2010 AICPA newly released questions – regulation

Solution: Rule: Per IRC Section 706b, a partnership tax year must have the same taxable year as the common taxable year of the partners that, in the aggregate, have interest greater th

Following are multiple choice questions recently released by the AICPA These

questions were released by the AICPA with letter answers only Our editorial board has provided the accompanying explanation

Please note that the AICPA generally releases questions that it does NOT intend to use again These questions and content may or may not be representative of questions you may see on any upcoming exams

1

What defense must an accountant establish to be absolved from civil liability under Section 18 of the Securities Exchange Act of 1934 for false or misleading statements made in reports or documents filed under the Act?

a Lack of gross negligence

b Exercise of due care

c Good faith and lack of knowledge of the statement's falsity

d Lack of privity with an injured party

Solution:

Choice "c" is correct Section 18 of the Securities Exchange Act of 1934 imposes civil liability on persons who intentionally make false statements in a registration statement or any other document required to be filed under the act Since the act proscribes only intentional misconduct, lack of intent to deceive is a defense Good faith and lack of knowledge of the statement's falsity would show that the false or

misleading statement was not made with an intent to deceive

Choice "a" is incorrect Lack of gross negligence sets the bar too high for the defense Gross negligence can be proved through reckless conduct Under section 18, liability cannot be imposed merely because the CPA acted recklessly

Choice "b" is incorrect Due care is the standard for negligence It is a much higher standard of care than

is required under section 18 Under section 18, a CPA need not prove that he or she was careful; only that he or she did not intentionally deceive

Choice "d" is incorrect Privity (e.g., a contractual relationship) is not a requirement of a section 18 cause

of action Therefore, lack of privity is not a defense

2

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a Gem will win because the contract was executory

b Gem will win because the contract was for services not goods

c Gem will lose because the contract could not be performed within one year

d Gem will lose because the contract required payment of more than $500

Solution:

Choice "c" is correct As a general rule, under the statute of frauds, a contract that cannot be performed within one year from the time of its making is unenforceable absent proof of its material terms in a writing signed by the party being sued Here, the contract by its terms could not be performed within a year from the time it was made and Gem cannot prove the material terms of the contract through a writing signed by Mason Therefore, Gem would lose its breach of contract action

Choice "a" is incorrect The statute of frauds requires proof of the material terms of certain contracts to

be evidenced by a writing signed by the party being sued There is an exception to the statute if the contract has been executed Since the contract here is executory, the exception does not apply, so Gem will lose (not be able to enforce the contract) rather than win because the contract is executory

Choice "b" is incorrect The statute of frauds applies to contract other than contracts for the sale of goods It applies to a service contract if by its terms it cannot be performed within a year Thus, the fact that the contract here is for services rather than goods is not a reason for Gem to win the law suit to enforce the agreement with Mason Gem will lose because the statute of frauds applies and Gem does not have a writing signed by Mason that sets out the material terms of the agreement

Choice "d" is incorrect The $500 threshold is not relevant to the contract here That threshold applies to contracts for the sale of goods The contract here is for services What matters for service contracts is whether or not they can be performed within a year of their making If they cannot, such as the contract here, they are within the statute of frauds regardless of the price involved

Choice "a" is incorrect A convertible bond is a corporate bond that may be converted into stock It has nothing to do with the obligations of a surety

Choice "b" is incorrect A debenture bond is simply an unsecured corporate bond It has nothing to do with the obligations of a surety

Choice "c" is incorrect A municipal bond is a bond issued by a city or other local government It has nothing to do with the obligations of a surety

4

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5

A calendar-year individual filed an income tax return on April 1 This return can be amended no later

than:

a Four months and 15 days after the end of the calendar year

b Ten months and 15 days after the end of the calendar year

c Three years, three months, and 15 days after the end of the calendar year

d Three years after the return was filed

Solution:

