2011 AICPA Newly Released Questions Regulation

Following are multiple choice questions and simulations 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.

2011 AICPA Newly Released Questions Regulation

1. Under the position taken by a majority of the courts, to which third parties will an accountant who negligently prepares a client's financial report be liable? a. b. c. d. Only those third parties in privity of contract with the accountant. All third parties who relied on the report and sustained injury. Any foreseen or known third party who relied on the report. Any third party whose reliance on the report was reasonably foreseeable.

Solution: Choice "c" is correct. Under the majority position an accountant is liable for negligence only to third parties whom the accountant knows or should foresee will be relying on the accountant's work. Choice "a" is incorrect. This choice reflects the minority Utramares position. In most states, an accountant's liability extends beyond those who are in privity (i.e., in a contractual relationship with) the accountant. Choice "b" is incorrect. This choice is too broad. An accountant is not liable in negligence merely because someone relied on the accountant's work. Choice "d" is incorrect. This answer is too broad because it is not enough that a party could have foreseeably relied the party must have actually relied.

2011 AICPA Newly Released Questions Regulation

2. A company engaged a CPA to perform the annual audit of its financial statements. The audit failed to reveal an embezzlement scheme by one of the employees. Which of the following statements best describes the CPA's potential liability for this failure? a. b. c. d. The CPA's adherence to generally accepted auditing standards (GAAS) may prevent liability. The CPA will not be liable if care and skill of an ordinary reasonable person was exercised. The CPA may be liable for punitive damages if due care was not exercised. The CPA is liable for any embezzlement losses that occurred before the scheme should have been detected.

Solution: Choice "a" is correct. A CPA will be liable in negligence if he or she fails to exercise the care and prudence that an ordinary CPA would exercise in performing an audit. An ordinary CPA would normally adhere to GAAS. Thus, proof of adherence to GAAS may prevent liability. Choice "b" is incorrect. A CPA must perform an audit with the care and skill that an ordinary CPA would exercise; exercising the care and skill of an ordinary, reasonable person is not enough. Choice "c" is incorrect. A CPA may be liable for punitive damages for willful fraud or recklessly performing an audit. While failure to exercise due care is a sufficient basis to impose liability for negligence, it is not a sufficient basis to impose liability for fraud. Choice "d" is incorrect. This choice sets up a strict liability standard CPAs are liable for any embezzlement losses that should have been detected. The law imposes no such liability. A CPA must at least be negligent before liability will be imposed.

2011 AICPA Newly Released Questions Regulation

3. In which of the following types of action, brought against a CPA who issues an audit report containing an unqualified opinion on materially misstated financial statements, may a plaintiff prevail without proving reliance on the audit report? a. b. c. d. An action for common law fraud. An action for common law breach of contract. An action brought under Section 11 of the Securities Act of 1933. An action brought under Rule 10b-5 of the Securities Exchange Act of 1934.

Solution: Choice "c" is correct. A plaintiff need only prove three elements to recover under section 11 the plaintiff acquired the stock, the registration statement was signed by the CPA and contains a material misrepresentation or omission of fact, and damages. All of the other causes of action listed require proof of reliance.

2011 AICPA Newly Released Questions Regulation

4. Under the Negotiable Instruments Article of the UCC, the proper party to whom a check is presented for payment is: a. b. c. d. The drawer. The maker. The holder. The drawee

Solution: Choice "d" is correct. A drawer (the check writer) draws a check payable to the payee from the drawee bank. Choice "a" is incorrect. The drawer is the person who writes the check. Choice "b" is incorrect. A maker is a person who makes a (promissory) note. A note is presented to the maker for payment, but a check is not a type of note; it is a type of draft, and drafts are presented to a drawee for payment. Choice "c" is incorrect. A holder is someone in legal possession of a check; the holder may be the payee or some subsequent transferee of the payee. In any event, a check is not presented to a holder for payment.

2011 AICPA Newly Released Questions Regulation

5. Under the Secured Transactions Article of the UCC, which of the following statements is correct regarding a security interest that has not attached? a. b. c. d. It is effective against the debtor, but not against third parties. It is effective against both the debtor and third parties. It is effective against third parties with unsecured claims. It is not effective against either the debtor or third parties.

Solution: Choice "d" is correct. A security interest is not effective against anyone before it attaches to the collateral. Thus, all of the other answer choices are incorrect.

2011 AICPA Newly Released Questions Regulation

6. Which of the following transactions is subject to registration requirements of the Securities Act of 1933? a. The public sale of stock of a trucking company regulated by the Interstate Commerce Commission. b. A public sale of municipal bonds issued by a city government. c. The issuance of stock by a publicly-traded corporation to its existing shareholders because of a stock split. d. The public sale by a corporation of its negotiable 10-year notes. Solution: Choice "d" is correct. No registration exemption is available for sales of long term notes. Choice "a" is incorrect. Securities of regulated common carriers are within a securities exemption (on the rationale that the regulating government agency will oversee the securities issuance). Choice "b" is incorrect. The issuance of securities of governmental bodies generally is within a securities exemption. Choice "c" is incorrect. Exchanges with existing shareholders are within a transaction exemption if no sales commission is paid in connection with the sale.

