2012 AICPA newly released questions – regulation

An individual taxpayer reports the following items for the current year: Ordinary income from partnership A, operating a movie theater Net loss from partnership B, operating an equipment

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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

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An individual taxpayer reports the following items for the current year:

Ordinary income from partnership A, operating a movie theater

Net loss from partnership B, operating an equipment rental business

in which the taxpayer does not materially participate (9,000)

Rental income from building rented to a third party 7,000

What is the taxpayer's adjusted gross income for the year?

Choice "c" is correct Except in the year in which an individual, estate, trust, or closely-held C corporation

disposes of an entire interest in a passive activity investment, such taxpayers cannot deduct passive

activity expenses and losses against income and gain attributable to non-passive activities A passive

activity is (i) any activity in which such taxpayers do not materially participate and (ii) as a general rule,

such taxpayers' rental real estate investments – regardless of the extent of such taxpayers' involvement

with the rental real estate operations A limited exception (the "Mom and Pop Exception") regarding

rental real estate activities is available to individuals, but the facts of this question do not provide any

information which would entitle the taxpayer to the benefits of this exception

Hence, the taxpayer can deduct, against the profit from the taxpayer's $7,000 passive activity rental

income from the building rented to a third party, only $7,000 of the $9,000 net loss from partnership B

which is operating an equipment rental business in which the taxpayer does not materially participate

Computation of adjusted gross income for the year:

Ordinary income from partnership A, operating a movie theater

Rental income from building rented to a third party (a passive activity) 7,000

Net loss from partnership B, operating an equipment rental business

in which the taxpayer does not materially participate (per the above

rule the taxpayer can deduct only $7,000 of the $9,000

Short-term capital gain from sale of stock (fully taxable) 4,000

Choices "a", "b", and "d" are incorrect per the above rule and per the above computations

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On February 1, year 1, a taxpayer purchased an option to buy 1,000 shares of XYZ Co for $200 per share The taxpayer purchased the option for $50,000, which was to remain in effect for six months The market declined, and the taxpayer let the option lapse on August 1, year 1 The taxpayer would report which of the following as a capital loss on the year 1 income tax return?

In this question, the options, which were capital assets purchased for $50,000 on February 1, Year 1, became worthless on the lapse date, August 1, Year 1 Thus, the $50,000 capital loss is treated as having occurred on December 31, Year 1, the last day of the taxable year in which the options became totally worthless Because, as of December 31, Year 1, the options had not been held for more than a year, the $50,000 capital loss will be reported on the income tax return as a short-term capital loss Choices "a", "c", and "d" are incorrect per the above rules

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A taxpayer lived in an apartment building and had a two-year lease that began 16 months ago The taxpayer's landlord wanted to sell the building and offered the taxpayer $10,000 to vacate the apartment immediately The taxpayer's lease on the apartment was a capital asset but had no tax basis If the taxpayer accepted the landlord's offer, the gain or loss would be which of the following?

a An ordinary gain

b A short-term capital loss

c A long-term capital gain

d A short-term capital gain

Solution:

Choice "c" is correct A capital asset which is sold or exchanged more than one year after the date of acquisition will generate either a long-term capital gain (if the capital asset is sold at a price greater than acquisition cost) or a long-term capital loss (if the capital asset is sold at a price less than the acquisition cost) In this question, the lease-hold interest, which is a capital asset, was acquired more than a year ago, and the basis (acquisition cost) in that capital asset is -0- So, the receipt of $10,000 to vacate the apartment will generate a $10,000 long-term capital gain

Choices "a", "b", and "d" are incorrect per the above rules

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In year 1, a taxpayer sold real property for $200,000, receiving $100,000 at closing and $100,000 plus accrued interest at the prime rate in the next year The buyer also assumed a $50,000 mortgage on the property The taxpayer's adjusted basis was $75,000, and the taxpayer incurred $10,000 of selling expenses If this transaction qualifies for installment sale treatment, what is the gross profit on the sale?