Rule: An individual may file an amended tax return (Form 1040X) within three (3) years of the date the

original return was filed or within two (2) years of the date the tax was paid, whichever is later An original return filed early is considered filed on the due date of the return

Choice "c" is correct In this question, the return was filed early (April 1), so the return is considered filed

on April 15 There is no information on when the tax was paid, but it can be reasonably assumed that the tax was properly paid on April 1 with the return So the latter of the two dates is three years The

question that arises is "three years from when," and here the question falls somewhat short

Three of the answers to this question are worded in terms of "the" calendar year These answers have to mean the prior calendar year Three years from April 15 (when the return was considered to be filed) would be three years, three months, and 15 days from the end of the prior calendar year

Choice "a" is incorrect The date is not four months and 15 days after the end of the (prior) calendar year This answer ignores the three years It appears to be trying to trick candidates into thinking that April is four months However, that would mean that the last day that an amended return could be filed was the date of the filing of the original return

Choice "b" is incorrect The date is not ten months and 15 days after the end of the (prior) calendar year Choice "d" is incorrect The date is not three years after the (original) return was filed This answer looks good at first glance, but note that the return was actually filed on April 1 The Rule above considers an original return filed early to be filed on the due date of the return However, the answer says "after the return was filed" and not "after the return was considered to be filed."

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c A tax year of one or more partners with a more than 50% interest in profits and capital

d A tax year of a principal partner having a 10% or greater interest

Solution:

Rule: Per IRC Section 706(b), a partnership tax year must have the same taxable year as the common

taxable year of the partners that, in the aggregate, have interest greater than 50%, which is determined based on the "testing day," the first day of the partnership's tax year (not considering the majority interest rule) Note: After a change is made to the "majority-interest" tax year end, the partnership does not have

to change to another tax year for two years following the year of change Exceptions to the rule exist (1)

If there is no "majority-interest" tax year, then the tax year is the tax year of all of the principal partners of the partnership (those owning 5% or more of the income or capital of the partnership) (2) If the

partnership is still unable to determine a tax year using the general rule or the first exception, then the tax

year that causes the least aggregate deferral of income to the partners must be adopted

Choice "c" is correct In the absence of election to adoption of an annual accounting period, the required tax year for a partnership would be the tax year of one or more partners who have an aggregate of more than 50% interest in profits and capital, per the majority interest rule This is the BEST answer to the question

Choice "a" is incorrect If there is no "majority-interest" tax year, then the tax year is the tax year of all of the principal partners of the partnership (those owning 5% or more of the income or capital of the

partnership) If the partnership is still unable to determine a tax year using the general rule or the first

exception, then the tax year that causes the least (not the greatest) aggregate deferral of income to the partners must be adopted

Choice "b" is incorrect A partnership may be able to avoid the rules above if it has a business purpose for selecting a different tax year and if this can be established with the IRS In this case, a calendar year (assuming it is not already required because it coincides with the general rule or the exceptions identified above) may be used Of course, while this answer may be correct in some circumstances, it is not the BEST answer to the question

Choice "d" is incorrect If there is no "majority-interest" tax year, then the tax year is the tax year of all of the principal partners of the partnership (those owning 5% or more of the income or capital of the

partnership) Note that this is the second-best answer, but it only applies if answer option "c" is not available

7

In the current year Tatum exchanged farmland for an office building The farmland had a basis of

$250,000, a fair market value (FMV) of $400,000, and was encumbered by a $120,000 mortgage The office building had an FMV of $350,000 and was encumbered by a $70,000 mortgage Each party assumed the other's mortgage What is the amount of Tatum's recognized gain?