2011 AICPA Newly Released Questions Regulation

7. In the current year, Essex sold land with a basis of $80,000 to Yarrow for $100,000. Yarrow paid $25,000 down and agreed to pay $15,000 per year, plus interest, for the next five years, beginning in the second year. Under the installment method, what gain should Essex include in gross income for the year of sale? a. b. c. d. $25,000 $20,000 $15,000 $5,000

Solution: Choice "d" is correct. Under the installment method, revenue is reported (recognized) over the period in which the cash payments are received. Included gross income is determined in 3 steps: Step 1: Gross Profit: Sale on Installment Cost Total Gross Profit Step 2: Gross Profit Percentage : Gross Profit/Sale on Installment ($20,000/$100,000) = 20% Step 3: Taxable Gross Profit: Collections ($25,000) x Gross Profit Percentage (20%) = $5,000 $100,000 $ 80,000 $ 20,000

2011 AICPA Newly Released Questions Regulation

8. Sam's year 2 taxable income was $175,000 with a corresponding tax liability of $30,000. For year 3, Sam expects taxable income of $250,000 and a tax liability of $50,000. In order to avoid a penalty for underpayment of estimated tax, what is the minimum amount of year 3 estimated tax payments that Sam can make? a. b. c. d. $30,000 $33,000 $45,000 $50,000

Solution: Choice "b" is correct. To avoid penalties, if a taxpayer owes $1,000 or more in tax payments beyond withholdings, such taxpayer will need to have paid in for taxes the lesser of: 90% of the current year's tax ($50,000 x 90%) = $45,000, or 100% of the previous year's tax ($30,000 x 100%) = $30,000 However, if the taxpayer had adjusted gross income in excess of $150,000 in the prior year, 110% of the prior year's tax liability is used to compute the safe harbor for estimated payments. (Previous year's tax $30,000 x 110% = $33,000). Choice "a" is incorrect. $30,000 is 100% of last year's tax. This would be sufficient if the previous year's income were $150,000 or less. Choice "c" is incorrect. $45,000 is 90% of this year's tax, which is sufficient, but we are looking for the minimum amount. Choice "d" is incorrect. $50,000 is 100% of the current year's tax, which is sufficient, but more than required.

2011 AICPA Newly Released Questions Regulation

9. On January 1, Fast, Inc. entered into a covenant not to compete with Swift, Inc. for a period of five years, with an option by Swift to extend it to seven years. What is the amortization period of the covenant for tax purposes? a. b. c. d. 5 years. 7 years. 15 years. 17 years.

Solution: Choice "c" is correct. Intangibles such as goodwill, licenses, franchises, trademarks and covenants not to compete may be amortized using the straight line basis over a period of 15 years, starting with the month of acquisition. Note, the difference for GAAP purposes: Intangible assets with indefinite lives are subject only to an impairment test, and intangible assets with finite lives are amortized over those lives and also subject to an impairment test. Choice "a" is incorrect. The time certain does not impact the amortization period. Choice "b" is incorrect. The option to extend does not impact the amortization period. Choice "d" is incorrect. 17 years is longer than required to amortize intangible assets.

10

2011 AICPA Newly Released Questions Regulation

10. Decker sold equipment for $200,000. The equipment was purchased for $160,000 and had accumulated depreciation of $60,000. What amount is reported as ordinary income under Code Sec. 1245? a. b. c. d. $0 $40,000 $60,000 $100,000

Solution: Choice "c" is correct. Under Sec. 1245, ordinary income is recognized on the gain to the extent of the accumulated depreciation. Any gain in excess of the original cost is capital gain. Choice "a" is incorrect. The total gain is $100,000 which is the sales price ($200,000) in excess of cost ($160,000) less depreciation ($60,000). Under Sec. 1245, ordinary income is recognized on the gain to the extent of the accumulated depreciation. Any gain in excess of the original cost is capital gain. Choice "b" is incorrect. Under Sec. 1245, ordinary income is recognized on the gain to the extent of the accumulated depreciation. Any gain in excess of the original cost is capital gain. The total gain is $100,000, but only $60,000 is ordinary income and $40,000 is capital gain income. Choice "d" is incorrect. The total gain is $100,000, but only $60,000 is ordinary income and $40,000 is capital gain income.

11

2011 AICPA Newly Released Questions Regulation

11. Lobster, Inc. incurs the following losses on disposition of business assets during the year: Loss on the abandonment of office equipment Loss on the sale of a building (straight-line depreciation taken in prior years of $200,000) Loss on the sale of delivery trucks $25,000 250,000 15,000

What is the amount and character of the losses to be reported on Lobster's tax return? a. b. c. d. $40,000 Section 1231 loss only. $40,000 Section 1231 loss, $50,000 long-term capital loss. $40,000 Section 1231 loss, $250,000 long-term capital loss. $290,000 Section 1231 loss.

Solution: Choice "d" is correct. Section 1231 assets are comprised principally of depreciable personal and real property used in the taxpayer's trade or business and held for over twelve months. Trade or business property and capital assets (held over twelve months) that have been involuntarily converted are also included. All of the assets listed in this problem are Section 1231 assets. Net 1231 losses (Sec. 1231 losses less Sec. 1231 gains) are treated as ordinary losses.