The gross profit will be the amount realized less selling costs less the adjusted basis of the property sold (note: IRS forms require the taxpayer (i) to increase the adjusted basis by the amount of the selling costs and (ii) not reduce the amount realized by the selling costs This requirement does not change the amount of gain/gross profit

If the contract requires that payments be made in a subsequent year and if the contract requires little or

no interest, the taxpayer may have to reduce the amount realized by the amount of unstated interest This rule does not apply here because the contract requires that the buyer pay accrued interest at the prime rate in the next year

Amount realized:

Cash to be received, excluding interest income $200,000

Related debt assumed by the buyer 50,000

Choices "a", "b", and "d" are incorrect per the above rule and per the above computations

a $2,500 long-term capital gain

b $2,500 short-term capital gain

c $5,000 long-term capital gain

d $5,000 short-term capital gain

Solution:

Choice "a" is correct Unless the executor elects the "alternative valuation date" method (not applicable

to this question), the basis of property acquired by bequest or by inheritance is the property's fair market value on the date of the decedent's death The decedent's basis is irrelevant Additionally, such acquired property is always considered to be "long-term" property, regardless of how long it has been held by the decedent and by the beneficiary or heir

Calculation of gain realized and recognized:

Less: Basis (date-of-death fair market value) (5,000)

Long-term capital gain realized and recognized $2,500

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

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Davidson was transferred from Chicago to Atlanta In connection with the transfer, Davidson incurred the following moving expenses:

Temporary living expenses in Atlanta 400

Less: employer reimbursement not included on IRS form W-2 (2,000)

Choices "b", "c", and "d" are incorrect per the above rule: The $400 temporary living expenses in Atlanta and the $40 meal expense are not deductible

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Which of the following statements is correct regarding the deductibility of an individual's medical

expenses?

a A medical expense paid by credit card is deductible in the year the credit card bill is paid

b A medical expense deduction is allowed for payments made in the current year for medical services received in earlier years

c Medical expenses, net of insurance reimbursements, are disregarded in the alternative minimum tax calculation

d A medical expense deduction is not allowed for Medicare insurance premiums

Choice "c" is incorrect Medical expenses, net of insurance reimbursements, are not disregarded in the

alternative minimum tax calculation However, the allowable amount for AMT purposes is the net amount

in excess of 10% of adjusted gross income (for regular tax purposes, the allowable amount is the net amount in excess of 7.5% of adjusted gross income)

Choice "d" is incorrect A medical expense deduction is allowed for Medicare insurance premiums

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An individual taxpayer earned $10,000 in investment income, $8,000 in noninterest investment expenses, and $5,000 in investment interest expense How much is the taxpayer allowed to deduct on the current-year's tax return for investment interest expenses?

Taxable investment income includes: (i) interest and dividends, (ii) rents (if the activity is not a passive activity), (iii) royalties (in excess of related expenses), (iv) net short-term capital gains, and (v) net long-term capital gains if the taxpayer elects not to claim the net capital gains reduced tax rate

Calculation:

Less: Related investment expenses other than investment interest expenses (8,000)

The taxpayer's deduction for investment interest expense is $2,000: the lesser of (i) $2,000 net

investment income or (ii) $5,000 investment interest expense

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

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Brenda, employed full time, makes beaded jewelry as a hobby In year 2, Brenda's hobby generated

$2,000 of sales, and she incurred $3,000 of travel expenses What is the proper reporting of the income and expenses related to the activity?

a Sales of $2,000 are reported in gross income, and $2,000 of expenses is reported as an itemized deduction subject to the 2% limitation

b Sales of $2,000 are reported in gross income, and $3,000 of expenses is reported as an itemized deduction subject to the 2% limitation

c Sales and expenses are netted, and the net loss of $1,000 is reported as an itemized deduction not

subject to the 2% limitation

d Sales and expenses are netted and deducted for AGI

Solution:

Choice "a" is correct Based upon the facts presented ("Brenda makes jewelry as a hobby "), this activity is not a trade or business activity but is an activity not engaged in for profit As such, the taxpayer can only deduct as itemized deductions on Schedule A of IRS form 1040 the following: (i) expenses, such

as state and local income taxes and property taxes, which would be allowed regardless of whether or not the activity were engaged in for profit and (ii) all other expenses that would be allowed if such activity were engaged in for profit However, the amount of these "other expenses" cannot exceed gross income reduced by the expenses described in "(i)," above Furthermore, the allowable "other expenses" are subject to the "2% of AGI" limitation