Rule: Per IRC Section 1031, non-recognition treatment is accorded to a like-kind exchange of property

used in a trade or business "Like-kind" exchanges include exchanges of business property for business property, where like-kind is interpreted very broadly and refers to the nature or character of the property and not to its grade or quality

Choice "b" is correct The exchange in this question qualifies for Section 1031 treatment since the exchange appears to be business property for business property However, the boot involved in the exchange (the mortgages) must be taken into account to determine the recognition or non-recognition of the gain realized on the exchange In this transaction, the total consideration received by Tatum is the FMV of the property received of $350,000 plus the mortgage of $120,000 that was assumed by the other party, for a total of $470,000 The adjusted basis of the property given up was $250,000, and there is also $70,000 of mortgage given up by the other party (and assumed by Tatum), for a total of $320,000 The realized gain is thus $470,000 – $320,000 = $150,000 The recognized gain will be the lesser of realized gain or net boot received The $120,000 of mortgage given up (and assumed by the other party)

is treated as boot received, and the $70,000 of mortgage assumed is treated as boot given up The net is

$50,000 of boot received The $50,000 of boot received is the recognized gain The treatment is

somewhat the same as if cash/boot had been received in the transaction

Choice "a" is incorrect Gain is recognized due to the net boot received

Choice "c" is incorrect The $100,000 is the amount of realized gain being deferred, not the recognized gain

Choice "d" is incorrect The $150,000 is the realized gain However, it is not the recognized gain

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8

Danielson invested $2,000,000 in DEC, a qualified small business corporation Six years later, Danielson sold all of the DEC stock for $16,000,000, and purchased an office building with the proceeds Danielson had not previously excluded any gain on the sale of small business stock What is Danielson's taxable gain after the exclusion?

Rule: Per IRC Section 1202, a non-corporate taxpayer can exclude from gross income (and thus taxable

income) 50% of any gain from the sale of exchange of qualified small business stock held for more than 5 years There are all sorts of special rules including special rules for property acquired between 2009 and

2011, but the rule stated is the general rule

Choice "c" is correct DEC is a qualified small business corporation and the stock has been held by Danielson for more than 5 years Danielson is not a corporation The realized gain on the sale of the stock is $14,000,000 ($16,000,000 – $2,000,000) The amount of this gain that is excluded from gross income is 50% of the $14,000,000, or $7,000,000 That means that $7,000,000 of the gain is taxable Choice "a" is incorrect A percentage (normally 50%) of the gain from the sale of qualified small business corporation stock can be excluded from gross income by a non-corporate taxpayer

Choice "b" is incorrect, per the above explanation

Choice "d" is incorrect, per the above explanation

9

Robbe, a cash basis single taxpayer, reported $50,000 of adjusted gross income last year and claimed itemized deductions of $5,500, consisting solely of $5,500 of state income taxes paid last year Robbe's itemized deduction amount, which exceeded the standard deduction available to single taxpayers for last year by $1,150, was fully deductible and it was not subject to any limitations or phase-outs In the current year, Robbe received a $1,500 state tax refund relating to the prior year What is the proper treatment of the state tax refund?

a Include none of the refund in income in the current year

b Include $1,150 in income in the current year

c Include $1,500 in income in the current year

d Amend the prior-year's return and reduce the claimed itemized deductions for that year

Solution:

Rule: IRC Section 111 provides that gross income does not include income attributable to the recovery

during the taxable year of any amount deducted in any prior taxable year to the extent such amount did

not reduce the amount of tax previously imposed (the tax benefit rule)

Choice "b" is correct Under the tax benefit rule, an itemized deduction recovered in a subsequent year is included in income in the year recovered In this question, only $1,150 of the state income taxes was actually deducted as an itemized deduction last year The recovery is thus limited in the amount actually deducted (and not to the entire amount of the state tax refund)

Choice "a" is incorrect The amount deducted, not $0, is included in income in the current year

Choice "c" is incorrect The amount originally deducted, not necessarily the entire amount of the refund,

is included in income in the current year

Choice "d" is incorrect The amount deducted is included in income in the current year There is no necessity to amend the prior year's return

