2014 REG 1 Practice Q A

Becker Professional Education Registered to: Dominique DAntonio

Question CPA-01404

Which of the following is (are) among the requirements to enable ataxpayer to be classified as a "qualifying widow(er)"?

I. A dependent has lived with the taxpayer for six months.

II. The taxpayer has maintained the cost of the principal residencefor six months.

a. Both I and II.b. I only.c. Neither I nor II.d. II only.

ExplanationChoice "c" is correct. The requirements that enable a taxpayer to beclassified as a "qualifying widow(er)" are:

1. The taxpayer's spouse died in one of the two previous years andthe taxpayer did not remarry in the current tax year,

2. The taxpayer has a child who can be claimed as a dependent,3. This child lived in the taxpayer's home for all of the current tax

year,4. The taxpayer paid over half the cost of keeping up a home for the

child,5. The taxpayer could have filed a joint return in the year the spouse

died.


Question CPA-07354

Robert Corp. granted an incentive stock option for 200 shares toBeverly, an employee, on March 14, Year 12. The option price and FMVon the date of grant was $150. Beverly exercised the option on August2, Year 14, when the FMV was $180 per share. She sold the stock onSeptember 20, Year 15, for $250 per share. How much gross incomedid Beverly recognize in Year 12?

a. $0b. $30,000c. $150d. $20,000

ExplanationChoice "a" is correct. Due to the fact that this is a qualified stock option,there is no recognition of income in the year of grant.Choice "b" is incorrect. This is the purchase price of the stock uponexercise of 200 shares at $150 per share. It is not income in the year ofgrant as per the above explanation.Choice "c" is incorrect. This is simply the option price per share on thedate of grant.Choice "d" is incorrect. This is the gain Beverly will recognize upon thesale 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. Thisgain is not recognized until the sale occurs in Year 15.


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Question CPA-01794

Under a $150,000 insurance policy on her deceased father's life, MayGreen is to receive $12,000 per year for 15 years. Of the $12,000received in the current year, the amount subject to income tax is:

a. $2,000b. $0c. $1,000d. $12,000

ExplanationChoice "a" is correct. $2,000.

Death benefit 150,000

Amount received in the current year 12,000

Less: Return of principal ($150,000 15 years) (10,000)

Taxable interest 2,000


Question CPA-01387

Darr, an employee of Sorce C Corporation, is not a shareholder. Whichof the following would be included in a taxpayer's gross income?

a. Employer-provided medical insurance coverage under a healthplan.

b. The dividend income on shares of stock that the taxpayer receivedfor services rendered.

c. A $10,000 gift from the taxpayer's grandparents.d. The fair market value of land that the taxpayer inherited from an

uncle.

ExplanationChoice "b" is correct. An individual receiving common stock for servicesrendered must recognize the fair market value as ordinary income. Anydividends received on that stock would also result in income recognition.Choice "a" is incorrect. Employer-provided medical insurance is a tax-free fringe benefit.Choices "c" and "d" are incorrect. Gifts and inheritances are both tax-free to the recipient. (Remember, tax is often paid by the person givingthe gift or the estate at death.)


Question CPA-01409

In Year 1, Smith, a divorced person, provided over one half the supportfor his widowed mother, Ruth, and his son, Clay, both of whom are U.S.citizens. During Year 1, Ruth did not live with Smith. She received$9,000 in Social Security benefits. Clay, a 25-year-old full-time graduatestudent, and his wife lived with Smith. Clay had no income but filed ajoint return for Year 1, owing an additional $500 in taxes on his wife'sincome. How many exemptions was Smith entitled to claim on his Year1 tax return?

a. 2b. 1c. 3d. 4

ExplanationChoice "a" is correct. Smith is entitled to an exemption for himself. He isalso entitled to an exemption for his mother Ruth (qualifying relative).Ruth has $9,000 in Social Security payments during Year 1, butbecause that is her only income, the Social Security is not taxable, andnontaxable income does not count in calculating whether an exemptioncan be taken for a dependent. Clay cannot be taken as a dependentbecause he filed a joint return with his wife. Because the joint return wasfiled for a purpose other than simply claiming a refund, the joint returnprevents Smith from claiming an exemption for Clay. An exemptioncannot be taken for Clay's wife because she filed a joint return withClay. Smith is entitled to two exemptions.Choice "d" is incorrect. Clay cannot be taken as a dependent becausehe filed a joint return with his wife. Because the joint return was filed fora purpose other than simply claiming a refund, the joint return preventsSmith from claiming an exemption for Clay. An exemption cannot betaken for Clay's wife because she filed a joint return with Clay.Choice "c" is incorrect. Clay cannot be taken as a dependent because


Question CPA-04765

Parker, whose spouse died during the preceding year, has notremarried. Parker maintains a home for a dependent child. What isParker's most advantageous filing status?

a. Married filing separately.b. Head of household.c. Single.d. Qualifying widow(er) with dependent child.

ExplanationChoice "d" is correct. A qualifying widow(er) is a taxpayer who may usethe joint tax return standard deduction and rates (but not the exemptionfor the deceased spouse) for each of two taxable years following theyear of death of his or her spouse, unless he or she remarries. Thesurviving spouse must maintain a household that, for the whole entiretaxable year, was the principal place of abode of a son, stepson,daughter, or stepdaughter (whether by blood or adoption). The survivingspouse must also be entitled to a dependency exemption for suchindividual. Parker may file as a qualifying widow(er) since her spousedied in the previous tax year, she did not remarry and she maintained ahome for a dependent child. Since qualifying widow(er) is the mostadvantageous status and Parker qualifies, Parker would file as aqualifying widow(er).Choice "c" is incorrect. Even though Parker would qualify as single,filing single would give Parker a higher tax liability than the qualifyingwidow(er) status and therefore is not most advantageous.Choice "b" is incorrect. Parker would not qualify as head of householdfor the first two years after the death of Parker's spouse because one ofthe requirements for Head of Household status is that the taxpayer isNOT a surviving spouse. (Also, note that the likely reason for thisrequirement is that filing as Head of Household status would give thequalifying surviving spouse taxpayer a higher tax liability than the


Question CPA-07355

Robert Corp. granted an incentive stock option for 200 shares toBeverly, an employee, on March 14, Year 12. The option price and FMVon the date of grant was $150. Beverly exercised the option on August2, Year 14, when the FMV was $180 per share. She sold the stock onSeptember 20, Year 15, for $250 per share. How much gross incomedid Beverly recognize in Year 15?

a. $30,000b. $150c. $0d. $20,000

ExplanationChoice "d" is correct. This is the gain Beverly will recognize upon thesale 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. Thisgain is not recognized until the sale occurs in Year 15.Choice "a" is incorrect. This is simply the purchase price of the stockupon exercise of 200 shares at $150 per share.Choice "b" is incorrect. This is simply the option price per share on thedate of grant.Choice "c" is incorrect. The realized gain on the sale must berecognized in the year of the sale per the above explanation.


Question CPA-01811

Cobb, an unmarried individual, had an adjusted gross income of$200,000 in the current year before any IRA deduction, taxable SocialSecurity benefits, or passive activity losses. Cobb incurred a loss of$30,000 in the current year from rental real estate in which he activelyparticipated. What amount of loss attributable to this rental real estatecan be used in the current year as an offset against income fromnonpassive sources?

a. $30,000b. $12,500c. $25,000d. $0

ExplanationChoice "d" is correct. Cobb may not use any of the loss attributable tohis rental real estate as an offset against income from nonpassivesources in the current year because he does not qualify for the "Momand Pop" exception. Under this exception, up to $25,000 of passivelosses and the deduction equivalent of tax credits that are attributable torental real estate may be used as an offset against income fromnonpassive sources. This $25,000 allowance is reduced, but not belowzero, by 50% of the amount by which the individual's modified AGIexceeds $100,000. The $25,000 is therefore completely phased outwhen modified AGI reaches $150,000. Because Cobb's AGI was$200,000, he did not qualify for the exception.Choices "b", "c", and "a" are incorrect. Rental activities are passiveactivities and generally are not allowed to use any of the lossattributable to the rental activity to offset any income produced fromnonpassive sources. There is a limited exception in the case of lossesfrom rental real estate in which the taxpayer actively participates, butCobb did not qualify for it.


Question CPA-01428

Adams owns a second residence that is used for both personal andrental purposes. During the current year, Adams used the secondresidence for 50 days and rented the residence for 200 days. Which ofthe following statements is correct?

a. All mortgage interest and taxes on the property will be deducted todetermine the property's net income or loss.

b. A rental loss may be deducted if rental-related expenses exceedrental income.

c. Utilities and maintenance on the property must be divided betweenpersonal and rental use.

d. Depreciation may not be deducted on the property under anycircumstances.