Because Brenda had only $2,000 of gross income, the most she can deduct is $2,000 of the $3,000 travel expenses she incurred Because the travel expenses constitute "all other expenses" (see "(ii)," above), this amount is subject to the "2% of AGI" limitation

Note that the activity-is-engaged-in-for-profit statutory presumption does not apply Reason: that

presumption applies only if the activity shows a profit for at least three taxable years during the five consecutive taxable year period ending with the year in question (year #2 for this question) Because the facts do not state that during the five year period ending with year 2 Brenda had a profit in at least three

of those five years, the presumption is not available to Brenda If the presumption would have been available to her and if she had had a profit in at least three of the five consecutive, ending with year #2, then the sales and expenses would have been netted and deducted for AGI (and choice "d" would have been correct)

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

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On their joint tax return, Sam and Joann had adjusted gross income (AGI) of $150,000 and claimed the following itemized deductions:

Interest of $15,000 on a $100,000 home equity loan to purchase a motor home

Real estate tax and state income taxes of $18,000

Unreimbursed medical expenses of $15,000 (prior to AGI limitation)

Miscellaneous itemized deductions of $5,000 (prior to AGI limitation)

Based on these deductions, what would be the amount of AMT add-back adjustment in computing alternative minimum taxable income?

- Taxes reduced by taxable refunds,

- Home mortgage interest when the mortgage loan proceeds were not used to buy, build, or improve the taxpayer’s qualified dwelling (house, condominium, apartment, or mobile home not used on a transient basis),

- Medical expenses not exceeding 10% of AGI, and

- Miscellaneous deductions subject to the 2% of AGI floor

The “PANIC TIMME” add-back is as follows:

Taxes $18,000 Home mortgage interest not used to buy, build, or improve a qualified dwelling (the

motor home is not a qualified dwelling) 15,000 Medical expenses in excess of 7.5% AGI but not in excess of 10% of AGI 3,750 Deductible miscellaneous expenses in excess of 2% of AGI 2,000 Total “PANIC TIMME” add-back $38,750 Choices “a”, “b”, and “c” are incorrect per the above rule and per the above calculations

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On January 1 of the current year, Locke Corp., an accrual-basis calendar-year C corporation, had

$30,000 in accumulated earnings and profits For the current year, Locke had current earnings and profits of $20,000, and made two $40,000 cash distributions to its shareholders, one in April and one in September What amount of the distributions is classified as dividend income to Locke's shareholders?

$80,000; so, $50,000 of the total distributions will be taxable dividends

Choices "a", "b", and "d" are incorrect per the above rule

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Gem Corp purchased all the assets of a sole proprietorship, including the following intangible assets:

Covenant not to compete 13,000

For tax purposes, what amount of these purchased intangible assets should Gem amortize over the specific statutory cost recovery periods?

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

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For year 2, Quest Corp., an accrual-basis calendar-year C corporation, had an $8,000 unexpired

charitable contribution carryover from year 1 Quest's year 2 taxable income before the deduction for charitable contributions was $200,000 On December 12, year 2, Quest's board of directors authorized a

$15,000 cash contribution to a qualified charity, which was made on January 6, year 3 What is the maximum allowable deduction that Quest may take as a charitable contribution on its year 2 income tax return?

• Any charitable contribution,

• The dividend received deduction,

• Any net operating loss carryback,

• Any net capital loss carryback, and

• The U.S production activities deduction

Accrued charitable contributions not paid by the end of the year are deductible in the year of accrual if (i) the board of directors authorizes the contribution during the tax year and (ii) the accrual-basis corporation pays the accrued amount by the fifteenth day of the third month (generally 2½ months) following the end

of the tax year

Any amount in excess of the "10% limitation" may be carried forward for five years

