSIONAL RESPONSIBILITIES FROM A TAX PERSPECTIVE Appendix — OTHER OBJECTIVE ANSWER FORMAT PROBLEMS FROM RECENT EXAMS Material from Uniform CPA Examination Questions and Unofficial Answers, copyright © 1977 through 2010 by the American Institute of Certified Public Accountants, Inc., is reprinted (or adapted) with permission Chapter One Contracts ELEMENTS OF A CONTRACT 1-1 OFFERS AND ACCEPTANCE 1-1 When Offers End When Acceptances Are Effective TYPES OF CONTRACTS 1-3 CONSIDERATION 1-3 STATUTE OF FRAUDS 1-4 COMPETENT PARTIES: MINORS, DRUNKS & THE INSANE 1-5 ILLEGAL CONTRACTS 1-5 FRAUD AND INNOCENT MISREPRESENTATIONS 1-5 MISTAKES, DURESS AND UNDUE INFLUENCE 1-6 PAROL EVIDENCE RULE 1-7 THIRD PARTY RIGHTS AND ASSIGNMENTS 1-7 Third Party Beneficiary Contracts Assuming and Buying Subject To a Mortgage Assignments and Delegations DISCHARGE AND CONTRACT REMEDIES 1-8 Performance & Discharge of Contract Duties Contract Remedies Chapter One Contracts ELEMENTS OF A CONTRACT A contract is an agreement, a meeting of the minds A contract contains the following six essential elements: a an offer b an acceptance c consideration d in proper form (i.e the Statute of Frauds may require a writing) e for a lawful object f by two or more competent parties Memory Device: Only Accuracy Can Pass Law Candidates Elements of a Contract Only = Offer Accuracy = Acceptance Can = Consideration Pass = Proper form (Statute of Frauds may require a writing) Law = Lawful object Candidates = or more Competent Parties OFFERS AND ACCEPTANCES An agreement requires both an Offer and an Acceptance An Offer has elements a it must be seriously intended (the test is whether a reasonable person would consider it to be a serious offer) b it must be communicated by either words or actions c it must be definite in its terms (must include a price) Advertisements and price quotes are not usually offers; they are invitations to deal An Acceptance has elements a an acceptance must be unconditional - the offeree must comply with all of the offeror's terms or a counteroffer is created b an acceptance must be communicated by words or actions (e.g silence is rarely an acceptance unless there is a long course of dealing between the parties) c an acceptance may only be accepted by the party to whom it's made (e.g offeree cannot assign his/her right to accept to accept an offer to a 3rd party) 1-1 WHEN OFFERS END Counteroffers end offers but they are only effective when they are received Example: A mails an offer to B on April which is received on April On April B mails a counteroffer to A On April B changes her mind and telephones an acceptance On April the counteroffer arrives There is a contract between A and B because the offer was accepted on April before the counteroffer took effect a b requests and inquiries are not counteroffers on the exam an inquiry will usually end in a question mark, not a period Rejections end offers but they are only effective when received Revocations end offers but they are only effective when received Offeror may usually revoke anytime before acceptance even if (s)he promises the offer will be held open a exception: Option Contracts can't be revoked 1) the offeree pays consideration to keep offer open (note: there is no option contract until the consideration is actually paid by the offeree) 2) counteroffers will not end an option contract Example: A pays X $1,000 for the right to buy X's house for the price of $250,000 anytime prior to June An option contract has been created and X may not revoke the offer to sell for $250,000 If on May A offers X $225,000 for the house, the option contract will not end and A will still have until June to buy for $250,000 b exception: In UCC Sales Firm Offers are irrevocable without consideration if: made by a merchant, in writing, and a guarantee the offer will be held open Offers end at the time stated (if no termination time is stated, it ends at reasonable time) Death or insanity ends offers immediately, but does not end most contracts Example: X purchases goods on credit from A and dies prior to payment The contract is still valid and X's estate owes A the balance of the purchase price) Destruction or sale of the subject matter will end an offer a destruction of the subject matter ends the offer immediately b sale of the subject only revokes the offer when the offeree learns of it, not when the subject is sold WHEN ACCEPTANCES ARE EFFECTIVE (also called the deposited acceptance rule) an acceptance is valid when sent if the offeree uses either of the following means of communication: a the express means (the form of communication the offeror said to use) OR b any reasonable means if none is specified (the same means offeror used or faster) Example: A mails an offer to B without specifying how acceptances are to be sent If B mails a valid acceptance, the acceptance is effective when sent If B telegraphs an acceptance, it is still effective when sent because a telegram is faster than the mail There would be a valid contract even if the acceptance were lost or never arrived c if a slower means of communication is used, it is valid when received 1-2 Exceptions when the mailbox rule does not apply a if an offer states an acceptance must be received