10

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10

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

Rule: Passive activity is any activity in which the taxpayer does not materially participate A net passive

activity loss generally may not be deducted against other types of income (e.g., wages, other ordinary or

active income, portfolio income (interest and dividends), or capital gains) In other words, passive losses may generally only offset passive income for a tax year—the remaining net loss is generally "suspended" and carried forward to a year when it may be used to offset passive income (or when the final disposition

of the property occurs) However, there is an exception (the "mom and pop exception," as we refer to it in the textbooks) to this general rule Taxpayers who own more than 10% of the rental activity, have

modified AGI under $100,000, and have active participation (managing the property qualifies), may deduct up to $25,000 annually of net passive losses attributable to real estate There is a phase-out provision for modified AGI from $100,000 - $150,000, and the deduction is completely phased-out for modified AGI in excess of $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 income is in excess of $150,000), passive losses may only offset passive income for a tax year (i.e., no "net loss" may exist) In this case, Lane has a $20,000 net loss from passive activity [$15,000 S Corporation income (passive, in this case because the facts state Lane does not materially participate) minus the $35,000 rental real estate loss] Thus, only $15,000 of the passive loss from real estate rental activity may be used to offset the $15,000 income from the S Corporation The remaining $20,000 passive activity loss is carried forward to be used in future years

Choice "a" is incorrect Per the above rule, passive losses may generally only offset passive income for a tax year Lane has passive income of $15,000 in the year; thus, passive loss up to $15,000 may be deducted from passive income

Choice "c" is incorrect This answer option is an attempt to confuse the candidate into using the "mom and pop" exception, which applies when taxpayers who actively participate, own more than 10% of the rental activity, and have modified AGI under $100,000 are able to deduct up to $25,000 annually of net passive losses attributable to real estate There is a phase-out provision for modified AGI from $100,000

- $150,000, and the deduction is completely phased-out for modified AGI in excess of $150,000 In this case, the facts state that Lane's modified adjusted gross income is $165,000; thus, Lane does not qualify

11

Which of the following disqualifies an individual from the earned income credit?

a The taxpayer's qualifying child is a 17-year-old grandchild

b The taxpayer has earned income of $5,000

c The taxpayer's five-year-old child lived in the taxpayer's home for only eight months

d The taxpayer has a filing status of married filing separately

Solution:

Rules: Earned income tax credit is a refundable tax credit It is designed to encourage low-income

workers (i.e., those with earned income) to offset the burden of U.S tax A claimant can have one

qualifying child or two or more qualifying children for this credit There is a maximum credit available for this purpose Further:

• The taxpayer must meet certain earned low-income thresholds

• The taxpayer must not have more than the specified amount of disqualified income

• The taxpayer must be over age 25 and less than 65 if there are no qualifying children

• If married, the taxpayer must generally file a joint return with his/her spouse (i.e., the married filing separate status disqualifies a taxpayer from claiming the earned income credit)

• A qualifying child can be up to and including age 18 at the end of the tax year, provided the child shared a residence with the taxpayer for 6 months or more

• The taxpayer must be related to the qualifying child (or children) through blood, marriage, or law

• The child must be either in the same generation or a later generation of the taxpayer

• A foster child qualifies if officially placed with the taxpayer by an agency

Choice "d" is correct Per the above rules, the filing status of married filing separately disqualifies a taxpayer from claiming the earned income credit

Choice "a" is incorrect If the taxpayer's qualifying child is a 17-year-old grandchild, the requirement of age and relation is satisfied, and the taxpayer may qualify to claim the EIC

Choice "b" is incorrect The taxpayer earning an income of $5,000 meets the earned low-income

requirements; thus, it does not disqualify him or her from claiming the EIC

Choice "c" is incorrect The taxpayer's five year old child lived in the taxpayer's home for eight months The above rules indicate that the otherwise qualifying child must live with the taxpayer for six or more months; thus, this fact does not disqualify the taxpayer from claiming the EIC

12

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12

Which of the following can be an advantage of a limited liability company over an S corporation?