In this question, the corporation has: (i) an $8,000 unexpired charitable contribution carryover from the previous year, (ii) -0- charitable contributions paid during the current year, and (iii) a $15,000 contribution which the board of directors authorized by the end of the year and which the corporation paid by the fifteenth day of the third month following the end of the tax year Hence, the deduction before application

of the "10% limit" is $23,000: $8,000 + 0 + $15,000 However, the taxable income before the five

deductions listed above is $200,000 So, the deduction is limited to $20,000: the lesser of (i) the $23,000 amount before application of the "10% limit" or (ii) $20,000 which is 10% of the $200,000 taxable income before the five deductions listed above

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

5 x lesser of (i) $15 value of each gift or (ii) $25 maximum per recipient per year $ 75

9 x lesser of (i) $30 value of each gift or (ii) $25 maximum per recipient per year $225

1 x lesser of (i) $100 value of the gift or (ii) $25 maximum per recipient per year $ 25

Choices "a", "b", and "d" are incorrect per the above rule and per the above computations

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In the current year, Fitz, a single taxpayer, sustained a $48,000 loss on Code Sec 1244 stock in JJJ Corp., a qualifying small business corporation, and a $20,000 loss on Code Sec 1244 stock in MMM Corp., another qualifying small business corporation What is the maximum amount of loss that Fitz can deduct for the current year?

a $50,000 capital loss

b $68,000 capital loss

c $18,000 ordinary loss and $50,000 capital loss

d $50,000 ordinary loss and $18,000 capital loss

Solution:

Choice "d" is correct The stock in each corporation is a capital asset The general rule is that a loss on the sale or exchange of a capital asset will be a capital loss (either a short-term capital loss or a long-term capital loss – depending upon the holding period) However, a special rule applies to “section 1244 small business stock): when a corporation’s stock is sold or becomes worthless, an original stockholder can be treated as having an ordinary loss (fully deductible), instead of a capital loss, up to $50,000 ($100,000 if married filing jointly) for the year Any loss(es) in excess of this amount is (are) a capital loss

In this question the taxpayer, who is not married, during the year has $68,000 of losses from the sale of section 1244 small business stock As such, the taxpayer will treat as an ordinary loss $50,000 of the total loss; the taxpayer will treat as a capital loss the remaining $18,000 of the total loss

Choices “a”, “b”, and “c” are incorrect per the above rule

Choice "d" is correct An S corporation is subject to the "built-in gains" tax (as well as the "LIFO

Recapture" tax and the "Passive Investment Income" tax) only if the S corporation had previously been a

C corporation In this question, the corporation elected "S" status on the day or incorporation; hence, the corporation was never a C corporation So, the "built-in gains" tax doesn't apply to the facts presented Choices "a", "b", and "c" are incorrect per the above rule

Choice "b" is incorrect The S corporation's unearned revenue is not separately stated but is a

component of "ordinary business income" or "net rental real estate income (loss)" or "other net rental income (loss)," each of which is separately stated on the Schedule K-1 of IRS form 1120S However, the various components (such as unearned revenue) of "ordinary business income," "net rental real estate income (loss)," and "other net rental income (loss)" are not separately stated on the K-1 of IRS form 1120S

Choice "c" is incorrect The S corporation's section 1245 gain (and section 1250 gain) is not separately stated but is a component of "ordinary business income" or "net rental real estate income (loss)" or "other net rental income (loss)," each of which is separately stated on the Schedule K-1 of IRS form 1120S However, the various components (such as section 1245 gain) of "ordinary business income," "net rental real estate income (loss)," and "other net rental income (loss)" are not separately stated on the K-1 of IRS form 1120S

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For which of the following entities is the owner's basis increased by the owner's share of profits and

decreased by the owner's share of losses but is not affected by the entity's bank loan increases or

by profits, losses, or loans made by the corporation

Choice "c" is incorrect The owner's basis in a partnership is increased by the owner's share of profits and decreased by the owner's share of losses For a partnership, the basis is also affected by increases and decreases of bank loans

Choice "d" is incorrect Limited Liability Companies are taxed as C corporations or partnerships, which are both incorrect as per above

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Turner, Reed, and Sumner are equal partners in TRS partnership Turner contributed land with an adjusted basis of $20,000 and a fair market value (FMV) of $50,000 Reed contributed equipment with an adjusted basis of $40,000 and an FMV of $50,000 Sumner provided services worth $50,000 What amount of income is recognized as a result of the transfers?