by a specified date, then the acceptance must be received by that date to be valid and cannot be effective when sent (reason: the offeree must comply with all of the offeror’s terms) b if the offeree has sent a previous rejection of the offer, for a later acceptance to be effective it must be received before the prior rejection TYPES OF CONTRACTS Bilateral and Unilateral contracts a a bilateral contract is a promise for a promise (most contracts are bilateral) b a unilateral contract is a promise for an act (e.g a reward) 1) note: the offeree must know of the reward to accept 2) if the offeree has made a substantial start on performing a unilateral offer, the offeror cannot revoke the offer Requirement and Output contracts a in a requirement contract, one party agrees to purchase all their requirements from another The contract is valid if the amounts requested are made in good faith and reasonable to normal amounts b in an output contract, one party agrees to purchase the entire output of a factory or manufacturer The contract is valid if the amounts are produced in good faith and reasonable to normal amounts Executed and Executory contracts a executed contracts are those that have been fully performed by both parties b executory contracts are those that have not been fully performed by both Valid, Void and Voidable contracts a a valid contract is legally binding and enforceable against both parties b a void contract is not enforceable against either party (e.g it's not a legal contract) c a voidable contract is a legal contract wherein one or both of the parties has the right to disaffirm or rescind the contract (e.g minor contracts are voidable by the minor and most fraud is voidable by the injured party) ***CONSIDERATION*** An essential element of a contract is that it be supported by adequate consideration a consideration is giving up of a legal right (e.g something you're legally free not to do) b consideration must be mutually bargained for (e.g one promise was given in exchange for the other party's promise or act) and legally sufficient Courts aren't usually concerned with the adequacy of consideration, only that it be present for both parties a thus, there is no requirement that the consideration be of equal value b exception: courts will consider the adequacy of consideration if the contract is unconscionable (so grossly one sided that it shocks the conscience of a court) Two cases where consideration is not present a past consideration is no good (e.g an employer promises a cash payment to a deceased employee's family in recognition of the employee's years of service) b there is no consideration when a party is already contractually or legally obligated to perform Additional consideration is needed from both parties to modify a contract exception: in UCC Sales contracts can be modified without additional consideration 1-3 Exceptions: some promises are enforceable without any consideration: a promises to donate to charity are often enforceable without consideration b a written promise to pay a debt barred by the Statute of Limitations can be enforced without consideration c promissory estoppel: a promise by one party relied upon by another can be enforced without consideration if the reliance was: 1) reasonable: a reasonable person would have relied on the promise 2) detrimental: party relying on the promise would be substantially harmed ***STATUTE OF FRAUDS*** There are types of contracts that require some type of writing to be enforceable G sale of Goods of $500 or more - the writing must state a quantity R Real estate contracts I contracts Impossible to perform in year - begin measuring from when the contract is made not when performance is to begin P Promise to answer the debt of another E Executor's promise to be liable for the debt of an estate Marriage contracts where Marriage is the consideration Any type of writing that states the major contract terms can satisfy the Statute of Frauds a the writing need only be signed by one party but it is only enforceable against the one who signed b the terms may be stated in more than one document Exceptions: no writing is required even though it is one of the types if: a the contract is fully performed by both parties (executed) b a contract impossible to perform in one year is enforceable without a writing if one side has fully performed (e.g X orally promises an employee a $25,000 bonus, if the employee will remain with her for years If the employee works for X for the years, X's oral promise is enforceable) c an oral real estate contract is enforceable in two different cases: 1) if the buyer is in possession of the land and has made a substantial payment or substantial improvements or 2) if the seller has completely performed (e.g delivered the deed to the buyer) d a promise to answer the debt of another is enforceable if the main or primary purpose of the promise was to benefit the promisor and not the debtor Example: X hires a contractor to build a house and the contractor subcontracts with a plumber The plumber threatens to quit due to contractor's nonpayment X, fearing the house will not be finished on time, orally promises to pay the plumber if the contractor doesn't Although X's oral promise to pay the plumber is a promise to pay the debt of another, it is enforceable because the main purpose was to benefit X, not the contractor.) 