ExplanationChoice "c" is correct. Because the second property was personally usedmore than 14 days, any net loss from the rental of the property will bedisallowed.All related expenses must be prorated between the personal use portionand the rental activity portion. Prorated depreciation is permitted for therental activity.

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Question CPA-01415

Jim and Kay Ross contributed to the support of their two children, Daleand Kim, and Jim's widowed parent, Grant. For Year 27, Dale, a 19-year-old full-time college student, earned $4,500 as a babysitter. Kim, a23-year-old bank teller, earned $12,000. Grant received $5,000 individend income and $4,000 in nontaxable Social Security benefits.Grant and Kim are U.S. citizens and were over one-half supported byJim and Kay, but neither of the two currently reside with Jim and Kay.Dale's main place of residence is with Jim and Kay, and he is currentlyon a temporary absence to attend school. How many exemptions canJim and Kay claim on their Year 27 joint income tax return?

a. Fourb. Fivec. Twod. Three

ExplanationChoice "d" is correct. Taxpayers are now entitled to an exemption foreach qualifying child and qualifying relative (two tests are "CARES" or"SUPORT"). For Dale, he does meet the residency requirementbecause there is an exception for a temporary absence while attendingschool. Therefore, he is a qualifying child under the CARES test. Kimdoes not qualify as a qualifying child (CARES test) because, althoughshe is under age 24, she is not a full-time student. Therefore, theincome limitations of the SUPORT test apply, and she does not qualifyunder that test either. Likewise, Grant's taxable income of $5,000exceeds the minimum. Thus, 3 total exemptions can be claimed (Jim,Kay, and Dale).

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Question CPA-05278

In which of the following situations may taxpayers file as married filingjointly?

a. Taxpayers who were divorced during the year.b. Taxpayers who were legally separated but lived together for the

entire year.c. Taxpayers who were married but lived under a legal separation

agreement at the end of the year.d. Taxpayers who were married but lived apart during the year.

ExplanationRULE: In order to file a joint return, the parties must be MARRIED atthe end of the year. Exception: If the parties are married but areLEGALLY SEPARATED under the laws of the state in which they reside,they cannot file a joint return (they will file either under the single orhead of household filing status).Choice "d" is correct. Per the above rule, taxpayers who are married butlived apart during the year are allowed to file a joint return for the year.The fact that they did not live together during the year has no bearing onthe issue.Choice "c" is incorrect. Per the above rule, taxpayers who are marriedbut lived under a legal separation agreement at the end of the year maynot file a joint return. They will generally file either under the single orhead of household filing status.Choice "a" is incorrect. Per the above rule, taxpayers who weredivorced during the year may not file a joint return together, as they arenot married at the end of the year. [Note, however, that they maybecome married again in the year and file a joint return with the newspouse.]Choice "b" is incorrect. Per the above rule, taxpayers who were legallyseparated but lived together for the entire year may not file a jointreturn. They will generally file either under the single or head ofhousehold filing status.


Question CPA-07356

Wade Inc. granted a nonqualified stock option for 100 shares at $50 pershare to Mary, an employee, on May 1, Year 12. On that date, the optionwas selling on an established market for $4 per share. Mary exercisedthe option on August 2, Year 13, when the FMV was $80 per share. Shesold the stock on September 2, Year 14, for $100 per share. How muchgross income and what type did Mary recognize in Year 12?

a. $5,000 ordinary incomeb. $5,000 capital gainc. $400 capital gaind. $400 ordinary income

ExplanationChoice "d" is correct. The employee receiving a nonqualified stockoption must recognize as ordinary income the value of the option iftraded on an established market. Here, that is 100 shares at $4 pershare, or $400.Choice "c" is incorrect. This is the correct amount, but it is ordinaryincome and not a capital gain.Choices "a" and "b" are incorrect per the above explanation.


Question CPA-01815

Dale received $1,000 in the current year for jury duty. In exchange forregular compensation from her employer during the period of juryservice, Dale was required to remit the entire $1,000 to her employer inthis year. In Dale's current year income tax return, the $1,000 jury dutyfee should be:

a. Claimed in full as an itemized deduction.b. Claimed as an itemized deduction to the extent exceeding 2% of

adjusted gross income.c. Included in taxable income without a corresponding offset against

other income.d. Deducted from gross income in arriving at adjusted gross income.

ExplanationChoice "d" is correct. The $1,000 jury duty fee that was required to beremitted to the employer may be deducted from gross income in arrivingat adjusted gross income. This, in effect, washes out the $1,000 incomeshe will have to report as part of gross income for the jury duty fees paidto her.Choices "a" and "b" are incorrect. The amount remitted is allowed as anadjustment in arriving at AGI, not as an itemized deduction.Choice "c" is incorrect. A corresponding offset is allowed against otherincome as an adjustment in arriving at AGI.


Question CPA-01433

Which of the following conditions must be present in a post-1984divorce agreement for a payment to qualify as deductible alimony?

I. Payments must be in cash or its equivalent.

II. The payments must end at the recipient's death.

a. Both I and II.b. II only.c. I only.d. Neither I nor II.

ExplanationChoice "a" is correct. Among the requirements for payments to beclassified as alimony are the following:

1. Payment must be in cash or its equivalent.2. Payments cannot extend beyond the death of the payee-spouse.3. Payments must be legally required pursuant to a written divorce

(or separation) agreement.4. Payments cannot be made to members of the same household.5. Payments must not be designated as anything other than alimony.6. The spouses may not file a joint tax return.

Note: The requirements for payments to be considered alimony(income) are the same as for payments to be alimony (deductions).

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Question CPA-04854

Janet and Ted have two children, Mary (age 10) and Seth (age 12).Janet's Aunt Martha resides with the family in an apartment over thegarage. Martha's only income is $1,500 a month in Social Securitybenefits. Janet and Ted receive no rent payments from Martha andprovide all remaining support for her living arrangements. How manyexemptions are Janet and Ted entitled to in filing their joint tax return?

a. 4b. 5c. 3d. 2

ExplanationChoice "b" is correct. Janet and Ted are entitled to dependencyexemptions for themselves, their two children and Aunt Martha. AuntMartha is a "qualified relative." The qualifications to take an exemptionfor a qualifying relative are found in the "SUPORT" mnemonic.

Support (over 50%) test

Under a specific amount of (taxable) gross income test

Precludes dependent filing a joint tax return test

Only citizens (residents of US/Canada or Mexico) test

Relative test OR

Taxpayer lives with individual for whole year test

The two children meet the test for a qualifying child. In addition, AuntMartha, a relative, qualifies because she does not have any taxableincome (social security is not taxed at this low level of income), is notfiling a joint tax return with another, is a citizen of the US, and is aqualifying relative. In this instance, note that Martha would not have to

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reside with the family. Only nonrelative members of a household mustreside with the taxpayer for the entire year in order for the taxpayer tobe entitled to a dependency exemption for that individual.Choices "d", "c", and "a" are incorrect per the above explanation.

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Question CPA-05964

A couple filed a joint return in prior tax years. During the current taxyear, one spouse died. The couple has no dependent children. What isthe filing status available to the surviving spouse for the first subsequenttax year?

a. Single.b. Surviving spouse.c. Head of household.d. Married filing separately.

ExplanationChoice "a" is correct. For the first subsequent tax year (and all othersubsequent tax years) after the death of a spouse with no dependentchildren, filing status is single.Choice "b" is incorrect. Filing status is not "surviving spouse" becausethere are no dependent children.Choice "d" is incorrect. Filing status is not "married filing separately" inthe first subsequent tax year after the death of a spouse since thecouple is no longer married.Choice "c" is incorrect. Filing status is not "head of household" becausethere are no dependent children and no other qualifying dependents.


Question CPA-07357

Which of the following statements is not correct?

a. Employee Stock Purchase Plans are a type of qualified stock optionplan.

b. For an Incentive Stock Option, once exercised, the stock must beheld at least two years after the grant date and at least one yearafter the exercise date.

c. The employer may recognize a deductible expense for anonqualified stock option in the same year that the employee willrecognize ordinary income.

d. The recipient of an Incentive Stock Option will generally have toreport compensation income in the year that the option is received.

ExplanationChoice "d" is correct. Generally there is no recognition of compensationexpense with an Incentive Stock Option.Choices "a", "c", and "b" are incorrect as these are all true statements.


Question CPA-01823

Clark bought Series EE U.S. Savings Bonds after 1989. Redemptionproceeds will be used for payment of college tuition for Clark'sdependent child. One of the conditions that must be met for taxexemption of accumulated interest on these bonds is that the:

a. Bonds must be bought by a parent (or both parents) and put in thename of the dependent child.

b. Bonds must be bought by the owner of the bonds before the ownerreaches the age of 24.

c. Purchaser of the bonds must be the sole owner of the bonds (orjoint owner with his or her spouse).

d. Bonds must be transferred to the college for redemption by thecollege rather than by the owner of the bonds.

