Federal Income Taxation Exam Review
Course Introduction
Federal Income Taxation introduces students to the fundamental concepts and principles underlying the United States federal income tax system. The course covers the determination of taxable income, the calculation of tax liability for individuals and entities, and the statutory and regulatory authorities that govern federal taxation. Topics include gross income, deductions, credits, capital gains and losses, basis, and the taxation of different types of entities such as partnerships, corporations, and trusts. Students will develop skills in applying tax laws to various fact patterns, interpreting Internal Revenue Code provisions, and understanding ethical considerations in tax practice. This course provides a solid foundation for those pursuing further study or careers in tax law, accounting, or financial planning.
Recommended Textbook
McGraw Hills Taxation of Individuals and Business Entities 7th Edition by Spilker
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Page 2
Chapter 1: An Introduction to Tax
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Sample Questions
Q1) Which of the following principles encourages a vertically equitable tax system?
A) Pay as you go
B) Economy
C) Income effects
D) Ability to pay principle
E) None of these
Answer: D
Q2) Common examples of sin taxes include the taxes imposed on airline tickets and gasoline.
A)True
B)False
Answer: False
Q3) The state of Georgia recently increased its tax on a carton of cigarettes by $2.00. What type of tax is this?
A) A sin tax
B) An excise tax
C) It is not a tax; it is a fine
D) Both a sin tax and an excise tax are correct
E) None of these is correct
Answer: D
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Chapter 2: Tax Compliance, the Irs, and Tax Authorities
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Q1) Which of the following is not a factor that determines whether a taxpayer is required to file a tax return?
A) Filing status.
B) Taxpayer's gross income.
C) Taxpayer's employment.
D) Taxpayer's age.
E) None of these.
Answer: C
Q2) Which of the following is not a common method that the IRS uses to select returns for audit?
A) DIF system.
B) Tax select system.
C) Information matching.
D) Document perfection.
E) None of these.
Answer: B
Q3) If a taxpayer is due a refund, she does not have to file a tax return.
A)True
B)False
Answer: False
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Chapter 3: Tax Planning Strategies and Related Limitations
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Q1) The value of a tax deduction is higher for a taxpayer with a lower tax rate.
A)True
B)False Answer: False
Q2) Which of the following is an example of the timing strategy?
A) A cash basis taxpayer paying all outstanding bills by year end
B) A parent employing her child in the family business
C) A business paying its owner a $30,000 salary
D) A taxpayer investing in a tax preferred investment
E) None of these Answer: A
Q3) Tax evasion is a legal activity that forms the basis of the basic tax planning strategies discussed in class.
A)True
B)False Answer: False
Q4) The income shifting strategy requires taxpayers with varying tax rates.
A)True
B)False Answer: True
Page 5
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Chapter 4: Individual Income Tax Overview, Exemptions, and Filing Status
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Q1) Jane is unmarried and has no children, but provides more than half of her mother's financial support. Jane's mother lives in an apartment across town and has a part-time job earning $5,000 a year. Which is the most advantageous filing status available to Jane?
A) Single
B) Head of household
C) Qualifying individual
D) Surviving single
Q2) Which of the following is not a filing status?
A) Head of household
B) Unmarried
C) Qualifying widow or widower
D) Married filing jointly
Q3) In June of year 1, Edgar's wife Cathy died and Edgar did not remarry during the year. What is his filing status for year 1 (assuming they did not have any dependents)?
A) Married filing jointly
B) Single
C) Qualifying widower
D) Head of household
6
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Chapter 5: Gross Income and Exclusions
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Q1) An employee may exclude up to a 40 percent employer-provided discount on services.
A)True
B)False
Q2) Mike received the following interest payments this year. What amount must Mike include in his gross income (for federal tax purposes)? \[\begin{array} { l r } { \underline { \text { Bond } } } & \underline { \text { Interest } } \\
\text { General Motors } & \$ 1,450 \\
\text { City of New York } & 900 \\
\text { State of New Jersey } & 1,200 \\
\text { U.S. Treasury } & 850 \end{array}\]
A) $2,650
B) $2,350
C) $2,050
D) $2,300
E) $3,500
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Page 7
Chapter 6: Individual Deductions
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Q1) Andres and Lakeisha are married and file joint. Andres is 72 years old and in good health. Lakeisha is 62 years old and blind. What amount of standard deduction can Andres and Lakeisha claim this year?
A) $14,800
B) $13,600
C) $9,100
D) $12,400
E) None of these.