1-4 COMPETENT PARTIES: MINORS, DRUNKS & THE INSANE A contract must be made by two or more competent parties note: the exam normally tests competent parties with minors, drunks and the insane Minors may disaffirm contracts anytime while a minor or a reasonable time thereafter (thus, minor contracts are voidable because the minor has the right to rescind) a minors cannot disaffirm real estate contracts while they are still a minor b minors cannot disaffirm necessary contracts (things like food, clothing or shelter) To disaffirm a minor need only return what (s)he possesses or controls at that time Minor may ratify a contract by words or actions (i.e use of the object) a minors can only ratify after becoming an adult; they can't ratify while still a minor b minors must ratify the entire contract - they can't ratify part and disaffirm part Minors may disaffirm contracts, but they are liable in damages for torts (civil wrongs) Example: A minor buys a car by misrepresenting that (s)he was an adult After putting 200,000 miles on the car, the minor attempts to disaffirm The minor may disaffirm the contract, but must pay damages for the tort of fraud A drunk may disaffirm only if (s)he was incapable of understanding what (s)he did Insane may usually disaffirm, but once adjudicated insane all future contracts are void ILLEGAL CONTRACTS Illegal contracts are void - courts won't aid either party in an illegal contract Failure to have a required license makes all your contracts void exception: the contract is enforceable if the license was a mere revenue raising measure Covenants not to compete in a sale of business or employment contract are valid if reasonable They must meet tests of reasonableness: a must be reasonably needed to protect a legitimate business interests b must be reasonable as to time c must be reasonable as to distance ***FRAUD*** and INNOCENT MISREPRESENTATIONS Actual Fraud has elements - MS RID Elements of Fraud = MS RID M Must have a Material Misrepresentation of fact or a deliberate concealment - must be a fact (opinions don't count unless made by experts) - no duty to disclose unless there is a known hidden defect, or to correct a previous representation later found out to be false or if the parties are in a fiduciary relationship S Must have Scienter (an intent to deceive - made knowingly or intentionally) R Must have Reasonable Reliance (justifiable reliance) I Must have Intent to rely D Must have Damages 1-5 Constructive Fraud - has the same elements as actual fraud but the intent to deceive element is fulfilled by a reckless disregard for the truth (making a statement without knowing if the statement is true or false) not scienter - MR RID Elements of Constructive Fraud = MR RID M Must have a Material Misrepresentation of fact R Must have Reckless disregard for the truth ( making a statement without knowing if it is true or false ) R Must have Reasonable Reliance (justifiable reliance) I Must have Intent to rely D Must have Damages Fraud in the execution is void (defrauded party didn't know a contract was made) Fraud in the inducement (party knows they made a contract but one or more terms are misrepresented) makes a contract voidable This means the injured party has choices: a rescission: cancel the contract and restore parties to their former positions b or the injured party may accept the contract and sue in tort for money damages c note: in UCC Sales a party may rescind and sue for money damages An Innocent Misrepresentation has of the elements of fraud but no scienter or reckless disregard for the truth - the injured party may only rescind and cannot sue for damages Elements of Innocent Misrepresentation = MR ID M Must have Material Misrepresentation of fact R Must have Reasonable Reliance (justifiable reliance) I Must have Intent to rely D Must have Damages MISTAKES, DURESS & UNDUE INFLUENCE Most mistakes have no effect on a contract There are exceptions: a mutual mistakes of material facts make a contract voidable b with material unilateral mistakes, one may disaffirm only if the other party knew or should have known a mistake was being made Duress is forcing someone into a contract by wrongful acts or improper threats of violence, economic devastation or criminal action a to constitute duress, it must actually induce the other party to enter the contract b forcing someone into a contract by actual physical force makes the contract void c forcing someone into a contract by improper threats makes a contract voidable 1) threat of economic devastation or criminal prosecution is voidable 2) threat of civil litigation is not duress, only threat of criminal action Undue Influence is an unfair use of a position of trust, confidence or affection to overcome another's free will in contract It makes a contract voidable 1-6 10 (A) $ -0- Receipt of a bonafide gift does not constitute gross income 11 (E) $ 5,000 When a taxpayer is not an active participant in an employer-sponsored plan, there are no threshold limitations In addition, the limitations for non-covered spouse have changed