Choice "a" is correct Generally, no gain or loss is recognized on a contribution of property to a

partnership in return for a partnership interest (note: when contributed property is subject to a liability, if the decrease in the contributing partner's individual basis exceeds the partner's partnership basis, the excess amount is treated like taxable boot and is a gain to that partner) So, given the facts in this

question, Turner and Reed will recognize no income or gain

On the other hand, the value of a partnership acquired for services is ordinary income to the partner rendering those services So, Summer must recognize $50,000 of ordinary income on account of

Summer's rendering to the partnership $50,000 worth of services in exchange for a partnership interest Choices "b", "c", and "d" are incorrect per the above rules

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While preparing a partnership tax return, the accountant discovered that ABC Partnership distributed property to Anne, a partner, in a nonliquidating transfer No money was distributed to Anne during the year, the property was in the partnership for over five years, and no debt was attached to the property Anne had a basis in her partnership interest of $10,000 The partnership had an adjusted basis of

$20,000 in the property distributed to Anne Which of the following are the tax consequences to Anne?

a $0 gain, basis in the partnership is reduced to $0, and basis in the property received is $10,000

b $0 gain, basis in the partnership is reduced to $0, and basis in the property received is $20,000

c $10,000 gain, basis in the partnership is reduced to $0, and basis in the property received is $20,000

d $10,000 gain, basis in the partnership is unchanged, and basis in the property received is $20,000

Solution:

Choice "a" is correct General rules:

1 A nonliquidating distribution to a partner is nontaxable

2 In nonliquidating distribution to a partner, the basis of property received will be the same as the basis in the hands of the partnership immediately prior to the nonliquidating distribution

3 Distributions to a partner reduce the partner's basis by the cash the partner receives and by the partnership's adjusted basis in property which the partner receives

Exception to the general rule (the exception does not apply to the facts set forth in the question): Gain is recognized only to the extent that cash (including the partner's share of partnership liabilities are assumed

by other partners) distributed exceeds the adjusted basis of the partner's interest in the partnership immediately before the distribution

In this question, the partner received no cash, and the partner's share of partnership liabilities did not change So, the partner will recognize no gain with respect to the distribution Although the partnership's adjusted basis in the distributed property was $20,000, because the partner's basis in the partner's partnership interest was only $10,000, the adjusted basis of the property which the partner received will

be limited to $10,000 The new basis in the partnership interest will be reduced from $10,000 to -0- Choices "b", "c", and "d" are incorrect per the above rules

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Able and Baker are equal members in Apple, an LLC Apple has elected not to be treated as a

corporation Able contributes $7,000 cash and Baker contributes a machine with a basis of $5,000 and a fair market value of $10,000, subject to a liability of $3,000 What is Apple's basis for the machine?

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

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The answer to each of the following questions would be irrelevant in determining whether a tuition

payment made on behalf of another individual is excludible for gift tax purposes, except:

a Was the tuition payment made for a part-time student?

b Was the qualifying educational organization located in a foreign country?

c Was the tuition payment made directly to the educational organization?

d Was the tuition payment made for a family member?

Solution:

Choice "c" is correct This question asks the reader to identify the listed question whose answer is relevant The answer to each of listed questions "a", "b", and "d" is irrelevant Only the answer to listed

question "c" is relevant Tuition payments made directly to a qualifying foreign or domestic educational

organization qualify for an unlimited exclusion from the gift tax The payments can be for the benefit of any student (not just the donor's family members), and the student can be enrolled either full-time or part-time (per the next to the last sentence of U.S Treasury Regulation section 25.2503-6(b)(2))

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Which of the following is not considered a primary authoritative source when conducting tax research?

a Internal Revenue Code

b Tax Court cases

c IRS publications

d Treasury regulations

Solution:

Choice "c" is correct IRS publications are not considered a primary authoritative source when one is

conducting tax research

Choices "a", "b", and "d" are incorrect The Internal Revenue Code, tax court cases, and Treasury regulations, respectively, are considered primary authoritative sources when one is conducting tax

research; hence they are incorrect choices (the question asks which item is not considered a primary

authoritative source)