12

2011 AICPA Newly Released Questions Regulation

12. In the current year, a taxpayer reports the following items: Salary Income from partnership A, in which the taxpayer materially participates Passive activity loss from partnership B $50,000 20,000 (40,000)

During the year, the taxpayer disposed of the interest in partnership B, which had a suspended loss carryover of $10,000 from prior years. What is the taxpayer's adjusted gross income for the current year? a. b. c. d. $20,000 $30,000 $60,000 $70,000

Solution: Choice "a" is correct. The $50,000 salary and income from partnership activity of $20,000 are taxable. Typically, passive activity losses, whether in the current or prior years, may only be used to offset passive activity income. The exception to this is in the year the passive activity is disposed of (sold), if still unused, passive activity losses are fully deductible in the year of disposal: Salary + Income from partnership A PAL from partnership B Loss carryover from partnership B $50,000 20,000 (40,000) (10,000) $20,000

Adjusted gross income

13

2011 AICPA Newly Released Questions Regulation

13. Stone owns 100% of an S corporation and materially participates in its operations. The stock basis at the beginning of the year is $5,000. During the year, the corporation makes a distribution of $3,500 and passes through a loss from operations of $2,000 for the year. What loss can Stone deduct on Stone's personal tax return? a. b. c. d. $0 $1,500 $2,000 $5,500

Solution: Choice "b" is correct. An S Corporation shareholder's basis is reduced by distributions to the shareholders as well as loss or expense items. However, loss deductions are limited to a shareholder's adjusted basis in S corporation stock plus direct shareholder loans to the corporation. Any losses disallowed may be carried forward indefinitely and will be deductible as the shareholder's basis is increased. Beginning Basis Less: Distributions to Shareholder Less: Shareholder share of losses Ending Shareholder Basis $5,000 ($3,500) ($1,500) Excess $500 carried forward indefinitely. 0

Choice "a" is incorrect. Losses are deductible only to the extent of the shareholder's basis. Choice "c" is incorrect. The shareholder cannot deduct the full loss without a sufficient amount of basis in the S corporation stock. Choice "d" is incorrect. The shareholder cannot have a negative basis as a result of distributions and losses.

14

2011 AICPA Newly Released Questions Regulation

14. Farr, an unmarried taxpayer, had $70,000 of adjusted gross income and the following deductions for regular income tax purposes: Home mortgage interest on a loan to acquire a principal residence Miscellaneous itemized deductions above the threshold limitation $11,000 $ 2,000

What are Farr's total allowable itemized deductions for computing alternative minimum taxable income? a. b. c. d. $0 $2,000 $11,000 $13,000

Solution: Choice "c" is correct. Both mortgage interest and miscellaneous itemized deductions are deductible for regular (schedule A) tax purposes. However, miscellaneous itemized deductions are "adjustments" and, therefore, are not allowed as deductions for alternative minimum tax (AMT) purposes. Choice "a" is incorrect. Mortgage interest is allowed as a deduction for AMT purposes. Choice "b" is incorrect. Miscellaneous itemized deductions are not allowed for AMT purposes Choice "d" is incorrect. The $2,000 miscellaneous itemized deductions are an add back for AMT purposes.

15

2011 AICPA Newly Released Questions Regulation

15. Robin, a C corporation, had revenues of $200,000 and operating expenses of $75,000. Robin also received a $20,000 dividend from a domestic corporation and is entitled to a $14,000 dividend-received deduction. Robin donated $15,000 to a qualified charitable organization in the current year. What is Robin's contribution deduction? a. b. c. d. $15,000 $14,500 $13,900 $13,100

Solution: Choice "b" is correct. Corporations making contributions to recognized charitable organizations are allowed a maximum deduction of 10% of their taxable income. Taxable income is calculated before the deduction of: (1) any charitable contribution; (2) the dividends received deduction; (3) any net operating loss carryback; (4) any capital loss carryback; or, (5) U.S. production activities deduction. Revenues Dividends Received Less: Operating expenses Income before the dividends received deduction $200,000 $20,000 ($75,000) $145,000 x Maximum allowable charitable deduction 10% $14,500

Note: Excess charitable contributions not allowed as a deduction due to the 10% limitation may be carried forward up to five years. Choice "a" is incorrect. The full $15,000 would not be allowed due to the 10% limitation illustrated above. Choice "c" is incorrect. The dividends received are considered in taxable income for purposes of the 10% limitation. Choice "d" is incorrect. The 10% limitation is applied before the dividends received deduction.

16

2011 AICPA Newly Released Questions Regulation

16. "Hot assets" of a partnership would include which of the following? a. b. c. d. Cash. Unrealized receivables. Section 1231 assets. Capital assets.

Solution: Choice "b" is correct. As a general rule, a partner who sells or exchanges his or her partnership interest has a recognized capital gain or loss. The capital gain or loss is measured by the difference between the amount realized for the sale and the adjusted basis of the partnership interest. An exception to the capital gain treatment is on any gain that represents a partner's share of "hot assets". Any gain that represents a partner's share of hot assets is treated as ordinary income. Hot assets are: (1) Unrealized receivables and, (2) Appreciated inventory. Choice "a" is incorrect. Cash is not a hot asset. Choice "c" is incorrect. Section 1231 assets are not hot assets. Choice "d" is incorrect. Capital assets are not hot assets.