ExplanationChoice "c" is correct. One of the conditions that must be met for taxexemption of accumulated interest on the bonds is that the purchaser ofthe bonds must be the sole owner of the bonds (or joint owner with hisor her spouse). Other conditions include, for post-1989 bonds, thetaxpayer is over age 24 when issued and is used to pay for highereducation, reduced by tax-free scholarships, of the taxpayer, spouse, ordependents.Choice "a" is incorrect. The bonds must be bought and put in the nameof the owner or co-owner, not in the name of the dependent child.Choice "b" is incorrect. The owner must be at least 24 years old beforethe bonds issue date.Choice "d" is incorrect. There is no requirement that the bonds must betransferred to the college for redemption by the college rather than bythe owner of the bonds.


Question CPA-01438

Which of the following costs is not included in inventory under theUniform Capitalization rules for goods manufactured by the taxpayer?

a. Warehousing costs.b. Quality control.c. Taxes excluding income taxes.d. Research.

ExplanationChoice "d" is correct. Uniform Capitalization rules provide guidelineswith respect to capitalizing or expensing certain costs. With regard toinventory, direct materials, direct labor, and factory overhead should becapitalized as part of the cost of inventory. Warehousing costs, qualitycontrol and taxes, excluding income taxes, are all considered factoryoverhead items. The research should be expensed.

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Question CPA-06533

A taxpayer's spouse dies in August of the current year. Which of thefollowing is the taxpayer's filing status for the current year?

a. Head of household.b. Qualified widow(er).c. Single.d. Married filing jointly.

ExplanationChoice "d" is correct. The joint return rates apply for two years followingthe death of a spouse, if the surviving spouse does not remarry andmaintains a household for a dependent child. There is nothing in thisquestion that says whether or not the surviving spouse maintains ahousehold for a dependent child. However, since the question is askingabout the current year, the surviving spouse is considered to be married(and thus able to file as married filing jointly) for the entire current yeareven if the spouse dies earlier in the year (in this case in August).Choice "c" is incorrect. The filing status is not single for the current year.Choice "b" is incorrect. The filing status is not qualified widow(er) for thecurrent year.Choice "a" is incorrect. The filing status is not head of household for thecurrent year.


Question CPA-07358

James Corp. issue stock options to employees under an EmployeeStock Purchase Plan. Which of the following statements is correct?

I. The option exercise price must be less than the lesser of 95%of the FMV of the stock when granted or exercised.

II. The option cannot be exercised more than 27 months after thegrant date.

a. Both.b. II only.c. Neither.d. I only.

ExplanationChoice "b" is correct. I is not correct because the rule states 85%, not95%. II is a correct statement. This is a requirement of an ESPP.Choices "d", "a", and "c" are incorrect per the above explanation.


Question CPA-01831

The rule limiting the allowability of passive activity losses and creditsapplies to:

a. Personal service corporations.b. Widely held C corporations.c. S corporations.d. Partnerships.

ExplanationChoice "a" is correct. The rule limiting the allowability of passive activitylosses and credits applies to personal service corporations.Choice "d" is incorrect. The passive activity limitations apply to thevarious partners in the partnership as opposed to the partnership itself.Choice "c" is incorrect. The passive activity limitations apply to thevarious shareholders in the S corporation as opposed to the corporationitself.Choice "b" is incorrect. The passive activity rules do not apply to widelyheld C corporations.


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Question CPA-01442

During Year 9, Ash had the following cash receipts:

Wages 13,000

Interest income from U.S. Treasury bonds 350

Workers' compensation following a job-related injury 8,500

What is the total amount that must be included in gross income on Ash'sYear 9 income tax return?

a. $13,000b. $21,500c. $13,350d. $21,850

ExplanationChoice "c" is correct. The total amount that must be included in grossincome is $13,350 ($13,000 in wages plus $350 in interest income onU.S. Treasury bonds).Rule: Wages and interest on U.S. Treasury bonds are includible ingross income and must be reported as part of gross income on ataxpayer's income tax return.Rule: Damages for personal injury (i.e., workers' compensation for ajob-related injury) are specifically excluded from gross income.Choices "a", "b", and "d" are incorrect, per the above rules.


Question CPA-01834

Hall, a divorced person and custodian of her 12-year-old child, filed hercurrent year federal income tax return as head of a household. Shesubmitted the following information to the CPA who prepared her return:

The divorce agreement, executed seven years ago, provides forHall to receive $3,000 per month, of which $600 is designated aschild support. After the child reaches 18, the monthly paymentsare to be reduced to $2,400 and are to continue until remarriageor death. However, for the current year, Hall received a total ofonly $5,000 from her former husband. Hall paid an attorney$2,000 in the current year in a suit to collect the alimony owed.In June of the current year, Hall's mother gifted her 100 shares ofa listed stock. The donor's basis for this stock, which she bought20 years ago, was $4,000, and market value on the date of thegift was $3,000. Hall sold this stock in July of the current year for$3,500. The donor paid no gift tax.During the year, Hall spent a total of $1,000 for state lotterytickets, and her lottery winnings totaled $200.Hall earned a salary of $25,000 in the current year. Hall was notcovered by any type of retirement plan, but contributed $2,000 toan IRA this year.During the year, Hall sold an antique that she bought 10 yearsago to display in her home. Hall paid $800 for the antique andsold it for $1,400, using the proceeds to pay a court-orderedjudgment.Hall paid the following expenses in the current year pertaining tothe home that she owns: realty taxes, $3,400; mortgage interest,$7,000; casualty insurance, $490; assessment by city forconstruction of a sewer system, $910; interest of $1,000 on apersonal, unsecured bank loan, the proceeds of which wereused for home improvements. Hall does not rent out any portionof the home.

What amount should be reported in Hall's current year tax return asalimony income?


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Question CPA-01451

Baum, an unmarried optometrist and sole proprietor of Optics, buys andmaintains a supply of eyeglasses and frames to sell in the ordinarycourse of business. In the current year, Optics had $350,000 in grossbusiness receipts and its year-end inventory was not subject to theuniform capitalization rules. Baum's current year adjusted gross incomewas $90,000 and Baum qualified to itemize deductions. During the year,Baum recorded the following information:

Business expenses:

Optics cost of goods sold35,000

Optics rent expense 28,000

Liability insurance premium on Optics 5,250

Other expenditures:

Baum's self-employment tax29,750

Baum's self-employment health insurance 8,750

Insurance premium on personal residence. In the currentyear, Baum's home wastotally destroyed by fire. The furniture had an adjustedbasis of $14,000 and afair market value of $11,000. During the year, Baumcollected $3,000 in insurancereimbursement and had no casualty gains during the year.

2,625

Qualified mortgage interest on a loan to acquire a personalresidence

52,500

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Question CPA-01840

A cash basis taxpayer should report gross income:

a. Only for the year in which income is actually received in cash.b. For the year in which income is either actually or constructively

received, whether in cash or in property.c. Only for the year in which income is actually received whether in

cash or in property.d. For the year in which income is either actually or constructively

received in cash only.

ExplanationChoice "b" is correct. A cash basis taxpayer should report gross incomefor the year in which income is either actually or constructively received,whether in cash or in property.Choice "a" is incorrect. Income also can be constructively received inproperty, not only actually in cash.Choice "c" is incorrect. Income also can be constructively received, notonly actually.Choice "d" is incorrect. Income also can be received in property, notonly cash.

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Question CPA-01472

Baker, a sole proprietor CPA, has several clients that do business inSpain. While on a four-week vacation in Spain, Baker took a five-dayseminar on Spanish business practices that cost $700. Baker's round-trip airfare to Spain was $600. While in Spain, Baker spent an averageof $100 per day on accommodations, local travel, and other incidentalexpenses, for total expenses of $2,800. What amount of total expensecan Baker deduct on Form 1040 Schedule C, "Profit or Loss FromBusiness," related to this situation?

a. $1,800b. $700c. $1,200d. $4,100

ExplanationChoice "c" is correct. Baker can deduct $1,200 in total expense on Form1040 Schedule C, calculated as follows:

Direct educational expenses 700 [cost of the course]

Daily expenses for 5-day seminar 500 [$100 per day 5]

Total educational expenses 1,200

Rule: If foreign travel is primarily for personal in nature (e.g., avacation), none of the travel expenses (e.g., round trip airfare) incurredwill be allowable business deductions, even if the taxpayer was involvedin business activities while in the foreign country.Note: It does not appear that the examiners are attempting to trickcandidates on the classification of the business expenses as travel oreducational. It appears that the purpose of the question is to test thecandidate's ability to recognize when expenses are deductible and whenthey are not deductible business expenses.Choice "b" is incorrect, as the expenses for the 5-day period Bakerattended the seminar were directly related to being in Spain for the

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additional period of time and are allowable business deductions.Choices "a" and "d" are incorrect, per the above rule.