a Double taxation of profits is avoided

b Owners receive limited liability protection

c Appreciated property can be distributed tax-free to an owner

d Incentive stock options can be used to compensate owners

Solution:

Rule: IRC Section 311 controls the taxability of corporate distributions An S corporation (and a C

corporation) recognizes a gain on any distribution of appreciated property (a property dividend) in the same manner as if the asset had been sold to the shareholder at its fair market value

Choice "c" is correct An S corporation cannot distribute appreciated property to its shareholders without gain In general, a partnership can distribute appreciated property tax-free to its partners (in general, a non liquidating distribution to a partner is nontaxable) Since a limited liability company (LLC) is taxed like

a partnership (an LLC properly structured and with two or more owners is taxed like a limited partnership with no general partners), a limited liability company can distribute appreciated property to its owners tax-free

Choice "a" is incorrect A limited liability company is a hybrid business entity that combines the corporate characteristic of limited liability for the owners with the tax characteristics of a partnership With a

partnership, there is no double taxation of profits Neither is there with a limited liability company There

is no advantage for a limited liability company over an S corporation here

Choice "b" is incorrect Owners receive limited liability protection with both an S corporation and a limited liability company so there is no advantage for a limited liability company over an S corporation here Choice "d" is incorrect Incentive stock options can be used to compensate owners with both an S corporation and a limited liability company There is no entity restriction for these stock options, other than that they can be granted only by corporations There is no advantage for a limited liability company over an S corporation here

13

Quigley, Roberk, and Storm form a corporation Quigley exchanges $25,000 of legal fees for 30 shares

of stock Roberk exchanges land with a basis of $10,000 and a fair market value of $100,000 for 60 shares of stock Storm exchanges $10,000 cash for 10 shares of stock What amount of income should each shareholder recognize?

Quigley Roberk Storm

Rule: IRC Section 351 controls the taxation of transfers to controlled corporations No gain or loss is

recognized to the transferors/shareholders on the property transferred if certain conditions are satisfied Choice "b" is correct The transaction in this question does not satisfy the conditions of Section 351, and gain or loss can be recognized for each of the shareholders For Section 351 to apply, the shareholders contributing property, including cash, must own, immediately after the transaction, at least 80% of the voting stock and at least 80% of the nonvoting stock of the corporation A shareholder who contributes only services (Quigley in this question) is not counted as part of the control group Thus, only Roberk and Storm are counted, and they together own only 70 shares out of the 100 shares (70%) The $25,000 of legal fees to Quigley is compensation for services rendered and is recognized as income by Quigley A gain of $90,000 (the fair market value of the land of $100,000 – its adjusted basis of $10,000) is

recognized to Roberk Storm bought shares for cash and has no gain

Choice "a" is incorrect This is what would happen if Section 351 applies to all of the

14

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Rule: IRC Section 1366 controls the pass-through of S corporation income items to shareholders In

general, items are divided into separately stated items (items that could potentially affect the tax liability of the shareholders) and non-separately stated items Non-separately stated items are lumped together and constitute the S corporation's ordinary income Separately stated items are passed through to the

shareholders (in a manner similar to partnerships) and retain their tax attributes to the shareholders Choice "c" is correct Tap's ordinary income is calculated as follows:

Choice "a" is incorrect The $13,000 would include both the long-term capital loss and the charitable contributions

Choice "b" is incorrect The $19,000 would include the long-term capital loss but not the charitable contributions

Choice "d" is incorrect The $24,000 would not include the interest expense

15

During the current year, a trust reports the following information:

Dividends $10,000

Tax-exempt interest from state bonds 4,000

Capital gain (allocated to corpus) 2,000

Trustee fee (allocated to corpus) 6,000

What is the trust's accounting income?