17

2011 AICPA Newly Released Questions Regulation

17. George and Martha are equal partners in G&M Partnership. At the beginning of the current tax year, the adjusted basis of George's partnership interest was $32,500, which included his share of $40,000 of partnership liabilities. During the tax year, the following information applied to G&M: Operating loss Interest and dividend income Partnership liabilities at end of year $30,000 8,000 24,000

What was the basis of George's partnership interest at year end? a. b. c. d. $13,500 $21,500 $29,500 $43,500

Solution: Choice "a" is correct. A partner's share of operating losses reduces that partner's basis. Likewise, a reduction in a partner's share of liabilities reduces basis. A partner's basis will increase by that partner's share of income such as dividends and interest. Initial basis in partnership interest Equal share of interest and dividends Equal share of operating loss Share of decreased partnership liabilities at year end Basis of George's partnership interest at year end Choice "b" is incorrect. Reducing liabilities decreases basis. Choice "c" is incorrect. Equal partners would divide partnership activity equally. Choice "d" is incorrect. Operating losses are a reduction of basis. $32,500 4,000 (15,000) (8,000) $13,500

18

2011 AICPA Newly Released Questions Regulation

18. As a general partner in Greenland Associates, an individual's share of partnership income for the current tax year is $25,000 ordinary business income and a $10,000 guaranteed payment. The individual also received $5,000 in cash distributions from the partnership. What income should the individual report from the interest in Greenland? a. b. c. d. $5,000 $25,000 $35,000 $40,000

Solution: Choice "c" is correct. A partner must include in income their share of partnership income (even if not received) on their tax return in the taxable year within which the taxable year of the partnership ends. This income includes guaranteed payments. Withdrawals/distributions are not a taxable event, yet will decrease the partner's basis. Choice "a" is incorrect. Cash distributions are not included in income. Choice "b" is incorrect. Guaranteed payments are taxable income to the receiving partner. Choice "d" is incorrect. Distributions are not income, since the money was taxed when the partnership earned such money, but would reduce the partner's basis.

19

2011 AICPA Newly Released Questions Regulation

19. In the current year, when Hoben's tax basis in Lynz Partnership interest was $10,000, Hoben received a liquidating distribution as follows: Adjusted tax basis $5,000 25,000 Fair market value $5,000 27,000

Marketable securities Land

Lynz had no appreciated inventory, unrealized receivables, or properties that had been contributed by its partners. What was Hoben's recognized gain on the distribution? a. b. c. d. $0 $15,000 $22,000 $32,000

Solution: Choice "a" is correct. In a complete liquidation, the partner's basis for distributed property is the same as the adjusted basis of his/her partnership interest, reduced by any money actually received. The partner recognizes gain only to the extent that money received exceeds the partner's basis in the partnership. Therefore, the partner's basis in the distributed assets as part of the liquidation would be $10,000, with no immediate recognized gain. Choice "b" is incorrect. The partner recognizes gain only to the extent that money received exceeds the partner's basis in the partnership. Choice "c" is incorrect. The partner recognizes gain only to the extent that money received exceeds the partner's basis in the partnership. Choice "d" is incorrect. The partner recognizes gain only to the extent that money received exceeds the partner's basis in the partnership.

20

2011 AICPA Newly Released Questions Regulation

20. Pursuant to Treasury Circular 230, which of the following statements about the return of a client's records is correct? a. The client's records are to be destroyed upon submission of a tax return. b. The practitioner may retain copies of the client's records. c. The existence of a dispute over fees generally relieves the practitioner of responsibility to return the client's records. d. The practitioner does not need to return any client records that are necessary for the client to comply with the client's federal tax obligations. Solution: Choice "b" is correct. A tax preparer should retain client records for three years. Choice "a" is incorrect. A tax preparer should retain client records for three years. Choice "c" is incorrect. Generally, at the request of the client, the practitioner must return all client records. An exception is if state law allows the practitioner to retain the records in the case of a fee dispute, the practitioner may do so. However, the practitioner must (1) return to the client those records which must be attached to the tax return, and (2) allow the client to review and copy the practitionerretained client records related to the client's federal tax obligation. Choice "d" is incorrect. The general rule is to return all requested records.

21

2011 AICPA Newly Released Questions Regulation

21. According to the AICPA Statements on Standards for Tax Services, which of the following factors should a CPA consider in choosing whether to provide oral or written advice to a client? a. b. c. d. Whether the client will seek a second opinion. The tax sophistication of the client. The likelihood that current tax litigation will impact the advice. The client's business acumen.

Solution: Choice "b" is correct. In determining whether to provide advice in writing, the tax preparer should consider, among other factors, the sophistication of the tax client. Choice "a" is incorrect. Whether the client will seek a second opinion should not impact giving verbal or written advice. Choice "c" is incorrect. Verbal or written advice should not be determined by tax legislation. Choice "d" is incorrect. The client's business acumen should not be considered when deciding to give them verbal as opposed to written advice.

22

2011 AICPA Newly Released Questions Regulation

22. Louis, the volunteer treasurer of a nonprofit organization and a member of its board of directors, compiles the data and fills out its annual Form 990, Return of Organization Exempt from Income Tax. Under the Internal Revenue Code, Louis is not considered a tax return preparer because: a. b. c. d. He is a member of the board of directors. The return does not contain a claim for a tax refund. He is not compensated. Returns for nonprofit organizations are exempt from the preparer rules.

