University of Wisconsin Parkside School of Business and Technology

Dr. R. Zameeruddin

INDIVIDUAL TAXATION, ACCT 305 PRACTICE FINAL EXAM

Name _______________________

MULTIPLE CHOICE
1. Jeanne had an accident while hiking on vacation. She sustained nose injuries that required cosmetic surgery. While having the surgery done to restore her appearance, she had additional surgery done to reshape her chin, which was not injured in the accident. The surgery to restore her appearance cost $15,000 and the surgery to reshape her chin cost $4,000. How much of Jeanne’s surgical fees will qualify as a deductible medical expense (before application of the 7.5% limitation)? a. $0. b. $4,000. c. $15,000. d. $19,000. e. None of the above.

ANS: C Cosmetic surgery is necessary (and therefore deductible) when it ameliorates (1) a deformity arising from a congenital abnormality, (2) a personal injury, or (3) a disfiguring disease. The $15,000 cost incurred in connection with the restorative surgery (required as a result of the accident) is deductible because the surgery was necessary. Amounts paid for the unnecessary cosmetic surgery ($4,000 for reshaping the chin) are not deductible as a medical expense. PTS: 1 REF: Example 2 | Example 3

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2.

Fred and Lucy are married and together have AGI of $120,000 in 2007. They have four dependents and file a joint return. They pay $5,000 for a high deductible health insurance policy and contribute $2,600 to a qualified Health Savings Account. During the year, they paid the following amounts for medical care: $9,200 in doctor and dentist bills and hospital expenses, and $3,000 for prescribed medicine and drugs. In October 2007, they received an insurance reimbursement of $4,400 for hospitalization. They expect to receive an additional reimbursement of $1,000 in January 2008. Determine the maximum deduction allowable for medical expenses in 2007. a. $1,100. b. $3,800. c. $9,200. d. $12,800. e. None of the above.

ANS: B Fred and Lucy can claim a medical expense deduction for the current year of $3,800, determined as follows: Physician bills, dentist bills, and hospital expenses Less: Reimbursement Unreimbursed expenses Health insurance premiums Prescribed medicines and drugs Total medical expenses Less: 7.5% of $120,000 (AGI) Deductible medical expenses $ 9,200 (4,400) $ 4,800 5,000 3,000 $12,800 (9,000) $ 3,800

The contribution of $2,600 to the HSA is a deduction for AGI, and is not included in the medical expense calculation. PTS: 1 REF: p. 10-2 | p. 10-3 | p. 10-7 to 10-10 | Example 12 | Example 15

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10-3 | Example 4 4 . $5. Liz made the following payments to Granite Falls on behalf of Art: Room at Granite Falls Meals for Art Doctor and nurse fees Cable TV service for Art’s room Total $36. Liz’s 84-year-old dependent grandfather. Liz.610). Disregarding the 7.300 + $7. PTS: 1 REF: p. None of the above. c. travels frequently on business.830 Granite Falls has medical staff in residence. how much.260 + $5. Art. if any. $41.170 ($36. who is single. The cable TV fee is a personal expense. b. e.300 7. $49.830.170. The room and board for Granite Falls qualifies because the move was motivated by Art’s need for medical care.610 660 $49. ANS: C The amount that qualifies for the medical expense deduction is $49. $49.3. lived with Liz until this year when he moved to Granite Falls Nursing Home because he needs daily medical and nursing care.5% floor. During the year.260 5.910. d. of these expenses qualifies for a medical expense deduction by Liz? a.610.