Q2) Taxpayers are allowed to deduct all ordinary and necessary expenses incurred in connection with determining their tax obligations imposed by federal authorities.
A)True
B)False
Q3) The medical expense deduction is designed to provide relief for doctors and medical practitioners.
A)True
B)False
Q4) All business expense deductions are claimed above the line.
A)True
B)False
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Chapter 7: Individual Income Tax Computation and Tax Credits
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Sample Questions
Q1) Which of the following represents the correct order in which credits are applied to gross tax liability (from first to last)?
A) Nonrefundable personal, business, refundable
B) Business, nonrefundable personal, refundable
C) Refundable, nonrefundable personal, business
D) Refundable, business, nonrefundable personal
Q2) John and Sally pay Janet (Sally's older sister) to watch John and Sally's child Dexter during the day. Janet cares for Dexter in her home. John and Sally may claim a child and dependent care credit based on the amount they pay Janet to care for Dexter.
A)True
B)False
Q3) Asteria earned a $25,500 salary as an employee in 2014. How much should her employer have withheld from her paycheck for FICA taxes (rounded to the nearest whole dollar amount)?
A) $370
B) $1,581
C) $1,951
D) $3,902
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Chapter 8: Business Income, Deductions, and Accounting Methods
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Q1) Shadow Services uses the accrual method and reports on a calendar year. This year Shadow agreed to a uniform cleaning contract with Odie Cleaning. Under the contract Odie bills Shadow for cleaning services as the services are provided. At year end Shadow paid Odie $2,350 for the services rendered during the year. In addition, Shadow paid Odie $700 for cleaning services expected in January of next year. What amount, if any, can Shadow deduct for the cleaning services this year?
Q2) Which of the following types of expenditures is not subject to capitalization under the UNICAP rules?
A) selling expenditures
B) cost of manufacturing labor
C) compensation of managers who supervise production
D) cost of raw materials
E) All of these are subject to capitalization under the UNICAP rules.
Q3) The 12-month rule allows taxpayers to deduct the entire amount of certain prepaid business expenses.
A)True
B)False
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Page 10
Chapter 9: Property Acquisition and Cost Recovery
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Sample Questions
Q1) Anne LLC purchased computer equipment (5-year property) on August 29 with a basis of $30,000 and used the half-year convention. During the current year, which is the fourth year Anne LLC owned the property, the property was disposed of on January 15.
Calculate the maximum depreciation expense:
A) $432
B) $1,728
C) $1,874
D) $3,456
E) None of these
Q2) Janey purchased machinery on April 8th of the current year. The relevant costs for the year are as follows: machinery for $10,000, $800 shipping, $50 for delivery insurance, $500 for installation, $750 for sales tax, $150 for the annual tune up, and $200 of property taxes (an annual tax on business property). What is Janey's tax basis for the machinery?
Q3) Depreciation is currently computed under the Modified Accelerated Cost Recovery System (MACRS).
A)True
B)False
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Chapter 10: Property Dispositions
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Sample Questions
Q1) The amount realized is the sale proceeds less the adjusted basis.
A)True
B)False
Q2) Buzz Corporation sold an office building that it used in its business for $500,000. Buzz bought the building ten years ago for $650,000 and has claimed $200,000 of depreciation expense. What is the amount and character of Buzz's gain or loss?
Q3) What is the character of land used in an active trade or business for two years?
A) Capital.
B) Ordinary.
C) §1231.
D) Investment.
E) None of these.
Q4) For corporations, §291 recaptures 20 percent of the lesser of depreciation taken or the realized gain as ordinary income.
A)True
B)False
Q5) An asset's tax adjusted basis is usually greater than its book adjusted basis.
A)True
B)False
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Chapter 11: Investments
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Q1) On January 1, 20X1, Fred purchased a corporate bond with a face value of $50,000 from the secondary market at a premium. The bond has a coupon rate of 8 percent and matures in five years. The market rate of the bond is a 6 percent annual before-tax return compounded semiannually. If Fred was trying to minimize interest income, what is the least amount of interest income Fred may report on his 20X1 tax return?
Q2) One primary difference between corporate and U.S. Treasury bonds is:
A) Treasury bonds always pay interest periodically
B) Corporate bonds always pay interest periodically
C) Interest from Treasury bonds is exempt from federal taxation
D) Interest from corporate bonds is exempt from state taxation
E) None of these
Q3) When a taxable bond is issued at a premium, the taxpayer must calculate and apply the yearly amortization amount to reduce a portion of the actual interest payments that taxpayers include in gross income.