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Question CPA-01884

The uniform capitalization method must be used by:

I. Manufacturers of tangible personal property.

II. Retailers of personal property with $2 million in average annualgross receipts for the three preceding years.

a. II only.b. I only.c. Both I and II.d. Neither I nor II.

ExplanationChoice "b" is correct. I only.Rule: The uniform capitalization rules apply to the following:

1. Real or tangible personal property produced by the taxpayer foruse in a trade or business.

2. Real or tangible personal property produced by the taxpayer forsale to customers.

3. Real or personal property acquired by the taxpayer for resale.4. However, the uniform capitalization rules do not apply to property

acquired for resale if the taxpayer's annual gross receipts for thepreceding three tax years do not exceed $10,000,000 (not $2million).

Choices "a", "c", and "d" are incorrect, per the above.

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Question CPA-01479

On December 1 of the current taxable year, Krest, a self-employed cashbasis taxpayer, borrowed $200,000 to use in her business. The loanwas to be repaid on November 30 of the following year. Krest paid theentire interest amount of $24,000 on December 1 of the current year.What amount of interest was deductible on Krest's current year incometax return?

a. $2,000b. $0c. $24,000d. $22,000

ExplanationChoice "a" is correct. Cash basis taxpayers deduct interest in the yearpaid or the year to which the interest relates, whichever is later. Eventhough all of the interest on this loan was paid on December 1, of thecurrent year, only the interest relating to December of the current yearcan be deducted in the current year. The question does not give aninterest rate, but because the loan is to be repaid in a lump sum atmaturity, 1/12 of the interest, or $2,000 applies to each month.Choice "b" is incorrect. Because $2,000 of the interest relates to thecurrent year, this amount is deductible in the current year.Choice "d" is incorrect. This is the amount that cannot be deducted untilthe following year, the year to which the interest relates. Be sure to readquestions like this very carefully, because if you had simply misread thequestion as seeking the amount deductible in the following year, youwould get the question wrong despite understanding the rule.Choice "c" is incorrect. Cash basis taxpayers can deduct interest in theyear paid or the year to which the interest relates, whichever is later,thus 11 months of the interest will not be deductible until next year.

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Question CPA-06431

Nicole and Andrew Harris contribute to more than half of the support oftheir three children, Travis, Luke, and John. Travis, age 20, worked fulltime at the local deli and earned $20,000. Luke, 18, is a part-timecollege student who earned $5,000 working as a resident assistant inthe student dormitory where he lived half of the year. John, age 25, is anaspiring actor who lives at home with Nicole and Andrew. John earned$2,500 for the three commercials he starred in. How many exemptionscan Nicole and Andrew claim on their Year 1 joint tax return?

a. Four.b. Three.c. Five.d. Two.

ExplanationChoice "a" is correct.Nicole and Andrew can claim two personal exemptions for themselves.Travis does not qualify for a dependency exemption. Travis is not a full-time student, so at age 20 he is not a qualifying child. Although Nicoleand Andrew provide more than half of his support, Travis makes morethan the exemption amount ($3,650), so he is not considered as aqualifying relative, either.Luke is a qualifying child of Nicole and Andrew because he is under theage of 19 and lives at home at least part of the year. There is no grossincome or support test that needs to be satisfied in the case of aqualifying child.John is a qualifying relative of Nicole and Andrew because theysupplied over half of his support and his taxable income is less than theexemption amount.Choices "d", "b", and "c" are incorrect, based on the above explanation.

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Question CPA-01482

Klein, a master's degree candidate at Blair University, was awarded a$12,000 scholarship from Blair in Year 8. The scholarship was used topay Klein's Year 8 university tuition and fees. Also in Year 8, Kleinreceived $5,000 for teaching two courses at a nearby college. Whatamount is includable in Klein's Year 8 gross income?

a. $0b. $5,000c. $12,000d. $17,000

ExplanationChoice "b" is correct. Scholarships are nontaxable for degree seekingstudents to the extent that the proceeds are spent on tuition, fees,books and supplies. The $5,000 for teaching courses is taxablecompensation for services delivered.Choice "a" is incorrect. The $5,000 for teaching courses is taxablecompensation for services delivered.Choice "c" is incorrect. The scholarship is not taxable because Klein is adegree seeking student and used the proceeds for tuition and fees.Furthermore, the $5,000 for teaching courses is taxable compensationfor services delivered.Choice "d" is incorrect. The scholarship is not taxable because Klein is adegree seeking student and used the proceeds for tuition and fees.

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Question CPA-06432

John and Theresa are in the process of obtaining a divorce. Althoughthey are not legally separated, John moved out of the family home inOctober of Year 1 and moved into an apartment nearby. John andTheresa's two children, Jenna and Stella, lived with Theresa in thefamily home for more than half of the tax year. What filing status canTheresa use to file her Year 1 tax return?

a. Single.b. Surviving spouse (qualifying widow).c. Head of household.d. Married filing jointly/separately.

ExplanationChoice "d" is correct. John and Theresa are still married at year-end,not legally separated, and have not lived apart for the last six months ofthe taxable year. Theresa must file as married, but may choose to do soeither jointly with John or separately.Choice "c" is incorrect. Head of household status is not an optionbecause the couple is not legally separated at year-end and John didnot live apart from Theresa for the last six months of the taxable year.Choice "b" is incorrect. Surviving spouse (qualifying widow) is not anoption for Theresa, as John is still alive. Choice "a" is incorrect. Filing as single is not an option, because Johnand Theresa are still married and not legally separated at year-end.

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Question CPA-01485

Which payment(s) is (are) included in a recipient's gross income?

I. Payment to a graduate assistant for a part-time teachingassignment at a university. Teaching is not a requirement towardobtaining the degree.

II. A grant to a Ph.D. candidate for his participation in a university-sponsored research project for the benefit of the university.

a. Neither I nor II.b. Both I and II.c. I only.d. II only.

ExplanationChoice "b" is correct.

I. A payment to a student for a part-time teaching assignment istaxable income just as a payment for any other campus jobwould be. This is not a scholarship or fellowship.

II. There is no exclusion in the tax law for amounts paid to adegree candidate for participation in university-sponsoredresearch.

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Question CPA-06433

Mort and Mindy met at a New Year's Eve party held December 31, Year1. They instantly bonded, fell madly in love, and were married at 11:38p.m. that night. Identify Mort's filing status for Year 1.

a. Single.b. Head of household.c. Married filing jointly.d. Surviving spouse.

ExplanationChoice "c" is correct. Mort and Mindy were married as of midnight onDecember 31, Year 1. Therefore, Mort's only options are to file asmarried either jointly or separately, and because "joint" is the only optionpresented that qualifies, choice "c" is correct.Choices "a", "b", and "d" are incorrect, based on the above explanation.

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Question CPA-01489

Under the uniform capitalization rules applicable to property acquired forresale, which of the following costs should be capitalized with respect toinventory if no exceptions are met?

Marketingcosts

Off-sitestorage costs

a. No No

b. No Yes

c. Yes No

d. Yes Yes

ExplanationChoice "b" is correct. Under the uniform capitalization rules, purchasersof inventory for resale may deduct their marketing costs but mustcapitalize their off-site storage costs.Choices "d", "c", and "a" are incorrect. Marketing costs are deductible,but off-site storage must be capitalized.

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Question CPA-06434

Mort and Mindy met at a New Year's Eve party held December 31, Year1. They instantly bonded, fell madly in love, and were married at 11:38p.m. that night. Sadly, Mort passed away November 15, Year 2. Whatfiling status should Mindy use for Year 2?

a. Married filing jointly.b. Surviving spouse.c. Head of household.d. Single.

ExplanationChoice "a" is correct. Mindy will be able to use the married filing jointlystatus for the year Mort passed away (Year 2) even though she was notmarried at year-end. Also, note that Mindy will be able to claim Mort asa personal exemption on the joint return in the year of death.Choices "d", "c", and "b" are incorrect, based on the above explanation.

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Question CPA-01564

In a tax year where the taxpayer pays qualified education expenses,interest income on the redemption of qualified U.S. Series EE Bondsmay be excluded from gross income. The exclusion is subject to amodified gross income limitation and a limit of aggregate bond proceedsin excess of qualified higher-education expenses. Which of the followingis (are) true?

I. The exclusion applies for education expenses incurred by thetaxpayer, the taxpayer's spouse, or any person whom thetaxpayer may claim as a dependent for the year.

II. "Otherwise qualified higher-education expenses" must bereduced by qualified scholarships not includible in gross income.

a. II only.b. Neither I nor II.c. I only.d. Both I and II.