4.000.000.500 to widen the hallways to accommodate his wheelchair. installing support bars and railings in bathrooms and other rooms.500). Phillip’s medical expense related to the ramp and hallways is $14. The increase in the value of the residence as a result of the room addition was determined to be $17. d.000 (7. 10-4 | p.5% × $100. ANS: C A capital improvement that ordinarily would not have a medical purpose qualifies as a medical expense if it is directly related to prescribed medical care and is deductible to the extent that the expenditure exceeds the increase in value of the related property.000) Less: 7. elevators. His physician advised him to add a first-floor bedroom to his home. widening hallways and doorways to accommodate wheelchairs. $21. Examples of such improvements include dust elimination systems.000). In addition.500 + $8. e.500 to construct an entrance ramp to his home and $8.000 – $17. The cost of constructing the room was $32. These expenditures are subject to the 7.000.000. Phillip’s AGI for the year was $100. The full cost of home-related capital expenditures incurred to enable a physically handicapped individual to live independently and productively qualifies as a medical expense.000 ($5. Phillip paid the contractor $5.000 + $14. 10-5 | Example 6 $29. and adjusting electrical outlets and fixtures. $14. c.000.000. Phillip developed hip problems and was unable to climb the stairs to reach his second-floor bedroom.500) $21. $29.5% floor only. b. and a room built to house an iron lung. and the increase in the home’s value is deemed to be zero. So Phillip’s medical expense deduction is as follows: Qualifying medical expenses ($15. Qualifying costs include expenditures for constructing entrance and exit ramps to the residence. Phillip’s medical expense related to the room addition is $15. How much of these expenditures can Phillip deduct as a medical expense? a.000 ($32. None of the above. $15.000 Deductible medical expenses PTS: 1 REF: p.500.500 5 .

000 – $129.000) increase in the value of the house.500 6 . 10-4 | p. c.200 1.5%)].000.000 after. 10-5 | Exhibit 10-1 $ 2.000 + $680) qualifies as medical expenses. Ed’s daughter who would otherwise qualify as his dependent. b. is physically handicapped as a result of a diving accident. ANS: C Ed may claim the medical expenses he paid on behalf of Marilyn. $30. he modifies his personal residence at a cost of $30.680. filed a joint return with her husband Henry.5. Quinn. This exception applies if the gross income and/or joint return tests are the only reasons why a person cannot be otherwise claimed as a dependent.500 – ($150. b. c.680. As a result of the operation of the stairway lift. The additional operating expenses of $680 are deductible as a medical expense.250. the $30. $0. Ed.000 × 7. So $30. who had AGI of $150. Therefore.250 [$12.680 ($30. PTS: 1 REF: p. e. 10-4 | p. $1. even though Marilyn cannot be claimed as his dependent. d.880. who is physically handicapped. $12. None of the above. installing support bars in the bathroom and kitchen. PTS: 1 REF: p.000. Disregarding percentage limitations. The modifications included widening halls and doorways for a wheelchair. Quinn pays $200 for an appraisal that places the value of the residence at $129.350 350 550 650 $12. and rewiring so he could reach electrical outlets and appliances. modified his residence so he could live independently. Marilyn. The $200 appraisal fee is not deductible as a medical expense. $34.000 ($140.900 500 6. but rather as a miscellaneous itemized deduction subject to the 2% of AGI floor.500. $11. e. 10-5 6. installing a stairway lift. $50. In order to live independently.000 before the improvements and $140.880. ANS: B Quinn. Ed’s medical expense deduction is $1.000 cost of the improvements is not reduced by the $11. None of the above. how much of the above expenditures qualify as medical expense deductions? a. incurred the following expenses: Laser surgery to correct Marilyn’s vision problem Marilyn’s prescribed medicines Ed’s doctor and dentist bills Prescribed drugs for Ed Contact lenses for Ed Cost of program for Ed to stop smoking Weight reduction program for Ed (related to obesity) Total Ed has a medical expense deduction of: a. Quinn experienced an increase of $680 in his utility bills for the current year. $30. All of the listed expenditures qualify. who is single and lives alone. d.

who is self-employed. he may deduct $3. Scotty itemized deductions in 2006. c. e. Which of the following statements best explains why Scotty is not required to report the reimbursement in gross income? a. Which of the following statements is true? a. Whether he itemized in 2007 will have no impact on the treatment of the reimbursement. If Boris is self-employed. If Boris is an employee. c.800) as a deduction for AGI. he may deduct $7. he can exclude the reimbursement from gross income in 2007. PTS: 1 REF: Example 12 8.800 as a deduction for AGI. he must report the reimbursement as gross income in 2007 to the extent he received a tax benefit from deducting medical expenses in 2006. In 2007.7. In addition. Scotty itemized deductions in 2007. If Boris is self-employed. b.800 as a deduction for AGI. d. ANS: A Boris. d. None of the above. e.000 as a deduction for AGI and may include the $4. Scotty itemized deductions in 2007 but not in 2006.800 premium when calculating his medical expense deduction.000 to a Health Savings Account. may deduct 100% of the premium ($4. ANS: B If Scotty did not itemize in 2006. If Scotty itemized deductions in 2006. Scotty did not itemize deductions in 2007. Scotty did not itemize deductions in 2006.000 HSA contribution as a deduction for AGI.800 premium for high-deductible medical insurance for himself and his family. He may also deduct the $3. PTS: 1 REF: Example 15 7 . If Boris is an employee. he may deduct $7. b. he contributes $3. Boris pays a $4.800 when calculating his medical expense deduction. Your friend Scotty informs you that he received a “tax-free” reimbursement in 2007 of some medical expenses he paid in 2006. he may include $7.