Solution: Choice "c" is correct. The term "tax return preparer" means any person who prepares for compensation, or who employs one or more persons to prepare for compensation, any tax return required under the IRC or any claim for refund of tax imposed by the IRC. Choice "a" is incorrect. Board status alone does not determine tax preparer status. Choice "b" is incorrect. Claim for a refund or underpayment is not a factor in determining tax preparer status. Choice "d" is incorrect. There is no such exception that exists.

23

2011 AICPA Newly Released Questions Regulation

23. Under agency law, which of the following statements best describes ratification? a. b. c. d. A principal's affirmation of an agent's authorized act. A principal's affirmation of an agent's unauthorized act. A principal's approval in advance of an agent's acts. A principal's disavowal of an agent's unauthorized act.

Solution: Choice "b" is correct. If an agent acts without authority but purportedly on behalf of a principal, and the principal is aware of all of the material facts regarding the transaction and affirms the agent's acts either expressly or impliedly (e.g., by retaining the benefits of the transaction when he or she could have declined or returned the benefits) a ratification has occurred. Choice "a" is incorrect. For a ratification to occur, the agent must have acted without authority. Choice "c" is incorrect. If a principal approves the agent's acts in advance, the agent acts with authority; ratification involves a situation in which the agent acts without authority. Choice "d" is incorrect. Disavowal of an agent's unauthorized act is the opposite of ratification.

24

2011 AICPA Newly Released Questions Regulation

24. Pierce owed Duke $3,000. Pierce contracted with Lodge to paint Lodge's house and Lodge agreed to pay Duke $3,000 to satisfy Pierce's debt. Pierce painted Lodge's house but Lodge did not pay Duke the $3,000. In a lawsuit by Duke against Pierce and Lodge, who will be liable to Duke? a. b. c. d. Pierce only. Lodge only. Both Pierce and Lodge. Neither Pierce nor Lodge.

Solution: Choice "c" is correct. Duke is a creditor of Pierce and Pierce made a contract with Lodge benefiting Duke, making Duke a creditor beneficiary of the Pierce-Lodge contract. If there is a breach of a contract benefiting a third party creditor, the creditor beneficiary may sue the promisor under the third party beneficiary contract or the party who owed the creditor the original debt under the original debt. Thus, none of the other choices is correct.

25

2011 AICPA Newly Released Questions Regulation

25. Under the Sales Article of the UCC, which of the following statements is correct regarding the creation of express warranties? a. b. c. d. Express warranties must contain formal words such as warranty or guarantee. Express warranties must be part of the basis of the bargain between buyer and seller. Express warranties are not enforceable if made orally. Express warranties cannot be based on statements made in the seller's promotional materials.

Solution: Choice "b" is correct. To be an express warranty, the language must be part of the basis of the bargain. Choice "a" is incorrect. An express warranty arises from any statement of fact or promise made by the seller, any description of the goods made by the seller, or any sample or model shown by the seller at a time when it could have become part of the basis of the bargain. Choice "c" is incorrect. An express warranty may be made orally, in writing or by conduct (e.g., the showing of a model). Choice "d" is incorrect. Express warranties can arise from any description of the goods given to the buyer before the contract is executed.

26

2011 AICPA Newly Released Questions Regulation

26. An individual taxpayer agreed to a finding of fraud on an income tax return filed two years ago. What is the maximum time limitation, if any, after which the IRS may not assess any additional taxes against the taxpayer for this tax return? a. b. c. d. One year. Two years. Three years. There is no time limitation.

Solution: Choice "d" is correct. There is no statute of limitations for fraud or filing false tax returns. Choice "a" is incorrect. There is no one year statute of limitations for assessment of tax. Choice "b" is incorrect. There is no two year statute of limitations for assessment of tax. Choice "c" is incorrect. The three year statute of limitations will apply to good faith mistakes with an understatement of income of less than 25%.

27

2011 AICPA Newly Released Questions Regulation

27. In calculating the tax of a corporation for a short period, which of the following processes is correct? a. Divide current-year income by prior-year income, then multiply the result by prior-year tax. b. Compute tax on short-period income, then multiply the result by 12 divided by the number of months in the short period. c. Determine the average taxable income for the past three years, then multiply the result by the number of months in the short period divided by 12. d. Annualize income and calculate the tax on annualized income, then multiply the computed tax by the number of months in the short period divided by 12. Solution: Choice "d" is correct. Corporations are required to pay estimated taxes on the fifteenth day of the fourth, sixth, ninth, and twelfth months of their tax year. One-fourth of the estimated tax is due with each payment. Unequal quarterly payments may be made using the annualized income method. Choice "a" is incorrect. The annualized income method should be used. Choice "b" is incorrect. The annualized income method should be used. Choice "c" is incorrect. Using the past three years could yield an estimated tax liability lower than required.

28

2011 AICPA Newly Released Questions Regulation

28. Which of the following costs are subject to the Uniform Capitalization Rules of Code Sec. 263A for manufactured tangible personal property? a. b. c. d. Off-site storage. Advertising. Research. Marketing.