ExplanationChoice "d" is correct. Interest earned on Series EE bonds issued after1989 may qualify for exclusion. One requirement is that the interest isused to pay tuition and fees for the taxpayer, spouse, or dependentenrolled in higher education. The interest exclusion is reduced byqualified scholarships that are exempt from tax and other nontaxablepayments received for educational expenses (other than gifts andinheritances).

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Question CPA-06435

Mort and Mindy met at a New Year's Eve party held December 31, Year1. They instantly bonded, fell madly in love, and were married at 11:38p.m. that night. Sadly, Mort passed away November 15, Year 2. InJanuary, Year 3, Mindy gave birth to triplets Mark, Mandy, and Maureen.Assuming that Mindy has not remarried, what filing status should sheuse for Year 4?

a. Head of household.b. Single.c. Surviving spouse.d. Married filing jointly.

ExplanationChoice "c" is correct. Because Mindy does not remarry and shemaintains a principal residence for her dependent children for the entireyear, she may file using the surviving spouse (qualifying widow) statusfor the two taxable years following Mort's death (but may not claim Mortas a personal exemption, because he was not alive for any part of thosetaxable years). In Year 4, the second year after Mort's death, Mindyshould file as a qualifying widow.Choices "b", "d", and "a" are incorrect, based on the above explanation.

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Question CPA-01568

During the year Kay received interest income as follows:

On U.S. Treasury certificates 4,000

On refund of prior year's federal income tax 500

The total amount of interest subject to tax in Kay's current year taxreturn is:

a. $4,500b. $0c. $500d. $4,000

ExplanationChoice "a" is correct. Interest income from U.S. obligations is generallytaxable. Interest income on a federal tax refund is taxable, even thoughthe refund itself is not taxed.Choice "d" is incorrect. Interest income on a federal tax refund istaxable, even though the refund itself is not taxed.Choice "c" is incorrect. Interest income from U.S. obligations isgenerally taxable.Choice "b" is incorrect. Interest income from U.S. obligations isgenerally taxable. Interest income on a federal tax refund is taxable,even though the refund itself is not taxed.

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Question CPA-06436

Mort and Mindy met at a New Year's Eve party held December 31, Year1. They instantly bonded, fell madly in love, and were married at 11:38p.m. that night. Sadly, Mort passed away November 15, Year 2. InJanuary, Year 3, Mindy gave birth to triplets Mark, Mandy, and Maureen.Assuming Mindy has not remarried, what filing status should she use forYear 5?

a. Surviving spouse.b. Married filing jointly.c. Single.d. Head of household.

ExplanationChoice "d" is correct. Mindy should file using the head of householdstatus. She has dependent children living with her, and no longerqualifies as married or as a surviving spouse. Head of household is themost favorable filing status for which she qualifies.Choice "c" is incorrect. Mindy qualifies for a more favorable filing statusthan single.Choice "b" is incorrect. Mindy is no longer married and Mort did not diein Year 5, so she is not eligible for the married filing jointly status.Choice "a" is incorrect. At Year 5, more than two years have passedsince Mort's death so Mindy no longer qualifies for surviving spouse(qualifying widow) status.

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Question CPA-01571

With regard to the inclusion of social security benefits in gross income,for the Year 8 tax year, which of the following statements is correct?

a. The social security benefits in excess of the modified adjusted grossincome over a threshold amount are included in gross income.

b. The social security benefits in excess of one half the modifiedadjusted gross income are included in gross income.

c. The social security benefits in excess of modified adjusted grossincome are included in gross income.

d. Eighty-five percent of the social security benefits is the maximumamount of benefits to be included in gross income.

ExplanationChoice "d" is correct. The amount of social security benefits that istaxed is dependent on whether the combined income (AGI plus intereston tax-exempt bonds and 50% of the social security benefits) is greaterthan a threshold amount. If the combined income is less than thethreshold, the amount taxed is the lesser of 1) 50% of the benefits or 2)50% of the excess of the combined income over the threshold. If thecombined income is greater than the threshold, the amount taxed is thelesser of 1) amount calculated above plus 85% of the excess of thecombined income over the threshold or 2) 85% of the benefits. Thus,85% of the benefits is the maximum amount of benefits that may beincluded in gross income.

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Question CPA-06437

In Year 4, after Mindy's three children have grown and moved out of thehouse, Mindy (unmarried) moved her mother, Mary, into an assistedliving facility for which Mindy pays 75% of the cost. Mindy had notpreviously lived with Mary, and Mary paid for her own living expenseswhile she lived in her own home. What filing status should Mindy use forYear 4, assuming Mary moved into the assisted living facility on January1, Year 4?

a. Single.b. Married filing jointly.c. Head of household.d. Surviving spouse.

ExplanationChoice "c" is correct. Mindy qualifies for and should use head ofhousehold status in Year 4, because she maintained more than half ofthe upkeep on Mary's principal residence for more than half the taxableyear (note that Mindy is not required to live with her mother to qualify forhead of household status). It is the most favorable filing status for whichshe qualifies.Choice "a" is incorrect. Mindy qualifies for a more favorable filing statusthan single.Choice "b" is incorrect. Mindy is not married.Choice "d" is incorrect. Mindy has not had a spouse die in the past twoyears.

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Question CPA-01596

Rich is a cash basis self-employed air-conditioning repairman withcurrent year gross business receipts of $20,000. Rich's cashdisbursements were as follows:

Air conditioning parts 2,500

Yellow Pages listing 2,000

Estimated federal income taxes on self-employmentincome

1,000

Business long-distance telephone calls 400

Charitable contributions 200

What amount should Rich report as net self-employment income?

a. $14,100b. $14,900c. $13,900d. $15,100

ExplanationChoice "d" is correct. Deductions to arrive at net self-employed incomeinclude all necessary and ordinary expenses connected with thebusiness. Estimated federal income tax payments are not an expense.Charitable contributions by an individual are only deductible as anitemized deduction on Schedule A. This assumes the contribution wasnot made with the "expectation of commensurate financial return."

Receipts 20,000

Parts (2,500)

Listing (2,000)

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Telephone (400)

Net self-employment income 15,100

Choice "b" is incorrect. Charitable contributions are an itemizeddeduction unless there is an expectation of commensurate financialreturn.Choice "a" is incorrect. Federal income taxes paid are not a deductibleexpense.Choice "c" is incorrect. Charitable contributions are an itemizeddeduction unless there is an expectation of commensurate financialreturn. Federal income taxes paid are not a deductible expense.

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Question CPA-06438

In Year 4, after Mindy's three children have grown and moved out of thehouse, Mindy (unmarried) moved her mother, Mary, into an assistedliving facility for which Mindy pays 75% of the cost. Mindy had notpreviously lived with Mary, and Mary paid for her own living expenseswhile she lived in her own home. What filing status should Mindy use forYear 4, assuming Mary moved into the assisted living facility on August1, Year 4?

a. Married filing jointly.b. Head of household.c. Surviving spouse.d. Single.

ExplanationChoice "d" is correct. Mindy should file using the single status. She doesnot qualify for more favorable filing status.Choice "a" is incorrect. Mindy is not married.Choice "b" is incorrect. Mindy does not qualify for head of householdstatus. Had Mary moved into the assisted living home more than half ayear before the taxable year-end, Mindy would have been eligible forhead of household status. Mindy did not provide more than half ofMary's support and for Year 4 is ineligible for head of household status.Choice "c" is incorrect. Mindy has not had a spouse die in the past twoyears.

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Question CPA-01603

On December 1, Year 1, Michaels, a self-employed cash basis taxpayer,borrowed $100,000 to use in her business. The loan was to be repaidon November 30, Year 2. Michaels paid the entire interest of $12,000 onDecember 1, Year 1. What amount of interest was deductible onMichaels' Year 2 income tax return?

a. $11,000b. $1,000c. $12,000d. $0

ExplanationChoice "a" is correct. Prepaid interest must be prorated over the time forwhich payment is made. This is true for both cash and accrual basistaxpayers. The loan is for 1 month in Year 1 and 11 months in Year 2.Therefore, 1/12 of the interest is deductible in Year 1 and 11/12, or$11,000 is deductible in Year 2.Choices "c", "b", and "d" are incorrect. Prepaid interest must be proratedover the time for which payment is made. This is true for both cash andaccrual basis taxpayers.

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Question CPA-01609

Perle, a dentist, billed Wood $600 for dental services. Wood paid Perle$200 cash and built a bookcase for Perle's office in full settlement of thebill. Wood sells comparable bookcases for $350. What amount shouldPerle include in taxable income as a result of this transaction?

a. $0b. $550c. $600d. $200

ExplanationChoice "b" is correct. The $200 cash received plus the $350 fair value ofthe bookcase received must be included in income by Perle, for a totalof $550. The income is based on the value in money or fair value ofproperty received by Perle, not the $600 billed.Choice "a" is incorrect. Perle must report taxable income as a result ofthis transaction.Choice "d" is incorrect. The $350 fair value of the bookcase received isalso income for Perle.Choice "c" is incorrect. The income is based on the total value receivedby Perle, not the $600 billed.