100 + $1. None of the above. $3.800 1.850. The total itemized deductions are $6. he files his state return for 2007 claiming a refund of $800.150 8 . b.550 $4.100 1. paying an additional $600 in state income taxes. 2008. how much may Brad claim as a deduction for state income taxes on his Federal income tax return for calendar year 2007 (filed in April 2008)? a. His deduction is limited to the amounts paid in 2007. 2007. Brad. The $800 refund is reported as income in 2008 under the tax benefit rule. 10-13 $ 600 3.650. who uses the cash method of accounting.800 + $1. During 2007. The state sales tax ($1. If he itemizes deductions. lives in a state that imposes an income tax (including withholding from wages). On April 14.750 300 475 What is the maximum amount Hugh can claim as taxes in itemizing deductions from AGI? a. he files his state return for 2006. 2007. $4. $8. ANS: B State sales taxes ($1. so Hugh should choose to deduct the sales tax rather than the state income tax. Brad’s state income tax deduction for 2007 is determined as follows: Paid April 14.600.150. for 2006 Withholdings for 2007 Total deduction PTS: 1 REF: p.550. During the current year. d. On April 13. ANS: C Brad is a cash basis taxpayer. 2008. $7. $5. PTS: 1 REF: p.150.700).350.9.200 1. $6.800 + $1. b.650 ($3. None of the above.750) and the real estate taxes ($3. $6. The state occupational license fee ($300) and the tax on his business use auto ($475) are deductible for AGI as business expenses. paid the following amounts: Real estate tax on Iowa residence State income tax Real estate taxes on land in Puerto Rico (held as an investment) Gift tax paid on gift to daughter State sales taxes State occupational license fee Property tax on value of his automobile (used 100% for business) $3. Brad receives the refund on August 3.100) are deductible as itemized deductions. c. d. e. $3.750) are more than the state income tax ($1.550. his withholdings for state income tax purposes amount to $3. The gift tax is not deductible. c.750).625. 10-11 to 10-13 | Exhibit 10-2 10. e. a self-employed individual. Hugh.700 1.

e. 2008. How much of the interest can Chickadee Corporation deduct in 2007? a. each loans the corporation $10. while Chickadee Corporation is on the accrual method. who are brothers. Chickadee repays the loans of $20.000. Consequently. are equal owners in Chickadee Corporation. d. $500.11. Under § 267.000 together with the specified interest of $2. PTS: 1 REF: p. c. $2.000.000 at annual interest of 10%. None of the above. ANS: A Chickadee Corporation can deduct interest expense of $2. 2007.000 in 2008 and $0 in 2007.000. Barry and Larry. b. Both shareholders are on the cash method of accounting. 10-18 9 . On June 30. Barry and Larry are regarded as related to the corporation. the deductibility must await actual payment (in 2008). All parties use the calendar year for tax purposes. $0. On July 1. $1.