subsequent to the inclusion of this Released problem Note – the taxpayer may elect to contribute up to $6,000 since she is 55 years old 12 (A) $ -0- Since there was never a tax deduction obtained for the federal income taxes paid, there is consequently, no income to be recognized 13 (F) $ 4,000 Guaranteed payments are includible in gross income because they represent a pre-distribution of a partners earnings for the year There is the assumption that the partnership is a calendar year partnership See Chapter 7’s discussion of guaranteed payments 14 (A) $ -0- The receipt of life insurance proceeds is generally non-taxable 15 (C) $ 2,000 A company can provide up to $50,000 of group term life insurance to its employees on a tax-free basis For any coverage beyond the $50,000, the employee must recognize the cost of providing the coverage as additional income Total insurance coverage Less: $50,000 exclusion Excess over the base $ 450,000 -50,000 $ 400,000 Cost per $1,000 of coverage $5 Total gross income $ 2,000 16 (G) $5,000 This is an easy question, but a difficult answer Even though gambling losses may be deducted to the extent of gambling winnings, this question asks for income and deductions up through adjusted gross income Since the loss deduction is an itemized deduction, only the $5,000 income is considered in this answer 17 (B) $ 1,000 Interest income is gross income, even if associated with a federal income tax refund 18 (A $ -0- The Cumacks may exclude up to $500,000 of the gain from the sale of their principal residence Their realized gain is only $150,000 ($200,000 less the basis of $50,000), therefore the entire gain is excludable 19 (A) Since there was no provision to receive either stock or cash, then the stock dividend is tax-free 20 (O) Frank and Dale are entitled to two personal exemptions on their return No deduction is allowed for Jacques, Dales’s father, because he is a French citizen and a French resident A-31 ANSWER (N) These gifts of $7,000 fall under the $13,000 exclusion and are not includible in the gross estate (F) Proceeds of a life insurance policy are includible in the gross estate if the decedent possessed an incident of ownership at death (F) Since Remsen owned the marketable securities at death, they are includible in his estate (N) This may be excluded from his estate since the payment was made directly to the institution (F) Since Remsen owned the cash at death, they are includible in his estate (N) The executor fees cannot be deducted on the estate return because they are already being deducted on the fiduciary return (N) There is no deduction on the estate return for payments to a beneficiary, unless it qualifies as a marital deduction Since this is his son, it obviously does not apply (G) This qualifies for the unlimited marital deduction (G) Funeral expenses are allowable deductions in determining the taxable estate 10 (E) The executor made elect to treat this as either an estate tax deduction or a federal income tax deduction ANSWER (N) Disclosing taxpayer information under a court order is allowed (E) This appears to be a realistic position to take by the preparer (P) This is clearly an act subject to penalty (N) The preparer is taking a realistic position and appears to have applied due diligence (P) When a preparer knowingly understates a taxpayer’s liability, they are subject to the penalty (N) Disclosing taxpayer information during a quality review is allowed (E) Because the preparer relied on information presented by the IRS, and was not aware of information to the contrary, the exception applies (P) This is clearly an act subject to penalty (P) This appears to be a willful attempt to understate taxes, therefore subject to a penalty A-32 ANSWER (D) 1,333 Organization cost, when properly elected, are amortized over a period of not less than fifteen years after a maximum of $5,000 is written off There is a book to tax difference of: To determine the tax amortization: $40,000 - $5,000 first year write-off = $35,000 to be amortized Annual amortization $ 35,000 / 15 years = Book amortization $ 40,000 / 40 years = Excess of tax over book $ 2,,333 -1,000 $ 1,333 (I) 5,000 Employee expenses for business meals and entertainment are allowable only to the extent of 50% of the expenditure Therefore, the reimbursements of $10,000, which are fully deductible for book purposes are only deductible to the extent of $5,000 for tax purposes, thus increasing taxable income by $5,000 (N) 000 When a corporation is the beneficiary of a life insurance policy on an officer or key employee, no deduction is allowed for the premiums paid Since Capital is not the beneficiary, the deduction is allowable No book to tax difference (I) 10,000 For tax purposes, only the direct write-off of bad debts is allowed in determining taxable income Therefore, the increase in the allowance of $10,000 is not allowed for tax purposes and must be added back to net income (P) Since Sunco owns 35% of the stock of a domestic corporation, Sunco is entitled to an 80% dividends received deduction Without doing the computations and testing for limits, Sunco would only be taxable on approximately 20% of the dividend (F) This is simply treated as income in the