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Question CPA-01610

Charles and Marcia are married cash-basis taxpayers. In Year 8, theyhad interest income as follows:

$500 interest on federal income tax refund.$600 interest on state income tax refund.$800 interest on federal government obligations.$1,000 interest on state government obligations.

What amount of interest income is taxable on Charles and Marcia's Year8 joint income tax return?

a. $2,900b. $500c. $1,100d. $1,900

ExplanationChoice "d" is correct. The $500 interest on federal income tax refund,the $600 interest on state income tax refund, and the $800 interest onfederal government obligations are taxable, for a total of $1,900. The$1,000 interest on state government obligations is normally not taxable.Choice "b" is incorrect. The $600 interest on state income tax refundand the $800 interest on federal government obligations is also taxable.Choice "c" is incorrect. The $800 interest on federal governmentobligations is also taxable.Choice "a" is incorrect. The $1,000 interest on state governmentobligations is normally not taxable.

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Question CPA-01614

Nare, an accrual-basis taxpayer, owns a building which was rented toMott under a ten-year lease expiring August 31, Year 8. On January 2,Year 2, Mott paid $30,000 as consideration for cancelling the lease. OnNovember 1, Year 2, Nare leased the building to Pine under a five-yearlease. Pine paid Nare $10,000 rent for the two months of November andDecember, and an additional $5,000 for the last month's rent. Whatamount of rental income should Nare report in its Year 2 income taxreturn?

a. $40,000b. $10,000c. $45,000d. $15,000

ExplanationChoice "c" is correct. Prepaid rent is income when received even for anaccrual-basis taxpayer. The $30,000 received as consideration forcancelling the lease is in substitution for rental payments and is thusrental income. The $5,000 prepaid for the last month's rent is also rentalincome.Choice "b" is incorrect. The $30,000 received as consideration forcancelling the lease is in substitution for rental payments and is thusrental income. The $5,000 prepaid for the last month's rent is also rentalincome.Choice "d" is incorrect. The $30,000 is in substitution of rental paymentsand is thus rental income.Choice "a" is incorrect. The $5,000 prepaid for the last month's rentwould also be rental income.

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Question CPA-01620

John and Mary were divorced last year. The divorce decree providesthat John pay alimony of $10,000 per year, to be reduced by 20% ontheir child's 18th birthday. During the current year, John paid $7,000directly to Mary and $3,000 to Spring College for Mary's tuition. Whatamount of these payments should be reported as income in Mary'scurrent year income tax return?

a. $8,000b. $5,600c. $8,600d. $10,000

ExplanationChoice "a" is correct. Alimony would be income to Mary while childsupport would not. Funds qualify as child support only if 1) a specificamount is fixed or is contingent on the child's status (e.g., reaching acertain age), 2) it is paid solely for the support of minor children, and 3)it is payable by decree, instrument or agreement. The actual use of thefunds is irrelevant to the issue. In this case, $2,000 (20% $10,000)qualifies as child support. The other $8,000 is alimony, which would beincome to Mary.Choice "b" is incorrect. Take 80% of the $10,000 paid, not 80% of the$7,000 received by Mary.Choice "c" is incorrect. Only $8,000 would be alimony per the divorcedecree (80% $10,000).Choice "d" is incorrect. The 20% reduction when the child turns 18makes 20% of the $10,000 payment, or $2,000, child support, which isnontaxable to Mary.

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Question CPA-01636

Clark filed Form 1040EZ for the Year 8 taxable year. In July, Year 9,Clark received a state income tax refund of $900 plus interest of $10, foroverpayment of Year 8 state income tax. What amount of the state taxrefund and interest is taxable in Clark's Year 9 federal income taxreturn?

a. $0b. $10c. $910d. $900

ExplanationChoice "b" is correct. Except for interest from state and localgovernment bonds, interest income is fully taxable, so the $10 isincluded in income. Filing Form 1040EZ means that Clark did notitemize in the prior year, and therefore, did not deduct any state incometaxes last year. Under the tax benefit rule, the refund is not taxable thisyear since Clark did not deduct the tax last year.

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Question CPA-01699

Freeman, a single individual, reported the following income in thecurrent year:

Guaranteed payment from services rendered to apartnership 50,000

Ordinary income from an S corporation 20,000

What amount of Freeman's income is subject to self-employment tax?

a. $70,000b. $50,000c. $20,000d. $0

ExplanationChoice "b" is correct. Guaranteed payments are reasonablecompensation paid to a partner for services rendered (or use of capital)without regard to his ratio of income. Earned compensation is subject toself-employment tax. Payments not guaranteed are merely another wayto distribute partnership profits. The ordinary income reported from an Scorporation is taxable income to the individual or their own individual taxreturn but is not subject to self-employment tax. The ordinary incomereported from a partnership may be subject to self-employment tax (if toa general partner).

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Question CPA-04721

During the current year, Adler had the following cash receipts:

Wages 18,000

Interest income from investments in municipal bonds 400

Unemployment compensation 3,900

What is the total amount that must be included in gross income onAdler's current year income tax return?

a. $21,900b. $22,300c. $18,000d. $18,400

ExplanationChoice "a" is correct. The wages of $18,000 and unemploymentcompensation are both includable in gross income on Adler's currentyear income tax return.Choice "c" is incorrect. The unemployment compensation must beincluded in gross income.Choice "d" is incorrect. Municipal bond interest income is excluded fromgross income, and the unemployment compensation must be includedin gross income.Choice "b" is incorrect. Municipal bond interest income is excluded fromgross income.

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Question CPA-04756

DAC Foundation awarded Kent $75,000 in recognition of lifelong literaryachievement. Kent was not required to render future services as acondition to receive the $75,000. What condition(s) must have been metfor the award to be excluded from Kent's gross income?

I. Kent was selected for the award by DAC without any action onKent's part.

II. Pursuant to Kent's designation, DAC paid the amount of theaward either to a governmental unit or to a charitableorganization.

a. II only.b. Neither I nor II.c. Both I and II.d. I only.

ExplanationChoice "c" is correct. Generally, the fair market value of prizes andawards is taxable income. However, an exclusion from income forcertain prizes and awards applies where the winner is selected for theaward without entering into a contest (i.e., without any action on theirpart) and then assigns the award directly to a governmental unit orcharitable organization. Therefore, conditions "I" and "II" must be met inorder for Kent to exclude the award from his gross income.Choice "d" is incorrect. "II" is a necessary condition as well. Seeexplanation above.Choice "a" is incorrect. "I" is a necessary condition as well. Seeexplanation above.Choice "b" is incorrect. "I" and "II" are both necessary conditions. Seeexplanation above.

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Question CPA-04760

Mosh, a sole proprietor, uses the cash basis of accounting. At thebeginning of the current year, accounts receivable were $25,000. Duringthe year, Mosh collected $100,000 from customers. At the end of theyear, accounts receivable were $15,000. What was Mosh's grosstaxable income for the current year?

a. $75,000b. $110,000c. $90,000d. $100,000

ExplanationChoice "d" is correct. The facts state that cash collections fromcustomers were $100,000 and as a cash basis taxpayer this is theamount of Mosh's gross taxable income for the year. Note thataccording to the formula BASE - we can determine the amount of sales= $90,000, but that would give us accrual, not cash basis, income.

Beginning A/R 25,000

AddSales 90,000 accrual basis taxableincome

115,000

SubtractCashcollections

(100,000) cash basis taxable income

Ending A/R 15,000

Choices "a" and "b" are incorrect. See explanation above.Choice "c" is incorrect. $90,000 is the amount of sales that would beMosh's taxable income if Mosh were an accrual basis taxpayer.

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Question CPA-05267

Porter was unemployed for part of the year. Porter received $35,000 ofwages, $6,400 from a state unemployment compensation plan, and$2,000 from his former employer's company-paid supplementalunemployment benefit plan. What is the amount of Porter's grossincome?

a. $43,400b. $37,000c. $41,400d. $35,000

ExplanationRULE: Gross income includes all income unless it is specificallyexcluded in the tax code.Choice "a" is correct. Wages and all unemployment compensation arenot excluded from being taxable; therefore, they are included in thetaxpayer's gross income for tax purposes.

Wages received 35,000

State unemployment compensation 6,400

Employer's unemployment compensation plan 2,000

43,400

Choice "d" is incorrect. All forms of unemployment compensation areincluded as part of gross income.Choice "b" is incorrect. The $6,400 of state unemploymentcompensation received is included as part of gross income.Choice "c" is incorrect. The $2,000 of his former employer's company-paid supplemental unemployment benefit plan is included as part ofgross income.