500. b.500.500 (5. Tony paid $3.400 3.500 net capital gain as investment income. a. $13.500 would be disallowed: Total investment interest expense Less: Net investment income Investment interest disallowed in 2007 $95.000 for a loan made to him in 2007 to purchase a parcel of unimproved land. or (2) $2. In addition to $1. His income from investments [dividends (not qualified) and interest] totaled $18. After reducing his miscellaneous deductions by the applicable 2% floor. $18. He has investment interest expense of $95. None of the above.000.000.400 of investment expenses included in miscellaneous deductions.800. and $77.000 4.500 net capital gain. e.000.500 *Net capital gain generally is not included in investment income. The beneficial alternative tax on net capital gain will not apply to the $4. 10-14 to 10-16 10 .600 of real estate taxes on the unimproved land.000 (17. c. Calculate Tony’s maximum investment interest deduction for 2007. In order to maximize his investment interest deduction.600 $5. the amount of investment expenses included in the total of miscellaneous itemized deductions subject to the 2% of AGI floor.500 The amount of investment interest disallowed may be carried over and becomes investment interest expense in the subsequent year subject to the net investment income limitation in that later year. Investment expenses Plus: Real property taxes on unimproved land Total investment expenses $1. Tony may elect to treat the $4. and thereby increase the deduction for investment interest by that amount. d.000 Tony’s investment interest expense deduction for 2007 is limited to $17. PTS: 1 REF: p. the amount of miscellaneous expenses deductible after the 2% of AGI floor is applied. Tony also has a $4. the amount of net investment income. ANS: C Tony’s net investment income in 2007 is computed as follows: Income from investments: Interest and dividends Long-term capital gain* Less: Investment expenses** Net investment income $18.500 net long-term capital gain from the sale of another parcel of unimproved land.800. however.000.000) $17. Tony is married and files a joint tax return for 2007.400.12. $95. **The amount of investment expenses is calculated as follows: The smaller of (1) $1.500) $77. the deductible portion amounted to $2. $17.

ANS: B The taxpayer’s donation of $1.000 is deductible as home equity interest. c.000. 10-20 11 . they took out a home equity loan for $220.000 is a personal expense that cannot be deducted as a charitable contribution.000). $1.000 for married persons filing separate returns). b.000 in lieu of the normal $200 registration fee would be deductible to the extent of $800 [$1. $7.000. $50.000 home equity loan that does not exceed the lesser of: • • The fair market value of the residence.000 and they owed $250. They used the funds to purchase a single engine airplane to be used for recreational travel purposes. e. What is the maximum amount of debt on which they can deduct home equity interest? a.000 FMV – $250. c. $220.000. $800. $100.000 home equity loan. e. None of the above.000 acquisition indebtedness = $200. Pedro paid the regular tuition of $6. Joseph and Sandra.800.13.000. Pedro’s child attends a school operated by the church the family attends. The tuition of $6.000 to the school. b. PTS: 1 REF: p.000 on the mortgage. took out a mortgage on their home for $350. In May of 2007.000 – $200 benefit received (the registration fee)].000. PTS: 1 REF: p. In addition. ANS: B Interest is deductible only on the portion of the $220.000 to the church in lieu of the normal registration fee of $200. $0. $6. Pedro made a donation of $1. married taxpayers. $230. d. reduced by the acquisition indebtedness ($450.000 ($50.000. $100. what is Pedro’s charitable contribution? a. when the home had a fair market value of $450. 10-16 | Example 25 14.000 in 1989.000. interest on $100. Based on this information. Of the $220. d.

None of the above. PTS: 1 REF: p. Roseann’s charitable contribution deduction for 2007 is: a. $2.800.000 + $1. $3. e. $10. $24.500 of her contributed services.500 Fair Market Value $ 2.200.15. Disregarding percentage limitations.100. However. who lives in Indiana.600 15. $25. e.000 The ABC stock and the inventory were given to Roseann’s church.500. Roseann makes the following donations to qualified charitable organizations: Inventory held for resale in Roseann’s business (a sole proprietorship) Stock in ABC.000). volunteered to travel to Louisiana in March to work on a homebuilding project for Habitat for Humanity (a qualified charitable organization). 10-23 to 10-25 12 . The comic book collection comes under the tangible personalty exception. d. $2. c.500 = $19.600 + $15. ANS: B Inventory is ordinary income property. $19. In 2007.200 for lodging.200 ($600 for transportation.000 7. $600. b. Since a sale of the ABC stock would have yielded a long-term capital gain. c. ANS: D Emily cannot deduct the estimated value of $1. What is Emily’s deduction associated with this charitable activity? a. In addition. and the adjusted basis ($1. she can deduct out-of-pocket costs of $2. d. $1.000 1. She was in Louisiana for three weeks. $1.000.000 6.600) must be used if lower than the basis ($3. Both donees promptly sold the property for the stated fair market value.200. and the comic book collection was given to the United Way. and $400 for meals. She normally makes $500 per week as a carpenter’s assistant and plans to deduct $1. Emily. Thus. the full fair market value qualifies for the deduction ($15. $1.600. Stock is intangible property and is not subject to the tangible personalty rules. held as an investment (acquired two years ago) Comic book collection held as an investment (acquired six years ago) Basis $3. PTS: 1 REF: p. Inc.500 as a charitable contribution. but the fair market value ($2.000). b.100. she incurred the following costs in connection with the trip: $600 for transportation.500) must be used. 10-21 16. and $400 for meals).200 for lodging. $1.700.