Solution: Choice "a" is correct. Costs required to be capitalized under the uniform capitalization rules include direct materials, direct labor, and applicable indirect costs. Applicable indirect costs include utilities, warehousing costs, repairs, maintenance, indirect labor, rents, storage, depreciation and amortization, insurance, pension contributions, engineering and design, repackaging, spoilage and scrap, and administrative supplies. Choice "b" is incorrect. Costs not required to be capitalized include selling, advertising, and marketing expenses, certain general and administrative expenses, research, and officer compensation not attributed to production services. Choice "c" is incorrect. Costs not required to be capitalized include selling, advertising, and marketing expenses, certain general and administrative expenses, research, and officer compensation not attributed to production services. Choice "d" is incorrect. Costs not required to be capitalized include selling, advertising, and marketing expenses, certain general and administrative expenses, research, and officer compensation not attributed to production services.

29

2011 AICPA Newly Released Questions Regulation

29. A taxpayer purchased five acres of land for $20,000 and placed in service other tangible business assets that cost $100,000. Disregarding business income limitations and assuming that the annual Section 179 (Election to Expense Certain Depreciable Business Assets) limit is $108,000, what maximum amount of cost recovery can the taxpayer claim this year? a. b. c. d. $120,000 $108,000 $100,000 $20,000

Solution: Choice "c" is correct. Under the election to expense certain depreciable business assets (sec. 179), the taxpayer may expense the cost of the depreciable asset up to the limitation, in this example $108,000. Therefore, only the cost of the depreciable tangible business assets can be expensed ($100,000). Choice "a" is incorrect. Land is not a depreciable asset. Choice "b" is incorrect. Taxpayer can only expense up to the purchase price, not to exceed the limitation. Choice "d" is incorrect. Land is not a depreciable asset.

30

2011 AICPA Newly Released Questions Regulation

30. Hogan exchanged a business-use machine having an original cost of $100,000 and accumulated depreciation of $30,000 for business-use equipment owned by Baker having a fair market value of $80,000 plus $1,000 cash. Baker assumed a $2,000 outstanding debt on the machine. What taxable gain should Hogan recognize? a. b. c. d. $0 $3,000 $10,000 $11,000

Solution: Choice "b" is correct. In a like-kind exchange, if property other than property qualifying for such exchange is received, (e.g., cash known as "boot"), the transaction, while not qualified for complete nonrecognition, produces recognized gain. The recognized gain is the lower of realized gain or the boot. Cancellation of debt is classified as "boot," so the total boot is $3,000 ($1,000 cash + $2,000 debt cancellation). Choice "a" is incorrect. To avoid all immediate gain on a like-kind exchange, boot cannot be received. Choice "c" is incorrect. The exchange of the like-kind assets alone does not result in gain. Choice "d" is incorrect. The exchange of the like-kind assets alone does not result in gain.

31

2011 AICPA Newly Released Questions Regulation

31. A married couple purchased their principal residence for $300,000. They spent $40,000 on improvements. After living in it for 10 years, the couple sold the home for $650,000 and paid $36,000 in real estate commissions. What gain should the couple recognize on their joint return? a. b. c. d. $0 $60,000 $274,000 $310,000

Solution: Choice "a" is correct. The sale of the taxpayer's personal (primary or principal) residence is subject to an exclusion from gross income for gain of $500,000 married filing joint or $250,000 single. To qualify, the taxpayer must have owned and used the property as a principal residence for two years or more during the five year period ending on the date of the sale or exchange. Taxpayer's Basis: $300,000 Purchase price $ 40,000 Improvements $ 36,000 Real estate commissions $376,000 Ending basis Sales Price: $650,000

Gain on sale:

$274,000 Under allowed $500,000 exclusion for married couple

Choice "b" is incorrect based on the above calculation. Choice "c" is incorrect. $274,000 is the realized gain, yet it does not need to be recognized. Choice "d" is incorrect based on the above calculation.

32

2011 AICPA Newly Released Questions Regulation

32. Carter incurred the following expenses in the current year: $500 for the preparation of a personal income tax return, $100 for custodial fees on an IRA, $150 for professional publications, and $2,000 for union dues. Carter's current year adjusted gross income is $75,000. Carter, who is not self-employed, itemizes deductions. What will Carter's deduction be for miscellaneous itemized deductions after any limitations in the current year? a. b. c. d. $0 $750 $1,250 $2,750

Solution: Choice "c" is correct. Miscellaneous itemized deductions are deductible to the extent that such miscellaneous itemized deductions exceed 2% of Adjusted Gross Income (AGI). AGI: $75,000 x 2% of AGI: 2% Tax preparation: Custodial Fees: Publications: Union Dues: Total Misc. Deductions: $500 $100 $150 $2,000 $2,750 ($1,500) 2% of AGI $1,250 Allowable Misc. Deductions

$ 1,500

33

2011 AICPA Newly Released Questions Regulation

33. Cole earned $3,000 in wages, incurred $1,000 in unreimbursed employee business expenses, paid $400 as interest on a student loan, and contributed $100 to a charity. What is Cole's adjusted gross income? a. b. c. d. $3,000 $2,600 $2,500 $1,600

Solution: Choice "b" is correct. Adjusted Gross Income (AGI) is gross income less adjustments or deductions to arrive at AGI. $3,000 in wages is part of gross income. The only adjustment listed is $400 in student loan interest, resulting in an AGI of $2,600. Choice "a" is incorrect. Student loan interest is a deduction to arrive at AGI. Choice "c" is incorrect. Charitable contributions are itemized deductions subtracted from AGI. Choice "d" is incorrect. Unreimbursed employee business expense is an itemized deduction subtracted from AGI.