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Question CPA-05279

Which one of the following will result in an accruable expense for anaccrual-basis taxpayer?

a. A repair completed prior to year end and paid upon completion.b. A repair completed prior to year end but not invoiced.c. An invoice dated prior to year end but the repair completed after

year end.d. A signed contract for repair work to be done and the work is to be

completed at a later date.

ExplanationRULE: An accruable expense is one is which the services have beenreceived/performed but have not been paid for by the end of thereporting period.Choice "b" is correct. The facts indicate that a repair was completedprior to year end but not yet invoiced. If it has not yet been invoiced, it isassumed that it has also not yet been paid for. Therefore, this is asituation in which the repair expense would be accrued at year end.Services have been performed, but they have not been paid for, as theyhave not even been invoiced yet.Choice "c" is incorrect. If the repair was completed after year end, thenthe expense is not accruable, as the benefit of the services hasn't beenreceived as of year end. The fact that the repair was invoiced prior toyear end does not impact the situation.Choice "a" is incorrect. If a repair was completed and paid for prior toyear end, no accrual is appropriate. On the accrual basis, the expenseis taken in the year the repair is completed and the benefit is received.In this case, the account payable was also paid in the same year, butthis has no effect on the expense.Choice "d" is incorrect. The facts indicate that the work is to becompleted at a date later than year end. Therefore, the expense is notaccruable at year end, as the benefit of the repair hasn't been receivedas of year end. It is reasonable that a signed contract for the repair workexists, but this has no effect on the accrual.

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Question CPA-05538

In the current year Jensen had the following items:

Salary 50,000

Inheritance 25,000

Alimony from ex-spouse 12,000

Child support from ex-spouse 9,000

Capital loss on investment stock sale (6,000)

What is Jensen's AGI for the current year?

a. $59,000b. $62,000c. $84,000d. $44,000

ExplanationChoice "a" is correct. The question asks for AGI, but all of the items inthe list are items of potential gross income. There are no adjustmentsincluded in the list; therefore, in this case, AGI is the same as grossincome. The calculation is as follows:

Salary50,000

Inheritance 0 [not taxable]

Alimony from ex-spouse 12,000

Child support from ex-spouse 0 [not taxable]

Capital loss on investment stock (3,000) [maximum

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sale deductible]

AGI59,000

Choices "d", "b", and "c" are incorrect, per the above calculation.

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Question CPA-05548

Which of the following is subject to the Uniform Capitalization Rules ofCode Sec. 263A?

a. Editorial costs incurred by a freelance writer.b. Mine development and exploration costs.c. Research and experimental expenditures.d. Warehousing costs incurred by a manufacturing company with $12

million in annual gross receipts.

ExplanationChoice "d" is correct. Uniform capitalization rules apply to the following:(1) real or tangible personal property produced by the taxpayer for usein his or her trade or business; (2) real or tangible personal propertyproduced by the taxpayer for sale to his or her customers; and (3) realor tangible personal property acquired by the taxpayer for resale,provided the taxpayer's annual average gross receipts for the precedingthree years exceeds $10,000,000. Warehousing costs incurred by amanufacturing company (making inventory for sale to its customers) aresubject to the Uniform Capitalization Rules. Further, they are the onlyitem on the list that is real or tangible personal property. In this case, theinventory is not acquired for resale (it is produced by the taxpayer forsale to his or her customers), so the fact that the annual sales are$12,000,000 does not matter in this case. The sales could have beenless than $10,000,000 annually, and the Uniform Capitalization Ruleswould still have applied.Choices "a", "c", and "b" are incorrect, based on the above discussion.

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Question CPA-05552

Under the uniform capitalization rules applicable to taxpayers withproperty acquired for resale, which of the following costs should becapitalized with respect to inventory if no exceptions have been met?

Repackagingcosts

Off-sitestorage costs

a. No No

b. Yes Yes

c. No Yes

d. Yes No

ExplanationChoice "b" is correct. Direct material, direct labor, and factory overhead(applicable indirect costs) are capitalized with respect to inventory underthe uniform capitalization rules for property acquired for resale.Applicable indirect costs include depreciation and amortization,insurance, supervisory wages, utilities, spoilage and scrap, designexpenses, repair and maintenance and rental of equipment and facilities(including offsite storage), some administrative costs, costs of bonusand other incentive plans, and indirect supplies and other materials(including repackaging costs).Choices "d", "c", and "a" are incorrect, per the above discussion.

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Question CPA-05969

Chris, age 5, has $3,000 of interest income and no earned income thisyear. Assume the current applicable standard deduction is $950, howmuch of Chris' income will be taxed at Chris' parents' maximum taxrate?

a. $2,050b. $0c. $1,100d. $3,000

ExplanationChoice "c" is correct. The amount of income for a child under 18 that istaxable at the parents' maximum tax rate is deemed the "kiddie tax." Tocalculate the amount that is taxed at the parents' highest rate, take thechild's total interest income ($3,000 in this question) and reduce it by thechild's standard deduction ($950 in this case). The next $950 is thentaxed at the child's rate, and the balance of $1,100 ($3,000 - $950 -$950 = $1,100) is taxed at the parents' highest rate. Choice "b" is incorrect. The $0 indicates that nothing is taxed at theparents' maximum tax rate. Taxing something at the parent's tax rate isthe whole idea of the "kiddie tax."Choice "a" is incorrect. The $2,050 uses only the $950 standarddeduction, but the next $950 would be taxed at the child's rate.Choice "d" is incorrect. The $3,000 indicates that the entire $3,000interest income is taxed at the parents' maximum tax rate.

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Question CPA-05293

Barkley owns a vacation cabin that was rented to unrelated parties for10 days during the year for $2,500. The cabin was used personally byBarkley for three months and left vacant for the rest of the year.Expenses for the cabin were as follows:

Real estate taxes 1,000

Maintenance and utilities 2,000

How much rental income (loss) is included in Barkley's adjusted grossincome?

a. $500b. $0c. $(1,500)d. $(500)

ExplanationRULE: If a vacation residence is rented for less than 15 days per year, itis treated as a personal residence. The rental income is excluded fromincome, and mortgage interest (first or second home) and real estatetaxes are allowed as itemized deductions. Depreciation, utilities, andrepairs are not deductible.Choice "b" is correct. Applying the RULE above, if a vacation residenceis rented for less than 15 days per year, it is treated as a personalresidence. The rental income ($2,500 in this case) is excluded fromincome. A Schedule E is not filed for this property (i.e., no income isreported, the taxes are reported as itemized deductions, and themaintenance and utilities are not deductible), so the effect on AGI iszero.Choice "a" is incorrect. This assumes that the property taxes arereported as itemized deductions but that the rental income ($2,500) lessthe maintenance and utilities ($2,000) are reported net on Schedule E.

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Per the above RULE, the rental income is excluded from income, andthe maintenance and utilities are not deductible.Choice "d" is incorrect. This assumes that all of the items shown arereported net on the Schedule E-$2,500 - $1,000 - $2,000 = ($500). Perthe above RULE, the rental income is excluded from income, themaintenance and utilities are not deductible, and the property taxes arereported on Schedule A as an itemized deduction.Choice "c" is incorrect, per the above RULE and discussion.

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Question CPA-02141

In a tax year where the taxpayer pays qualified education expenses,interest income on the redemption of qualified U.S. Series EE Bondsmay be excluded from gross income. The exclusion is subject to amodified gross income limitation and a limit of aggregate bond proceedsin excess of qualified higher-education expenses. Which of the followingis (are) true?

I. The exclusion applies for education expenses incurred by thetaxpayer, the taxpayer's spouse, or any person whom thetaxpayer may claim as a dependent for the year.

II. "Otherwise qualified higher-education expenses" must bereduced by qualified scholarships not includible in gross income.

a. I only.b. II only.c. Both I and II.d. Neither I nor II.

ExplanationChoice "c" is correct. Both I and II are true per the following rule.Rule: Qualified higher education expenses are tuition and fees requiredfor the enrollment or attendance of the taxpayer, the taxpayer's spouse,or any dependent for whom the taxpayer is allowed a dependencyexemption, at an eligible educational institution.The expenses otherwise taken into account must be reduced by thetotal amounts received for excludable qualified scholarships, certaineducational assistance allowances, and other tax-exempt payments(other than gifts, bequests, devises, or inheritances).