year received (P) The general rule is that the contribution must be authorized by the Board of Directors by the end of the end, and paid by the 15th day of the third month following the end of the year Having met that provision, the current year’s limitation on the $38,000 contribution is 10% of the corporation’s adjusted taxable income ($200,000), or $20,000 (N) No deduction is allowed for penalties (U) For AMTI purposes, seven-year personal property must be depreciated over a longer period of time, resulting in a smaller amount of annual depreciation A proper adjustment will cause AMTI to be higher Since these three questions assume that if no adjustment/preference is identified, how will this impact AMTI, the proper answer is Understated 10 (U) For AMTI purposes, 39-year non-residential property must be depreciated over a longer period of time, resulting in a smaller amount of annual depreciation A proper adjustment will cause AMTI to be higher Since these three questions assume that if no adjustment/preference is identified, how will this impact AMTI, the proper answer is Understated 11 (C) Only interest income on private activity bonds would be treated as a tax preference and require an adjustment However, the excluded interest would be an ACE adjustment, but your question asks for the AMTI prior to ACE A-33 ANSWER Note: The answers to Items through have dual answers They are presented in the five digit numeric response format and followed by the appropriate letter response 15,000 / (I) Only 50% of business meals are deductible The travel expenses are fully deductible The disallowed expense of $15,000 increases taxable income 07,000 / (I) Premiums paid for the life insurance of corporate officers are not deductible when the beneficiary is the corporation (Likewise, the receipt of the insurance proceeds upon the death of an officer would not be taxable as income.) The disallowed expense causes an increase in taxable income 00,000 / (N) A state franchise tax expense is a fully deductible item The estimated tax payments of only $15,000 assumes an accrual of $3,000 which is proper in coming up with the full $18,000 No adjustment is needed 06,000 / (D) The MACRS depreciation for 2010 would be $16,000, resulting in an additional deduction of $6,000 This decreases the taxable income The computer is five year property and the straight-line rate is 20% MACRS uses double the straight-line rate, or 40% of the declining balance (Alternatively, the second year MACRS rate is 32% of the original cost of $50,000.) Original cost First year MACRS: $50,000 X 40% X ½ year Remaining balance $ 50,000 -10,000 $ 40,000 Second year MACRS: $40,000 X 40% $16,000 01,000 / (I) There is a net capital loss of $1,000 from these two transactions A corporation cannot deduct a net capital loss It can, however, carry the loss back three years and forward five The disallowed loss increases taxable income this year 00,000 / (N) Charitable contributions authorized by the Board by December 31 and paid by March 15 are allowed as current deductions by accrual corporations The total contributions of $50,000 not exceed the ceiling which is exactly 10% of $500,000 (taxable income without regard to the charitable contributions and dividends received deduction) No adjustment is needed (P) Only 50% of entertainment expenses are deductible (F) The expense relates to products which are predominantly sold No proration required (N) No deduction is allowed for interest expense incurred to purchase tax-free bonds 10 (N) Penalties for violating laws are not deductible business expenses 11 (F) Bonuses for non-shareholder employees, properly accrued are deductible if paid within two and one-half months after the year-end 12 (N) The federal income taxes paid are not deductions, nor is the refund of them taxable 13 (F) Interest income on the federal refund is fully taxable 14 (N) Interest from a municipal bond is tax-free The “dividends” are derived solely from the municipal bond interest A-34 15 (F) The reduction in the lease agreement due to capital improvements causes the recognition of income 16 (P) The portion of the life insurance which equaled the debt is a tax-free return of basis The excess is treated as income to the corporation 17 (N) The 70% dividends-received deduction is not an adjustment, but does represent an ACE adjustment 18 (N) Only private activity bonds are preference items if issued before 2010 The state’s general obligation bond interest (not private activity) is an ACE adjustment 19 (I) The acceptable method uses 150% declining balance over a longer ADR life, where MACRS uses 200% declining balance 20 (I) Commercial real property is depreciated using a straight-line rate over a longer period than MACRS 21 (N) Cash contributions have no alternative minimum tax impact, only the contributions of appreciated property 22 (F) The reduction is 25% of the amount over $150,000 23 (F) There is no statute on fraudulent returns 24 (F) The statute for an omission of more than 25% is six years from the date the return was filed or the due date of the return, whichever is later 25 (T) This is one of the general business credits 26 (T) This is a credit allowed to small businesses 27 (T) The CPA