34

2011 AICPA Newly Released Questions Regulation

34. Doyle has gambling losses totaling $7,000 during the current year. Doyle's adjusted gross income is $60,000, including $3,000 in gambling winnings. Doyle can itemize the deductions. What amount of gambling losses is deductible? a. b. c. d. $0 $3,000 $5,800 $7,000

Solution: Choice "b" is correct. Gambling losses are miscellaneous itemized deductions not subject to the 2% AGI limitation. The deductions for gambling losses are, however, limited to gambling winnings. Choice "a" is incorrect. Gambling losses are deductible up to gambling winnings. Choice "c" is incorrect. Gambling losses are not subject to the 2% limitation. Choice "d" is incorrect. The deduction for gambling losses cannot exceed gambling winnings.

35

2011 AICPA Newly Released Questions Regulation

35. Which of the following statements about qualifying shareholders of an S corporation is correct? a. b. c. d. A general partnership may be a shareholder. Only individuals may be shareholders. Individuals, estates, and certain trusts may be shareholders. Nonresident aliens may be shareholders.

Solution: Choice "c" is correct. This is a true statement. Generally, only individuals, estates, and certain trusts can be shareholders. Choice "a" is incorrect. Generally, only individuals, estates, and certain trusts can be shareholders. Choice "b" is incorrect. Estates and certain trusts can also be shareholders. Choice "d" is incorrect. Generally, foreign shareholders are prohibited.

36

2011 AICPA Newly Released Questions Regulation

36. Absent an election to close the books, the allocation of nonseparately stated income or loss for an S corporation shareholder that changed his ownership interest during the year is computed based on which of the following ownership percentages? a. b. c. d. Ownership percentage at the end of the S corporation year. Ownership percentage computed on a per-share per-day basis. Ownership percentage at the beginning of the S corporation year. Ownership percentage determined as an average of the beginning and ending ownership percentages.

Solution: Choice "b" is correct. Allocations to shareholders are made on a per-share, per-day basis. Choice "a" is incorrect. Ownership in the S Corporation could change during the year. Choice "c" is incorrect. Ownership in the S Corporation could change during the year. Choice "d" is incorrect. Ownership in the S Corporation could change during the year.

37

2011 AICPA Newly Released Questions Regulation

37. Lamont signed a promissory note in favor of Roth as part of Lamont's purchase of supplies from Roth. The note required that the $10,000 be repaid 90 days from the date of the note. There were no conditions attached to repayment. Roth endorsed the note in blank and sold it to the bank. Lamont defaulted on the promissory note. The bank sought a judgment ordering Lamont to pay the bank. Under the Negotiable Instruments Article of the UCC, how will the court most likely rule? a. The court will direct Lamont to pay the bank because the promissory note was a negotiable instrument negotiated to the bank in due course. b. The court will direct Lamont to pay the bank because the note was part of a transaction between merchants. c. The court will not direct Lamont to pay the bank because the promissory note was a negotiable instrument negotiated with Roth. d. The court will not direct Lamont to pay the bank because the promissory note was not a negotiable instrument. Solution: Choice "a" is correct. When a maker signs a negotiable promissory note, the maker enters into a contract that he will pay the note when due according to its terms when the maker signed. Choice "b" is incorrect. The mere fact that the note was part of a transaction between merchants is not a reason to order the maker to pay it. Choice "c" is incorrect. The note here appears to be negotiable a writing, signed by the maker, containing an unconditional promise to pay a fixed amount of money at a definite time (90 days) with no unauthorized other promises (making choice "d" incorrect). The maker of a negotiable promissory note must pay it when presented for payment.

38

2011 AICPA Newly Released Questions Regulation

38. Simon, a C corporation, had a deficit in accumulated earnings and profits of $50,000 at the beginning of the year and had current earnings and profits of $10,000. At year end, Simon paid a dividend of $15,000 to its sole shareholder. What amount of the dividend is reported as income? a. b. c. d. $0 $5,000 $10,000 $15,000

Solution: Choice "c" is correct. Dividends are a distribution of property by a corporation out of its earnings and profits (E&P). Dividends come from current E&P and then from accumulated E&P. If current E&P is positive and accumulated E&P is negative, distributions are dividends only to the extent of current E&P. Any excess distribution above E&P reduces the shareholders basis in the stock, if any. If the shareholder has no basis, then the excess distribution is reported as a capital gain. Choice "a" is incorrect. A distribution is a dividend to the extent of E&P. Choice "b" is incorrect. The dividend would be the distribution to the extent of E&P, not the distribution above E&P. Choice "d" is incorrect. The full distribution can only be a dividend if the corporation has sufficient E&P.