A)True
B)False
Q4) What is the tax treatment for qualified small business stock acquired in 2014 and held for more than five years and what is the tax treatment if held for less than five years?
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Chapter 12: Compensation
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Sample Questions
Q1) Kimberly's employer provides her with a personal travel allowance of $10,000 annually. Her marginal tax rate is 30 percent. Her employer has a marginal tax rate of 35 percent. What is Kimberly's after-tax benefit, ignoring payroll taxes?
Q2) An employee's income with respect to restricted stock is the fair market value on the vesting date.
A)True
B)False
Q3) A section 83(b) election freezes the value of restricted stock for compensation purposes on the vesting date.
A)True
B)False
Q4) Rick recently received 500 shares of restricted stock from his employer, Crazy Corporation, when the share price was $5 per share. Rick's restricted shares vested three years later when the market price was $12. Rick held the shares for a little more than a year and sold them when the market price was $15. What is the amount of Rick's income on the sale of the stock? Assuming a marginal tax rate of 30 percent, what is Rick's tax on the sale of the stock?
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Chapter 13: Retirement Savings and Deferred Compensation
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Sample Questions
Q1) Which of the following best describes distributions from a defined benefit plan?
A) Distributions from defined benefit plans are fully taxable as ordinary income.
B) Distributions from defined benefit plans are partially taxable as ordinary income and partially nontaxable as a return of capital.
C) Distributions from defined benefit plans are fully taxable as capital gains.
D) Distributions from defined benefit plans are partially taxable as capital gains and partially nontaxable as a return of capital.
Q2) Taxpayers who participate in an employer-sponsored retirement plan are not allowed to deduct contributions to individual retirement accounts (IRAs) under any circumstances.
A)True
B)False
Q3) On December 1, 2014 Irene turned 71 years old. She is still working for her employer and she participates in her employer's 401(k) plan. Irene is not required to receive a minimum distribution for 2014 from her 401(k) account because she has not yet retired.
A)True
B)False
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Page 15
Chapter 14: Tax Consequences of Home Ownership
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Q1) A self-employed taxpayer reports home office expenses as for AGI deductions while employees report home office expenses as from AGI deductions.
A)True
B)False
Q2) When a taxpayer experiences a net loss from a nonresidence (rental property):
A) The taxpayer will not be allowed to deduct the loss under any circumstance if the taxpayer does not have passive income from other sources.
B) The loss is fully deductible against the taxpayer's ordinary income no matter the circumstances.
C) If the taxpayer is not an active participant in the rental, the taxpayer may be allowed to deduct the loss even if the taxpayer does not have any sources of passive income.
D) If the taxpayer is not allowed to deduct the loss due to the passive activity loss limitations, the loss is suspended and carried forward until the taxpayer generates passive income or until the taxpayer sells the property.
Q3) A tax loss from a rental home is a passive activity loss.
A)True
B)False
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Chapter 15: Entities Overview
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Q1) Tax rules require that entities be classified the same way for tax purposes as they are classified for legal purposes.
A)True
B)False
Q2) In its first year of existence Aspen Corp. (a C corporation) reported a loss for tax purposes of $50,000. In year 2, it reports a $30,000 loss. For year 3, it reports taxable income from operations of $120,000. How much tax will Aspen Corp. pay for year 3? Consult the corporate tax rate table provided to calculate your answer.
Q3) Jerry would like to organize FBC as either an LLC or as a C corporation generating an 8 percent annual before-tax rate of return on a $400,000 investment. Individual and corporate tax rates are both 35 percent and individual capital gains and dividends tax rates are 15 percent. FBC will pay out its after-tax earnings every year to either its members or its shareholders.
a. How much would Jerry keep after taxes if FBC is organized as either an LLC or as a C corporation (ignore self-employment taxes)?
b. Ignoring self-employment taxes, what are the overall tax rates (combined owner and entity level) tax rates if FBC is organized as either an LLC or as a C corporation?
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Page 17
Chapter 16: Corporate Operations
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Q1) For tax purposes, companies using nonqualified stock options deduct expenses in the year the options are exercised.
A)True
B)False
Q2) Which of the following statements regarding net operating losses generated in 2013 is true?
A) Corporations can carry net operating losses back two years and forward up to 15 years.
B) A corporation may elect to forgo carrying a net operating loss back and instead carry it over to future years.
C) When a corporation applies a net operating loss carryover, it reports a favorable, permanent book-tax difference in the amount of the applied carryover.
D) Marginal tax rates are irrelevant in determining the tax benefit of applying a net operating loss carryback or carryover.