may use them for certain restricted uses 28 (F) Reliant may file an amended return up to three years after the filing of the return ANSWER 06,140 The amount of net business income, or ordinary income as is more appropriate, represents: $ 7,260 -1,120 $ 6,140 Gross receipts Less: Supplies expense Ordinary income In the computation of ordinary income, you must exclude any separately stated items which possess special characteristics In this problem interest income is separately stated because it is portfolio income; and charitable contributions are excluded because of the percentage limitation of the shareholder’s adjusted gross income A-35 02,700 Whereas there was no election to terminate the tax year, the income of an S Corporation is allocated on a per-share, per-day approach Because the S Corporation was formed on January the problem states that there are 363 days Therefore, the computation is as follows: $ 14,520 Ordinary income 363 Divided by # of days 40 Per day ordinary income 200 Number of shares Ordinary income per-day, per share $ 20 Because Pike purchased his 40 shares on January 31, he has held the shares for 334 days His share of the ordinary income is therefore: 40 shares x 334 days x $.20 = $2,672 As required in the problem, this answer rounded up to the nearest $100 is now $2,700 03,150 An S Corporation’s shareholder’s basis needs to take into consideration any pass-through items and distributions occurring during the year The items of income are allocated first (even the tax-exempt income from the municipal bonds increase basis), and the items of deductions next Pike has sufficient basis to absorb the loss Pike’s basis is determined as follows: Beginning basis Pike’s share of interest income Pike’s share of the ordinary loss Ending basis $ 4,000 150 -1,000 $ 3,150 09,000 An S Corporation’s shareholder’s basis needs to take into consideration any pass-through items and distributions occurring during the year The items of income are allocated first and the items of deductions next A shareholder’s basis is then reduced by any distributions, but not below zero Taylor’s basis is determined as follows: Beginning basis Taylor’s share of ordinary income Taylor’s cash distribution Ending basis $ 10,000 2,000 -3,000 $ 9,000 (F) The eligibility requirements restrict an S Corporation to only one class of stock Having both common and preferred stock violates that provision (F) There is a provision that if an S Corporation has passive investment income for consecutive years following the year a valid S Corporation takes effect, the S Corporation election will terminate However, that is only if there are C Corporation accumulated earnings and profits Whereas Lan has been an S Corporation since inception, it could not have an C Corporation earnings and profits; this provision does not apply A-36 ANSWER 10 The following answers are the AICPA’s Unofficial Answers to the problem The format in response “a” is slightly different from the way we present the material in the text and the way a tax return is prepared An illustration of this is their “net approach” of reporting the dividend income For example, Clove Corporation’s dividends qualify for the 80% dividends received deduction, thus only 20% is included At Lambers CPA Review Course we feel that this may be confusing and ultimately lead to wrong answers if limitations are exceeded, etc Dividend income should be reported at the gross amount and then the dividends received deduction should be calculated and deducted later on as a special deduction Regardless, follow the flow of their answer in part “a” because the examiners may revert to a similar format on future exams and this will help prepare you for them Parts "b" and "c" are presented in a format consistent with our text a Ral Corp SCHEDULE OF TAXABLE INCOME For the Year Ended December 31, 2010 Sales Cost of sales Gross profit Expenses: Per books Excess of estimated over actual bad debts Keyman life insurance premiums Balance before other income Dividend income: Clove Corp ($7,000 × 20%) Ramo Corp ($6,000 × 30%) Sol Corp ($1,000 × 100%) Real Estate Investment Trust (fully taxable) Money Market Fund (fully taxable) Interest income Taxable income $1,000,000 700,000 300,000 $220,000 $2,000 4,000 $1,400 1,800 1,000 2,700 2,100 6,000 $ 9,000 5,000 214,000 86,000 14,000 $ 100,000 Note 1: The $400 capital gain distribution is netted against the $6,400 in capital losses, resulting in a net capital loss of $6,000 which is not allowed as a deduction See part c for this reconciling item Note 2: Since the stock in Sol Corporation was not held for at least 45 days, the dividends received deduction is not available.) b Ral Corp COMPUTATION OF FEDERAL INCOME TAX For the Year Ended December 31, 2010 Taxable income Income tax [$13,750 + (34% × $25,000)] Estimated tax paid Overpayment A-37 $100,000 $ 22,250 35,000 $ 12,750 c Ral Corp RECONCILIATION OF INCOME PER BOOKS WITH INCOME PER RETURN For the Year Ended December 31, 2010 $ 98,000 6,000 Income per books Excess of capital losses over capital gains Expenses recorded on books not deducted on return: Bad debts Life insurance premiums Subtotal $2,000 4,000 Income recorded on books not included on return: Dividends