39

2011 AICPA Newly Released Questions Regulation

39. Campbell acquired a 10% interest in Vogue Partnership by contributing a building with an adjusted basis of $40,000 and a fair market value of $90,000. The building was subject to a $60,000 mortgage that was assumed by Vogue. The other partners contributed cash only. The basis of Campbell's partnership interest in Vogue is: a. b. c. d. $84,000 $34,000 $30,000 $0

Solution: Choice "d" is correct. A partner's initial basis in their partnership interest is determined by, among other items, the adjusted basis of appreciated property contributed. Such basis is reduced by liabilities assumed by the other partners. When property that is subject to a liability is contributed to a partnership and the subsequent decrease in the partner's individual liability exceeds partnership basis, the excess amount is treated like taxable boot, which means there is a taxable gain to the partner. Initial Basis: Less: liabilities assumed by others: Net Basis: Campbell's basis in partnership: $ 40,000 (basis in asset contributed to the partnership) ($54,000) ($60,000 in total liabilities less 10% retained) ($14,000) Excess liability, taxable to Campbell $0

Choice "a" is incorrect. Basis determination begins with the contributed asset's basis, not fair market value. Choice "b" is incorrect. The incoming partner is considered as being relieved of 90% of the liability because the partner is purchasing a 10% interest. Therefore, 90% of the liability is the responsibility of the other partners. Choice "c" is incorrect. Basis determination begins with the contributed asset's basis, not fair market value.

40

2011 AICPA Newly Released Questions Regulation

AICPA 2011 Released REG Simulations Task 1714_01

41

2011 AICPA Newly Released Questions Regulation

42

2011 AICPA Newly Released Questions Regulation

Explanations: 2. Partners do not include the cash as income, but must reduce their basis in the partnership. This is the general rule in partnerships. Cash distributions are not taxable income but reduce basis. They are only taxable if the distribution is in excess of basis, which we are told is not the case here. 3. Treated partly as a separately stated section 1231 gain and partly as partnership ordinary business income. The portion of the gain up to accumulated depreciation is recaptured as ordinary income. The gain in excess of accumulated depreciation is a section 1231 gain. 4. Treated as a separately stated item by the partnership and potentially deductible by the partners. A section 179 deduction is always a separately stated item. There are income limitations that must be applied at the individual level to ultimately determine if it is deductible by the partners. 5. Treated as a separately stated item by the partnership and potentially deductible by the partners. Charitable contributions are always separately stated items. Each partner then applies the AGI limitations at the individual level to determine if it is deductible. 6. Treated as a separately stated item by the partnership, taxable to the partner. The sale of an investment held for less than one year at a gain would result in a short-term capital gain, which is a separately stated item. The gain is then taxable to each partner. 7. Deductible by the partnership in arriving at partnership ordinary business income. This is an ordinary and necessary business expense. Therefore, it is deductible by the partnership against ordinary business income. 8. Deductible by the partnership in arriving at partnership ordinary business income. This is an ordinary and necessary business expense. Therefore, it is deductible by the partnership against ordinary business income. 9. Partners are not entitled to a deduction and decrease their basis in the partnership. In order to be deductible, a charitable contribution must be to a charitable organization registered in the United States. If it is not registered in the United States, it is a non-deductible contribution. A non-deductible expense, such as this one, still results in a decrease in the basis of the partners. This is consistent with the fact that tax-exempt income results in an increase to basis.

43

2011 AICPA Newly Released Questions Regulation

Task 3437_01

44

2011 AICPA Newly Released Questions Regulation

Explanations: Gross Receipts All business gross receipts of a self-employed individual are reported on Schedule C. Secretarial Expenses Secretarial expenses are ordinary and necessary business expenses that are always reported on Schedule C. Supplies Supplies are ordinary and necessary business expenses that are always reported on Schedule C. Other Business Expenses Other business expenses are ordinary and necessary business expenses that are always reported on Schedule C. Property Insurance Property insurance is a personal expense for the home. Because the home is used 10% as the taxpayers primary place of business, 10% (500) may be deducted on Schedule C. The remainder is a non-deductible personal expense. Mortgage Interest Mortgage interest is a personal expense for the home. Because the home is used 10% as the taxpayers primary place of business, 10% (2,400) may be deducted on Schedule C. The remainder (21,600) is an allowable interest deduction on Schedule A. Real Estate Taxes Real estate taxes are a personal expense for the home. Because the home is used 10% as the taxpayers primary place of business, 10% (1,000) may be deducted on Schedule C. The remainder (9,000) is an allowable tax deduction on Schedule A. Furnace Repair Furnace repair is a personal expense for the home. Because the home is used 10% as the taxpayers primary place of business, 10% (200) may be deducted on Schedule C. The remainder is a nondeductible personal expense. Kitchen Remodeling Kitchen remodeling is a personal capital expenditure for the home. It is not an expense of operating the home. Therefore, none of this expenditure is deductible at all. It will, however, add to the adjusted basis of the home. Utilities Utilities are a personal expense for the home. Because the home is used 10% as the taxpayers primary place of business, 10% (600) may be deducted on Schedule C. The remainder is a non-deductible personal expense. Cleaning Services Cleaning services are a personal expense for the home. Because the home is used 10% as the taxpayers primary place of business, 10% (100) may be deducted on Schedule C. The remainder is a non-deductible personal expense.

45

2011 AICPA Newly Released Questions Regulation

Depreciation Depreciation of the office portion of a home used as a principal place of business is deductible on Schedule C. This amount is given here as 4,000. However home office deductions may not create a loss on Schedule C. There is 3,000 income remaining after deducting all of the expenses in column C from the gross receipts of 50,000. Therefore, only 3,000 of the depreciation is deductible. The additional 1,000 (of the 4,000 allocated to the home office) may be carried forward to the next year.

46

2011 AICPA Newly Released Questions Regulation

Task 3765_01

Keywords: Gift tax and Marital deduction and Spouse not a citizen

47