E) None of these is a true statement.
Q3) An affiliated group must file a consolidated tax return.
A)True
B)False
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18
Chapter 17: Accounting for Income Taxes
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Q1) ASC 740 permits a corporation to net its current and long-term deferred tax liabilities.
A)True
B)False
Q2) Which of the following items is not a temporary difference?
A) Vacation pay accrued for tax purposes in a prior period is deducted in the current period
B) Tax depreciation for the period exceeds book depreciation
C) A goodwill impairment expense is recorded on the income statement; the goodwill did not have a tax basis when it was created
D) Bad debts charged off in the current period exceed the bad debts accrued in the current period
Q3) The focus of ASC 740 is the income statement.
A)True
B)False
Q4) A corporation undertakes a valuation allowance analysis to determine if a deferred tax asset should be recognized on the balance sheet.
A)True
B)False
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Page 19
Chapter 18: Corporate Taxation: Nonliquidating Distributions
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Q1) Brothers and sisters are considered "family" under the stock attribution rules that apply to stock redemptions.
A)True
B)False
Q2) Tammy owns 60 percent of the stock of Huron Corporation. Unrelated individuals own the remaining 40 percent. For a stock redemption to be treated as an exchange under the "substantially disproportionate" rule, Tammy must reduce her stock ownership to below 48 percent.
A)True
B)False
Q3) Madison Corporation reported taxable income of $400,000 in 20X3 and accrued federal income taxes of $136,000. Included in the computation of taxable income was regular depreciation of $200,000 (E&P depreciation is $60,000) and a net capital loss carryover of $20,000 from 20X2. The corporation's current earnings and profits for 20X3 would be:
A) $424,000
B) $404,000
C) $380,000
D) $344,000
Page 20
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Chapter 19: Corporate Formation, Reorganization, and Liquidation
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Q1) Which of the following statements does not describe a requirement that must be met in a tax-deferred forward triangular merger?
A) The 40 percent continuity of interest test must be met with respect to the stock transferred from the acquisition corporation to the target corporation shareholders.
B) The acquirer must hold substantially all of the target corporation's properties after the merger.
C) The continuity of business enterprise test must be met with respect to the target corporation.
D) The target corporation shareholders must receive voting stock in the acquiring corporation.
Q2) A taxpayer's tax basis in property always begins with its cost to the taxpayer. A)True B)False
Q3) Maria defers $100 of gain realized in a section 351 transaction. The stock she receives in the exchange has a fair market value of $500. Maria's tax basis in the stock will be $400.
A)True B)False
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Chapter 20: Forming and Operating Partnerships
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Q1) Fred has a 45% profits interest and 30% capital interest in the SAP Partnership and his tax basis before considering his share of SAP's current year loss is $11,000. Included in his tax basis is a $2,600 share of recourse debt and $5,300 share of nonrecourse debt. Fred is a limited partner in SAP. He is not involved in any other activities. If SAP has a $15,000 ordinary loss for the year, how much of the loss can be deducted currently, and how much of the loss is suspended because of the tax basis, the at-risk, and the passive activity loss limitations?
Q2) Nonrecourse debt is generally allocated according to the profit-sharing ratios of the partnership.
A)True
B)False
Q3) Which of the following does not represent a tax election available to either partners or partnerships?
A) Electing to change an accounting method
B) Electing to amortize organization costs
C) Electing to expense a portion of syndication costs
D) Electing to immediately expense depreciable property under Section 179
Q4) What general accounting methods may be used by a partnership and how and by whom are they selected?
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Chapter 21: Dispositions of Partnership Interests and Partnership Distributions
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Q1) Victor is a 1/3 partner in the VRX partnership with an outside basis of $156,000 on January 1. Victor sells his partnership interest to Raj on January 1st for $200,000 cash. The VRX Partnership has the following assets and no liabilities as of January 1: \[\begin{array} { l r r } & \underline { \text { Basis } } & \underline { \text { FMV } } \\
\text { Cash } & \$ 27,000 & \$ 27,000 \\
\text { Accounts receivable } & - \mathbf { 0 }- & \mathbf { 1 8 , 0 0 0 } \\
\text { Inventory } & \mathbf { 1 0 3 , 5 0 0 } & \mathbf { 1 2 1 , 5 0 0 } \\
\text { Equipment } & \mathbf { 2 7 0 , 0 0 0 } & \mathbf { 3 3 7 , 5 0 0 } \\
\text { Stock investment } & \underline { \mathbf { 6 7 , 5 0 0 } } & \underline { \mathbf { 9 6 , 0 0 0 } } \\
\text { Totals } & \underline { \mathbf { \$ 4 68 , 0 0 0 } } & \underline { \$ 600,000 } \end{array}\] The equipment was purchased for $360,000 and the partnership has taken $90,000 of depreciation. The stock was purchased 7 years ago. What is the amount and character of Victor's gain or loss on the sale of his partnership interest?