$24. $84. Since short-term capital gain property is treated as ordinary income property for charitable contribution purposes. 2007).100 if she had sold the property. e.000 if the reduced deduction election is not made. Karen’s AGI is $450. d. $100. Rosie would have recognized a short-term capital gain of $8. In most instances.000. the city of Terre Haute sold the land for $210. c.000 (cash) + $135. made the following donations to qualified charitable organizations in 2007: Cash donation to Indiana State University Unimproved land to the city of Terre Haute.000 if the reduced deduction election is not made.000 The land had been held as an investment and was acquired 4 years ago. The carryover to the next five years is $75.000 if the reduced deduction election is made.200 when she made the donation? a. b. Karen. If the reduced deduction election is made. e. None of the above.000 AGI. $8. PTS: 1 REF: Example 32 18.100 on October 22. d. 2006 September 6.000. Since she had not held the property long enough to meet the long-term capital gain requirement (October 22. The long-term capital gain property is limited to 30% of $450. $20. 2007. a calendar year taxpayer. $165.000 210.000 if the reduced deduction election is not made. the deduction is limited to the adjusted basis of the property to the donor.200. Indiana Basis $30.000 (FMV of the land) – $135. c.000 (deduction allowed for 2007)].000 (cash) + $70.150.000 [$210.100. Shortly after receipt. Rosie’s charitable contribution deduction is limited to the property’s adjusted basis of $20.000 Fair Market Value $ 30. $170. b.000 AGI) = $165. or $135. $28.000.100. Rosie owned stock in Acme Corporation that she donated to a university (a qualified charitable organization) on September 6. 10-24 to 10-26 | Example 35 | Example 36 13 . What is the amount of Rosie’s charitable contribution deduction assuming that she had purchased the stock for $20. ANS: B If ordinary income property is contributed to a qualified charitable organization.100.000 [$30. ANS: C $30. 2006. PTS: 1 REF: p.000. the deduction becomes $100. The allowable charitable contribution deduction is: a.000 (30% × $450.17. and the stock had a value of $28.000 (basis of land)]. None of the above.000 70. the deduction is equal to the fair market value of the property less the amount of ordinary income that would have been reported if the property were sold.

In the year of her death. Roger is considering making a $3. by how much will Roger’s tax liability decline because of the investment? a. $1.000 investment in a venture that its promoter promises will generate immediate tax benefits for him.000 [$150. e.000. b. By making the reduced deduction election. ANS: D REF: Exhibit 12-1 14 . the charitable deduction on Pat’s final return is increased by $60. how much of the charitable contribution should Pat’s executor deduct? a.000 (fair market value of the Coyote Corporation stock) – $90.000 (allowed under the reduced deduction election) – $90.000 (30% of $300. c.000 × 40%). $90. $1.000 AGI). Tax credit for rehabilitation expenses.000 appreciation [$180.200. the executor must forgo a deduction of the $30. Credit for certain retirement plan contributions. In completing her final income tax return.000 (50% of $300.000 [$180. Thus. who does not anticipate itemizing his deductions.000 (allowed under the general rule)].000 (cost)] of the stock. e. d. PTS: 1 REF: p. $210.000. Before she died.000. PTS: 1 REF: p.000. The stock was worth $180.000. e. Refundable tax credits include the: a.000 shares of stock in Coyote Corporation (a publicly traded corporation) to her church (a qualified charitable organization).19. $180. Pat died in 2007. If the investment is of a type that produces a tax credit of 40% of the amount of the expenditure. which moves the longterm capital gain property from the 30% limitation to the 50% limitation with no further carryover.000 (fair market value) – $150. ANS: B Under the general rule concerning long-term capital gain property. d.000 and she had acquired it as an investment four years ago at a cost of $150.200 ($3. Pat had AGI of $300. Pat’s executor can. Earned income credit. None of the above. $0. None of the above. b. 10-26 | Example 46 20. Pat’s executor could deduct $90. ANS: D The tax credit reduces Roger’s tax liability by $1. c. d. c. $150. Roger. Foreign tax credit.100.000 (current deduction)] would be lost because there is no five-year carryover period in Pat’s case. is in the 30% marginal income tax bracket. b.000.000 AGI). 12-4 | Example 4 21. None of the above. To do so. however. Pat gave 5. The remaining $90. $900. make the reduced deduction election. the charitable contribution deduction on Pat’s final income tax return becomes $150.