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Question CPA-06013

Kant, a cash-basis individual, owns and operates an office building.Kant received the following payments during the current year:

Current rents 30,000

Advance rents for the next year 10,000

Security deposits held in a segregated account 5,000

Lease cancellation payments 15,000

What amount is included in gross income?

a. $60,000b. $55,000c. $30,000d. $40,000

ExplanationRule: The basic formula for determination of net rental income or lossfollows:

Gross rental income

Prepaid rental income

Rent cancellation payments

Improvements in lieu of rent

(Rental expenses)

Net rental income (loss)

If security deposits are held separately and not available to be applied

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to last month's rent (as in a segregated account), they are a liability ofthe taxpayer and not included in income in the year received.Choice "b" is correct. The calculation of gross income for the yearfollows:

Current rents 30,000

Advance rents for the next year 10,000

Security deposits held in a segregated account

Lease cancellation payments 15,000

Gross income from the rental activity 55,000

Choice "c" is incorrect. This answer option incorrectly includes only thecurrent rents as part of gross income, when advance rents and leasecancellation payments also must be included.Choice "d" is incorrect. This answer option incorrectly includes only thecurrent rents and the advance rents as part of gross income, whenlease cancellation payments also must be included.Choice "a" is incorrect. This answer option incorrectly includes all of thepayments collected for the rental activity in the year, when the securitydeposits that are held in a segregated account are excluded from grossincome.

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Question CPA-06018

An individual received $50,000 during the current year pursuant to adivorce 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 inthe individual's gross income?

a. $25,000b. $0c. $40,000d. $50,000

ExplanationRules: Payments for the support of a spouse are income to the spousereceiving the payments and are deductible to arrive at adjusted grossincome by the contributing spouse. Child support is not taxable.Property settlements are not taxable.Choice "a" is correct. Only the $25,000 in alimony is included in thegross income of the receiving spouse.Choice "d" is incorrect. This answer option incorrectly includes all of thepayments received in the year. The child support ($10,000) and theproperty settlement ($15,000) are NOT included in the gross income ofthe receiving spouse.Choice "c" is incorrect. This answer option incorrectly includes thepayments received in the year for alimony and property settlement forthe year [$25,000 + $15,000 = $40,000]. The property settlement($15,000) is NOT included in the gross income of the receiving spouse.Choice "b" is incorrect. The amount received for alimony ($25,000) isincluded in the gross income of the receiving spouse.

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Question CPA-01806

Which one of the following statements is correct with regard to anindividual taxpayer who has elected to amortize the premium on a bondthat yields taxable interest?

a. The amortization is not treated as a reduction of taxable income.b. The bond's basis is increased by the amortization.c. The amortization is treated as an itemized deduction.d. The bond's basis is reduced by the amortization.

ExplanationChoice "d" is correct. The bond's basis is reduced by the amortization ofthe premium.Choice "c" is incorrect. For bonds acquired after 12/31/87, theamortization of the premium is an offset to interest income on the bondrather than a separate interest deduction.Choice "a" is incorrect. The amortization of the premium will reducetaxable income.Choice "b" is incorrect. The bond's basis will be decreased by theamortization.

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Question CPA-01859

For a cash basis taxpayer, gain or loss on a year-end sale of listed stockarises on the:

a. Trade date.b. Date of delivery of stock certificate.c. Date of receipt of cash proceeds.d. Settlement date.

ExplanationChoice "a" is correct. Trade date.Gain or loss on a year-end sale of listed stock arises on the trade date.Rule: Whether on the cash or accrual method of accounting taxpayerswho sell stock or securities on an established securities market mustrecognize gains and losses on the trade date, rather than on thesettlement date.Choices "d", "c", and "b" are incorrect, per the above rule.

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Question CPA-06515

Lane, a single taxpayer, received $160,000 in salary, $15,000 in incomefrom an S Corporation in which Lane does not materially participate,and a $35,000 passive loss from a real estate rental activity in whichLane materially participated. Lane's modified adjusted gross incomewas $165,000. What amount of the real estate rental activity loss wasdeductible?

a. $35,000b. $15,000c. $0d. $25,000

ExplanationRule: Passive activity is any activity in which the taxpayer does notmaterially participate. A net passive activity loss generally may not bededucted against other types of income (e.g., wages, other ordinary oractive income, portfolio income (interest and dividends), or capitalgains). In other words, passive losses may generally only offset passiveincome for a tax year-the remaining net loss is generally "suspended"and carried forward to a year when it may be used to offset passiveincome (or when the final disposition of the property occurs). However,there is an exception (the "mom and pop exception," as we refer to it inthe textbooks) to this general rule. Taxpayers who own more than 10%of the rental activity, have modified AGI under $100,000, and haveactive participation (managing the property qualifies), may deduct up to$25,000 annually of net passive losses attributable to real estate. Thereis a phase-out provision for modified AGI from $100,000 $150,000,and the deduction is completely phased-out for modified AGI in excessof $150,000.Choice "b" is correct. Per the above rule, unless an exception exists(and it does not in this case, as Lane's modified adjusted gross incomeis in excess of $150,000), passive losses may only offset passiveincome for a tax year (i.e., no "net loss" may exist). In this case, Lanehas a $20,000 net loss from passive activity [$15,000 S Corporationincome (passive, in this case because the facts state Lane does not

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materially participate) minus the $35,000 rental real estate loss]. Thus,only $15,000 of the passive loss from real estate rental activity may beused to offset the $15,000 income from the S Corporation. Theremaining $20,000 passive activity loss is carried forward to be used infuture years.Choice "c" is incorrect. Per the above rule, passive losses maygenerally only offset passive income for a tax year. Lane has passiveincome of $15,000 in the year; thus, passive loss up to $15,000 may bededucted from passive income. Choice "d" is incorrect. This answer option is an attempt to confuse thecandidate into using the "mom and pop" exception, which applies whentaxpayers who actively participate, own more than 10% of the rentalactivity, and have modified AGI under $100,000 are able to deduct up to$25,000 annually of net passive losses attributable to real estate. Thereis a phase-out provision for modified AGI from $100,000 $150,000,and the deduction is completely phased-out for modified AGI in excessof $150,000. In this case, the facts state that Lane's modified adjustedgross income is $165,000; thus, Lane does not qualify to use theexception.Choice "a" is incorrect. This answer option assumes that the full amountof the rental real estate loss is deductible against the passive incomefrom the S Corporation, and, thus, against Lane's other taxable income.As indicated in the rule above, unless an exception applies (it does notin this case), a net passive activity loss may not be deducted againstother types of income (e.g., wages, other ordinary or active income,portfolio income (interest and dividends), or capital gains). Thus, the full$35,000 rental real estate loss is not deductible in the year by Lane.

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Question CPA-06008

A 33-year-old taxpayer withdrew $30,000 (pretax) from a traditional IRA.The taxpayer has a 33% effective tax rate and a 35% marginal tax rate.What is the total tax liability associated with the withdrawal?

a. $13,000b. $10,500c. $13,500d. $10,000

ExplanationRule: Generally, unless an exception applies, retirement money cannotbe withdrawn until the individual reaches the age of 59 . If retirementmoney (without an exception) is withdrawn before the age of 59 , thepremature distribution is subject to a 10% penalty tax (in addition to theapplicable regular income tax that applies to all distributions oftraditional IRA money).Choice "c" is correct. The taxpayer is under the age of 59 , and thefacts do not indicate that an exception applies; therefore, the taxpayer issubject to the 10% penalty on the IRA distribution in addition to theregular income tax. The regular income tax that applies is the marginalrate (the rate for the next dollar of taxable income). The effective taxrate is simply the total tax divided by the total taxable income. In thiscase, the taxpayer would have to pay the regular tax on the distributionat the 35% marginal rate PLUS the 10% penalty on early distributionwithout an exception. The calculation to arrive at the total tax associatedwith the withdrawal follows:

Regular Income Tax 30,000

35% 10,500

Penalty Tax 30,000

10% 3,000

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Choice "d" is incorrect. This answer option assumes the effectiveincome tax rate (rounded, assuming 33.33%) applied to the $30,000distribution. It uses the incorrect tax rate (the marginal rate should beused) and omits the inclusion of the applicable 10% penalty tax.[$30,000 33.33% = $10,000]Choice "b" is incorrect. This answer option includes the $30,000distribution multiplied by the (proper) marginal tax rate, but it omits theinclusion of the applicable 10% penalty tax. [$30,000 35% = $10,500]Choice "a" is incorrect. This answer option assumes the effectiveincome tax rate (rounded, assuming 33.33%) applied to the $30,000distribution plus the applicable 10% penalty tax [($30,000 33.33%) +($30,000 10%) = $13,000]. It uses the incorrect tax rate (the marginalrate should be used).

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Question CPA-06531

Which of the following should be included when determining adjustedgross income?

a. Compensation for injuries or sickness.b. Rental value of parsonages.c. Alimony received.d. Tuition scholarship.

ExplanationRule: IRC Sections 71, 62, and 215 control the taxation of alimony.Payments for the support of a spouse (a

2014 REG 1 Practice Q A

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