Interest from corporate bonds 12,000

Tax-exempt interest from state bonds 4,000

The capital gain and trustee fee are not included in the trust's income since they are both allocated to corpus

Choice "a" is incorrect The $22,000 would not include the tax-exempt interest

Choice "c" is incorrect The $28,000 would include the capital gain, which is allocated to corpus

Choice "d" is incorrect The $34,000 would include the capital gain and the trustee fee, both of which are allocated to corpus

16

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16

Mackenzie is the grantor of a trust over which Mackenzie has retained a discretionary power to receive income Kelly, Mackenzie's child, receives all taxable income from the trust unless Mackenzie exercises the discretionary power To whom is the income earned by the trust taxable?

a To the trust to the extent it remains in the trust

b To Mackenzie because he has retained a discretionary power

c To Kelly as the beneficiary of the trust

d To Kelly and Mackenzie in proportion to the distributions paid to them from the trust

Solution:

Rule: IRC Sections 671-679 control the taxation of grantor trusts when the grantor of the trust retains the

beneficial enjoyment or substantial control over the trust property or income In that case, the grantor is taxed on the trust income The trust is disregarded for income tax purposes The grantor is taxed on the income if he/she retains (1) the beneficial enjoyment of the corpus or (2) the power to dispose of the trust income without the approval or consent of any adverse party

Choice "b" is correct Income earned by the grantor trust is taxable to the grantor (Mackenzie) since he/she retained discretionary power to receive the taxable income from the trust The fact that the

discretionary power may not actually be exercised is irrelevant

Choice "a" is incorrect Income earned by a grantor trust is taxable even if it is not distributed by the trust Choice "c" is incorrect Income earned by a grantor trust is taxable to the grantor of the trust, not to the beneficiary, basically to the extent that the grantor has retained discretionary power to receive the taxable income from the trust

Choice "d" is incorrect Income earned by a grantor trust is not allocated to the grantor (Mackenzie) and the beneficiary (Kelly) of the trust based on the amount of distributions paid to the parties

17

Lawson, a CPA, discovers material noncompliance with a specific Internal Revenue Code (IRC)

requirement in the prior-year return of a new client Which of the following actions should Lawson take?

a Wait for the statute of limitations to expire

b Discuss the requirements of the IRC with the client and recommend that client amend the return

c Contact the IRS and discuss courses of action

d Contact the prior CPA and discuss the client's exposure

Solution:

Choice "b" is correct The CPA should notify the client concerning the noncompliance and recommend the proper course of action

Choice "a" is incorrect The CPA is required to notify and discuss the situation with the client

Choice "c" is incorrect The CPA must discuss the situation with the client and is barred from contacting the IRS without the client's permission

Choice "d" is incorrect, per the above explanation

18

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18

Able, CPA, was engaged by Wedge Corp to audit Wedge's financial statements Wedge intended to use the audit report to obtain a $10 million loan from Care Bank Able and Wedge's president agreed that Able would give an unqualified opinion on Wedge's financial statements in the audit report even though there were material misstatements in the financial statements Care refused to make the loan Wedge then gave the audit report to Ranch to encourage Ranch to purchase $10 million worth of Wedge

common stock Ranch reviewed the audit report and relied on it to purchase the stock After the

purchase, Able's agreement with Wedge's president was revealed As a result, Wedge stock lost half its value and Ranch sued Able for fraud What will be the result of Ranch's suit?

a Ranch will win because Able intentionally gave an unqualified opinion on Wedge's materially

misstated financial statements

b Ranch will win because Able is strictly liable for errors made in auditing Wedge's financial statements

c Ranch will lose because Ranch is not a foreseen user of Able's audit report

d Ranch will lose because Ranch is not in privity with Able

Solution:

Choice "a" is correct This question is about to whom a CPA owes a duty A CPA's duties are broadest with regard to fraud A duty to refrain from fraud is owed to anyone who can make out the elements of a fraud case (misrepresentation, intent to deceive, reliance, intent to induce reliance, and damages) Because Able intentionally made the false statement and Ranch was harmed as a result, Ranch can hold Able liable for his damages