Unused amounts are first carried back one year and then forward for 20 years.000 8. 12-6 23. Unused amounts are carried forward for five years. her business generates an additional $30.000 15. $23.000 15.000 10.000 In the current year. $28. ANS: B REF: p.22. c. None of the above.000) $28. how much of the general business credit generated in 2007 is available for future years? a. ANS: D Total credit allowed in 2007 (based on tax liability) Utilization of carryovers: 2003 2004 2005 2006 Remaining credit allowed: Utilization of current year credit Carryover of unused current year general business credit General business credit generated in 2007 Applied against 2007 general business credit Unused 2007 amount available for carry forward to 2008 PTS: 1 REF: p. Molly has generated general business credits over the years that have not been utilized.000) $ 2. c. After utilizing the carryforwards and the current year credits.000 (38. Unused amounts are first carried back one year and then forward for 15 years. 12-6 | Example 8 $40.000. $2.000.000 $ 5. based on her tax liability before credits.000 (2. she can utilize a general business credit of up to $40. e.000. 2007. $0. Which of the following best describes the treatment applicable to unused business credits? a. b.000 8. Unused amounts are carried forward indefinitely.000. e.000 10. b. d. In 2007. The amounts generated and not utilized follow: 2003 2004 2005 2006 $ 5.000 15 . None of the above.000 general business credit.000 $30. d.

No recapture provisions apply. Black Company’s deduction for wages for the year is: a.g.000. The cost of facilities related to the building (e. ANS: D REF: p.24. b. Three and one-half years ago she incurred qualifying rehabilitation expenditures of $200.000. b. ANS: B $164. In the current year.000 × 40%)]. $12. None of the above. c. $164. $140. d. d.000. ANS: B $8. e. No credit is allowed for the rehabilitation of personal use property. e. c.000 was qualified wages for the work opportunity tax credit under the general rules.000 = [$180. a. $16. Shirley sold the property in a taxable transaction. $0.000. a parking lot) is a qualifying expenditure.000 = 40%($200. c.000. $180. $166.000. 12-9 | Example 11 16 . Which of the following correctly describes the tax credit for rehabilitation expenditures? a. PTS: 1 REF: Table 12-1 | Example 10 26. PTS: 1 REF: p. of which $40. b. Calculate the amount of the recapture of the tax credit for rehabilitation expenditures. Several years ago. d.000 × 10%). The cost of enlarging any existing business building is a qualifying expenditure. None of the above.. 12-8 25.000. $8.000. Black Company paid wages of $180.000 – ($40. 12-7 | p. None of the above. The structure was held for more than 3 years but less than 4 years. e.000.000 that was originally placed in service in 1929. Shirley purchased a structure for $150.