Interest Subtotal Taxable income 6,000 $110,000 $ 9,800 200 10,000 $100,000 ANSWER 11 (C) $8,000 In 1990 when the partnership was formed, Brink’s basis would have been his transferred basis in the land, adjusted for any change in the liabilities Brink was relieved of the $5,000 mortgage on the land, but as partner became liable for his share (20%) of the partnership debt ($5,000) Original basis in land Less: debt transferred Plus: debt assumed Initial basis $ 12,000 -5,000 +1,000 $ 8,000 (A) $25,500 In 1990 when the partnership was formed, Carson’s basis would have been his transferred basis in the inventory, adjusted for any change in the liabilities As a partner, Carson assumed 30% of the partnership debt ($5,000) $ 24,000 1,500 $ 25,500 Original basis in inventory Plus: liabilities assumed (30%) Initial basis (F) A partner’s basis cannot be reduced below zero Cash distributions in excess of basis will cause the recognition of gain (T) The nonliquidating distribution reduces the partner’s basis dollar for dollar, but not below zero (T) Basis must be allocated to the non-cash property received when the basis of the partnership property exceeds the partner’s basis prior to the distribution No gain is recognized (F) See item above (T) See item above (F) When a partner is no longer liable for partnership debt, there is a reduction in that partner’s basis (This is just the opposite of when a partner’s basis is increased by their share of the partnership debt.) A-38 Regulation Schedule A, Itemized Deductions (2106, Medical, Interest, Casualty) TAB – Directions TAB – Situation Miller, age 38, is a single taxpayer and is the sales manager of Standard Co., an auto stereo dealer Miller’s adjusted gross income (AGI) for the year is $67,000, which includes $4,000 of gambling winnings Miller’s job is to oversee the sales operations of Standard Co Miller has a private office at the dealership and is responsible for attracting new customers and retaining current customers As the sales manager, Miller has the authority to hire and discharge sales personnel During the year, Miller attended several trade shows While at these shows, Miller entertained clients, met with manufacturers, and spent some time gambling During the year, Miller incurred and can properly document $5,000 of gambling losses Miller’s mother incurred unreimbursed medical expenses during the year totaling $4,200 Because she was unable to pay these medical expenses herself, Miller paid them on her behalf Miller cannot claim the mother as a dependent solely because her gross income is $10,000 TAB - Unreimbursed Business Expenses During the year, Miller paid the business expenses shown in the following table Miller’s employer did not reimburse any of these expenses In column C of the table, enter the amounts that are reportable unreimbursed business expense deductions, subject to a statutory percentage limitation, if any If none of a particular unreimbursed expense is a reportable business expense deduction, enter a zero for that expense in column C The total amount deductible on Schedule A, Itemized Deductions, of Form 1040, U.S Individual Income Tax Return, as unreimbursed employee business expenses will automatically calculate Note: Disregard all AGI limitations, if any, in completing the first section of this table Then follow the instructions in the table in completing the second section A B Expense Amount Unreimbursed airfares Dry cleaning costs for business suits worn at dealership Cost of meals during which business was discussed with potential customers Entertainment for clients, immediately after a business discussion Purchase of tuxedo to wear to trade show functions Cost of a business gift to a client Total C Amount reportable on Schedule A 2,200 440 820 770 400 50 4,680 In the following section, indicate the dollar amount of the limitations, if any, that apply to the expenses above Enter any limitation as a negative number 11 12 13 14 Total amount from table above Other miscellaneous deduction - gambling losses AGI limitation (in dollars) Total amount deductible on Schedule A TAB – Medical Expenses During the year, Miller paid the expenses shown in the following table The amount of each expense shown in the table is net of any insurance reimbursements received In column C of the table, enter the amounts that are reportable unreimbursed medical expense deductions, subject to a statutory percentage limitation, if any If none of a particular unreimbursed expense is a reportable medical expense deduction, enter a zero for that expense in column C The total amount deductible on Schedule A, Itemized Deductions, of Form 1040, U.S Individual Income Tax Return, as medical expense will automatically calculate Note: Disregard all AGI limitations, if any, in completing the first section of this table Then follow the instructions in the table in completing the second section A B Expense Amount Medical insurance premiums paid with after-tax dollars Disability insurance premiums Vision correction surgery Hair transplant procedure Chin enhancement surgery to improve appearance Mother's medical expenses paid by Miller during the year Total C Amount reportable on Schedule A 2,650 720 2,400 900 3,100 