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Page 23
Chapter 22: S Corporations
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Q1) Hector formed H Corporation as a C corporation at the beginning of 2014. Hector was the sole shareholder of H Corporation. H Corp. reported 2014 taxable income (and earnings and profits) of $200,000. At the beginning of 2015, H Corp. elected S corporation status. During 2015, H Corp. had a rough year, reporting an ordinary business loss of $70,000, $4,000 of dividend income, and $3,000 of interest income. H Corp. also distributed $15,000 to Hector. What is the amount and character of gain/income Hector must recognize on the distribution (if any)? What is the balance in H Corporation's accumulated adjustments account (AAA) at the end of 2015?
Q2) An S corporation can make a voluntary revocation of an S election if shareholders holding more than 25 percent of the S corporation stock (including nonvoting shares) agree.
A)True
B)False
Q3) An S corporation can use a non-calendar year-end if it can establish a business purpose for an alternative year end.
A)True
B)False
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Page 24
Chapter 23: State and Local Taxes
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Q1) Assume Tennis Pro discovered that one salesman has gone into Arkansas once each year of the past 4 years and performed activities creating both sales and use tax nexus and income tax nexus. Assume that Arkansas sales were $25,000 each year. Assume that Arkansas business income would be 200,000 each year and that Tennis Pro's Arkansas apportionment percentage would be 1 percent. Assume there would be no Arkansas nonbusiness income. Assume that Arkansas sales and use tax rate was 6.5 percent and corporate income tax rate was 5 percent. What would Tennis Pro's Arkansas sales and use tax and income tax liability be ignoring any possible penalties and interest?
Q2) A gross receipts tax is subject to Public Law 86-272. A)True B)False
Q3) Gordon operates the Tennis Pro Shop in Blacksburg, Virginia. The Shop sells, manufacturers, and customizes tennis racquets for serious amateurs. Virginia has a 5 percent sales tax. Determine the sales and use tax liability that the Shop must collect and remit if it sells a $500 racquet to a Tennessee customer that purchases the merchandise in the retail store?
Q4) The annual value of rented property is included in the property factor. A)True B)False
Page 25
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Chapter 24: The Us Taxation of Multinational Transactions
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Q1) Which of the following income earned by a controlled foreign corporation incorporated in Spain is not foreign personal holding company income?
A) Interest income received from a loan to an unrelated party
B) Dividend income from a five percent investment in an unrelated corporation
C) Rent received from a passive investment in an apartment complex
D) Gross profit from the manufacture and sale of inventory to an unrelated party
Q2) Natsumi is a citizen and resident of Japan. She has a full-time job in Japan and has lived there with her family for the past 20 years. In 2012, Natsumi came to the United States on business and stayed for 240 days. She came to the United States again on business in 2013 and stayed for 120 days. In 2014 she came back to the United States on business and stayed for 120 days. Does Natsumi meet the U.S. statutory definition of a resident alien in 2014 under the substantial presence test?
Q3) Under most U.S. treaties, a resident of the other country must have a permanent establishment in the United States before being subject to U.S. taxation on business profits earned within the United States.
A)True B)False
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Chapter 25: Transfer Taxes and Wealth Planning of the Cfa Institute
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Q1) Adjusted taxable gifts are added to the taxable estate to accomplish which of the following objectives?
A) Prevent double taxation of previously taxed gifts.
B) Increase the marginal tax rate on previously taxed gifts.
C) Increase the marginal tax rate on the taxable estate.
D) Remove inter vivos transfers from cumulative taxable transfers.
E) None of these.
Q2) For 2014, the exemption equivalent for the estate tax is $5.34 million.
A)True
B)False
Q3) The tax on cumulative taxable gifts is reduced by the unified credit regardless of whether any unified credit was used in prior years.
A)True
B)False
Q4) Grace transferred $800,000 into trust with the income to be paid annually to her spouse, Isaiah, for life and the remainder to Taylor. Calculate the amount of the taxable gifts from the transfers.
Q5) Ricardo transferred $1,000,000 of cash to State University for a new sports complex. Calculate the amount of the taxable gift.
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