Choice "b" is incorrect A CPA is not strictly liable for misstatements in financial statements; the CPA must be at least negligent in order to have any liability in most cases

Choice "c" is incorrect It does not matter whether or not Ranch was a foreseen user of the audit report because the action here is for fraud If the action were for negligence, foreseeability would limit Able's liability

Choice "d" is incorrect It does not matter whether or not Ranch was in privity of contract with Able A CPA's liability for fraud (or even for negligence in most states) is not limited to those with whom the CPA

is in privity

19

Which of the following terms best describes the relationship between a corporation and the CPA it hires to audit corporate books?

a Employer and employee

b Employer and independent contractor

c Master and servant

d Employer and principal

Solution:

Choice "b" is correct An employer/independent contractor relationship arises when an employer hires someone to do a job but does not have control over the manner in which the work is performed In performing and audit, a CPA must have independence with regard to how the audit is performed Thus,

an employer/independent contractor relationship arises

Choice "a" is incorrect An employer has control over the manner in which an employee performs his work An employer does not have control over the methods that a CPA uses to perform an audit Thus, the CPA is an independent contractor rather than an employee

Choice "c" is incorrect Master/servant is older terminology for employer/employee Thus, this choice is wrong for the same reason that choice b is wrong

Choice "d" is incorrect An employer is a principal In an agency, there must be both a principal and an agent There cannot be a principal/principal relationship

20

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20

Card communicated an offer to sell Card's stereo to Bend for $250 Which of the following statements is correct regarding the effect of the communication of the offer?

a Bend should immediately accept or reject the offer to avoid liability to Card

b Card is not obligated to sell the stereo to Bend until Bend accepts the offer

c Card is required to mitigate any loss Card would sustain in the event Bend rejects the offer

d Bend may not reject the offer for a reasonable period of time

Solution:

Choice "b" is correct In order to form a contract, there must be at least an offer, an acceptance, and consideration Card's communication is an offer The stereo and the $250 would be the consideration for the contract here But, Card will not be bound until Bend accepts the offer

Choice "a" is incorrect As a general rule, silence cannot constitute an acceptance, and Bend cannot be liable on a contract until it is accepted If Bend remains silent, no contract is formed and Bend has no liability

Choice "c" is incorrect Card owes no contractual duties to Bend until Bend has accepted Card's offer Thus, there is no duty to mitigate here

Choice "d" is incorrect An offeree may reject an offer at any time

21

Worker's compensation benefits are available to which of the following parties?

a Only those employees injured while working on workplace premises

b Only those employees injured while working within the scope of employment

c All agents injured while commuting to and from work

d All agents injured while using the employer's automobile for personal use

Choice "c" is incorrect This choice is wrong for two reasons: worker's compensation covers only

employees ("agent" is broader) and, in most cases, commuting to and from work is not within the scope of

employment

Choice "d" is incorrect This choice also is wrong for two reasons: again, not all agents are employees and so not all agents are covered, and use of one's automobile for personal purposes is not within the scope of employment

22

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22

Under the Negotiable Instruments Article of the UCC, which of the following statements is correct regarding a check?

a A check is a promise to pay money

b A check is an order to pay money

c A check does not need to be payable on demand

d A check does not need to be drawn on a bank

Solution:

Choice "b" is correct A check is a type of draft with two particular characteristics, namely drawn on a

bank and payable on demand A draft is order paper (a drawer orders the drawee to pay money to a

23

A tax preparer has advised a company to take a position on its tax return The tax preparer believes that there is a 75% possibility that the position will be sustained if audited by the IRS If the position is not sustained, an accuracy-related penalty and a late-payment penalty would apply What is the tax

preparer's responsibility regarding disclosure of the penalty to the company?

a The tax preparer is responsible for disclosing both penalties to the company

b The tax preparer is responsible for disclosing only the accuracy-related penalty to the company

c The tax preparer is responsible for disclosing only the late-payment penalty to the company

d The tax preparer has no responsibility for disclosing any potential penalties to the company, because

the position will probably be sustained on audit

Solution:

Choice "a" is correct This position passes the realistic possibility standard, and it is proper for the tax preparer to recommend it to the client However, the tax preparer is required to notify the client of all possible penalties in the event that the position is not sustained

Choice "b" is incorrect, per the above rule

Choice "c" is incorrect, per the above rule

Choice "d" is incorrect, per the above rule

24

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Rule: IRC Section 267 controls the nonrecognition of realized losses on sales or exchanges of property to

related parties The most common related parties for individual taxpayers are members of a family (although there are certainly many other examples)

Choice "b" is correct The loss realized on the transaction by Terry is $4,000 ($8,000 – $12,000).This transaction appears to qualify under Section 267 "Relative" is not defined in the question Section 267 limits "family" to brothers and sisters, spouse, ancestor, and lineal descendants However, the definition

of relative is really irrelevant if the question is read closely The question wants to know the relative's gain

or loss, not Terry's gain or loss Since all the relative did to this point was to buy the stock, the relative has no gain or loss

Choice "a" is incorrect, per the above explanation

Choice "c" is incorrect, per the above explanation

Choice "d" is incorrect, per the above explanation

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Winkler, a CPA, provided accounting services to a client, Thompson On December 15 of the same year, Thompson gave Winkler 100 shares of Foster Corp as compensation for services The adjusted basis of the stock was $4,000, and its fair market value at the time of transfer was $5,000 Two months later, Winkler sold the stock on February 15 for $7,500 What is the amount that Winkler should recognize as gain on the sale of stock?

Choice "a" is incorrect There is gain on the sale, effectively in the amount of the increase in fair market value between the date of the transfer and the date of the sale

Choice "b" is incorrect The $1,000 appears to be the difference between Thompson's basis and the fair market value of the stock on the date of the transfer to Winkler This might be the gain to Thompson, but the question asks about Winkler

Choice "d" is incorrect The $5,000 fair market value of the stock on the date of the transfer is not the amount of the gain on the sale

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26

Which of the following should be included when determining adjusted gross income?

a Alimony received

b Compensation for injuries or sickness

c Rental value of parsonages

d Tuition scholarship

Solution:

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

(alimony) are income to the spouse receiving the payments and are deductible to arrive at adjusted gross income (AGI) by the spouse making the payments To be alimony:

1 Payments must be legally required pursuant to a written divorce or separation agreement,

2 Payments must be in cash or its equivalent

3 Payments cannot extend beyond the death of the payee-spouse,

4 Payments cannot be made to members of the same household

5 Payments must not be designated as anything other than alimony, and

6 The spouses may not file a joint tax return

Choice "a" is correct Alimony received is definitely considered part of income and of adjusted gross income

Choice "b" is incorrect Compensation for injuries or sickness is excluded from income and thus adjusted gross income

Choice "c" is incorrect The rental value of parsonages (furnished by churches or synagogues) is

excluded from the income of a minister and thus that minister's adjusted gross income

Choice "d" is incorrect A scholarship for tuition is excluded from income and thus adjusted gross income There are certainly limits or restrictions such as the student has to be a degree-seeking student and amounts must actually be spent on tuition, fees, books, and supplies, but, as a general statement, the amount is excluded

Rule: IRC Section 221 allows the deduction of student loan interest (above-the-line for AGI) paid on

qualified education loans up to a maximum of $2,500 for the tax year There is a phase-out for the deduction in 2010, and there are some minor restrictions such as a married couple must file joint returns

to take the deduction

Choice "d" is correct There is no limitation of the number of years that the interest may be deducted, other than that the interest may be deducted only when paid

Choice "a" is incorrect, per the above rule

Choice "b" is incorrect, per the above rule

Choice "c" is incorrect, per the above rule

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© 2010 DeVry/Becker Educational Development Corp All rights reserved