4,200 13,970 In the following section, indicate the dollar amount of the limitations, if any, that apply to the expenses above Enter any limitation as a negative number 11 12 13 Total amount from table above AGI limitation (in dollars) Total amount deductible on Schedule A TAB – Interest Expenses During the year, Miller made the interest payments shown in the following table In column C of the table, enter the amounts that are reportable interest expense deductions, subject to a statutory percentage limitation, if any If none of a particular payment is a reportable interest expense deduction, enter a zero for that expense in column C The total amount deductible on Schedule A, Itemized Deductions, of Form 1040, U.S Individual Income Tax Return, as interest expense will automatically calculate Note: Disregard all AGI limitations, if any, in completing the first section of this table Then follow the instructions in the table in completing the second section A B Interest payment Amount Mortgage interest paid on principal residence Points on 30-year mortgage for the purchase of the principal residence paid on June 30 of the current year Mortgage interest paid on commercial rental property Interest paid on personal credit cards Interest paid to IRS for late filing of income tax return Interest paid on a $50,000 home equity loan; the FMV of the home exceeds the acquisition indebtedness by $70,000 Total C Amount reportable on Schedule A 11,400 4,200 2,150 470 25 475 18,720 In the following section, indicate the dollar amount of the limitations, if any, that apply to the expenses above Enter any limitation as a negative number 11 12 13 Total amount from table above AGI limitation (in dollars) Total amount deductible on Schedule A TAB – Casualty Losses During the year, Miller suffered the losses shown in the following table In column D of the table, enter the amounts that are reportable casualty losses, subject to a statutory percentage limitation, if any If none of a loss suffered is a reportable casualty loss deduction, enter a zero for that expense in column D The total amount deductible on Schedule A, Itemized Deductions, of Form 1040, U.S Individual Income Tax Return, as a casualty loss will automatically calculate Note: Disregard all AGI limitations, if any, in completing the first section of this table Then follow the instructions in the table in completing the second section A B C Loss suffered Amount of loss Insurance reimbursement Damage to articles stored in basement due to water heater explosion Repair costs to prevent further roof deterioration from water damage Cost to rebuild detached garage due to damage from termites Total 8,200 1,000 1,200 - 5,500 14,900 2,100 3,100 D Amount reportable on Schedule A In the following section, indicate the dollar amount of the limitations, if any, that apply to the expenses above Enter any limitation as a negative number 10 11 Total amount from table above Casualty nonpercentage floor (in dollars) AGI limitation (in dollars) Total amount deductible on Schedule A TAB – Communication A new individual client just received a substantial refund of state income taxes paid last year The client wants to know how this refund will be treated on this year’s federal income tax return Write a letter to the client explaining that the answer depends on whether the client itemized deductions last year Your explanation should include discussions of the following: • • • Why the refund should not be included in this year’s income if the standard deduction was taken last year The circumstances under which the refund would be only partially included in this year’s income if itemized deductions were taken last year Why all of the refund must be included in income if itemized deductions were taken last year Type your communication in the response area below the horizontal line using the word processor provided REMINDER: Your response will be graded for both technical content and writing skills Technical content will be evaluated for information that is helpful to the intended reader and clearly relevant to the issue Writing skills will be evaluated for development, organization, and the appropriate expression of ideas in professional correspondence Use a standard business memo or letter format with a clear beginning, middle, and end Do not convey information in the form of a table, bullet point list, or other abbreviated presentation TAB - Research Which section and subsection of the Internal Revenue Code describes the substantiation that a taxpayer must maintain in order to claim a valid business deduction for entertainment expenses? Answer: _ ... FEDERAL INCOME TAXES (Chapters 1-13 plus Appendix) by Joseph R Lanciano, CPA Michael F Farrell, J.D Arthur E Reed, MBA, MST, CPA Paul DeBole, J.D Published by Copyright © 2012 by LearnForce Partners,... oral d Immediately sue for breach of contract 83 Jones, CPA, entered into a signed contract with Foster Corp to perform accounting and review services If Jones repudiates the contract prior to... Co., CPAs, to audit Victor's financial statements for the year ended December 31, 1992 Victor is in the business of buying, selling, and servicing new and used construction equipment While reviewing