$9. c. $4. PTS: 1 REF: p. while the 2008 credit amount is $4. d. $8. Green Company.500 (50% × $9.000 – $250) × 50%. $4. Each employee was paid $11. PTS: 1 REF: p. 12-10 | Example 13 28. incurs $8. PTS: 1 REF: p. $8. they also can be expensed in the year incurred (option b.000 in 2007.875 = ($8. None of the above.000 wages × 1 employee). All corporations qualify for the basic research credit.). plus 50% of the first $10.000 of expenditures that qualify for the disabled access credit. $3. e. Only one of the individuals continued to work for Gray Corporation in 2008. and the energy research credit (option a. earning $9. c. S corporations and personal service corporations do not qualify for the basic research credit (option d. $8. ANS: B The maximum work opportunity tax credit in this case is 40% of the first $10. b. the basic research credit. in the renovation of its building. or the energy research credit. $3.000 during the year.000 in 2008. Which.000 (40% × $10. d. the basic research credit. Therefore. In March 2007.000 in 2007.27. $4. Gray Corporation hired two individuals. The research activities credit is the greater of the incremental research credit.000 in 2008.000 in 2007. both of whom were certified as long-term recipients of family assistance benefits.750. The disabled access credit is: a. Qualifying expenditures not only are eligible for the credit. 12-10 to 12-12 29.500 in 2008.750. the 2007 credit amount is $8. None of the above. c. No additional workers were hired in 2008. None of the above.000 in 2008. if any.875.000 wages × 2 employees). ANS: C The research activities credit is the sum of the incremental research credit. no deduction is allowed for research and experimentation expenditures. e. 12-13 17 . $4.000. Gray Corporation’s work opportunity tax credit amounts for 2007 and 2008 are: a. b. $7. The credit is not available for research conducted outside the United States. of the following correctly describes the research activities credit? a.000 in 2007.). d. b. ANS: C $3.).000 of qualified wages per employee paid in the first year of employment. e.000 during 2007.000 of qualified wages per employee paid in the second year of employment. If the research activities credit is claimed. $5.

$0.000. received interest income of $200.98%] Allowable earned income credit PTS: 1 REF: p. During 2007. Michelle (age 7) and Nancy (age 5). $2.853.276 32.790 × 40%) Less: Phaseout [($20. Their earned income credit for the year is: a. Rex and Dena are married and have two children.390 × 34%) Less: Phaseout [($19.390) × 21.200* – $17. 12-15 and 12-16 | Table 12-2 $4. c.000 – $15. e. George. She qualifies for an earned income credit of the following amount: a. $1.390 × 34%) Less: Phaseout [($26. $2. $2. Dena had $0 gross income. Rex earned a salary of $20.408.408) $1. e. b.124 31. Their earned income credit for the year is: a. d.853 (1. ANS: C Maximum earned income credit ($8.716 (592) $4. $577. Cheryl is single. Barry earned a salary of $26. $0. d.390) × 15.200). $1. $592. have one child. None of the above. Her salary for the year is $19. $0.000) or AGI ($26. c.000 and they received interest income of $200.276. None of the above.98%] Allowable earned income credit * The greater of earned income ($26. $4. has one child (age 6). 12-15 and 12-16 | Table 12-2 $2. ANS: C Maximum earned income credit ($11.853 (577) $2. d.390) × 15. b. e.30. 12-15 and 12-16 | Table 12-2 $2. ANS: C Maximum earned income credit ($8. c. PTS: 1 REF: p. Barry and Susan. During 2007. and files as head of household during 2007.445.000. and filed a joint income tax return. b.716. $4. who are married and file a joint return.124.445 18 .06%] Allowable earned income credit PTS: 1 REF: p. None of the above.853.200 – $17.

the adoption expenses credit is $11. 12-19 | Example 25 35.390 in 2007.300 of adoption expenses. ANS: B The overall limitation is [($300. The U.000. Also. or $102. The foreign-source income generates foreign income taxes of $100. Purple Corporation (a U.S. Juan and Juanita incur $7.000/$1.000. $102. $375.125.33. $1. In 2006. During the year.000 and foreign income of $300. they incur another $4. Which of the following choices properly reflects the amounts and years in which the adoption expenses credit is available.200. The adoption becomes final in 2007.000. $100.000 and have adjusted gross income of $11.-source income of $900.S. d. 12-20 | Example 26 19 . George and Jill are husband and wife. None of the above. $450.000 (Social Security benefits) – $500 (one-half of adjusted gross income in excess of $10.S.000. Assuming they file a joint return.000. 12-18 | p.000 × 15% = $450. they receive Social Security benefits of $4. the adoption expenses credit must be claimed in the year following the year the expense is paid.000. b.300 b. e.390 in 2007. During the year.000) = $3. Corporation) has U. ages 67 and 65 respectively. Purple Corporation’s foreign tax credit is: a. None of the above. c. income tax before the foreign tax credit is $408. None $10. However. 12-17 | p. Over the next year. 2006 2007 a. None of the above. ANS: C $7. PTS: 1 REF: p. b. PTS: 1 REF: p. ANS: E For qualifying adoption expenses paid or incurred in a tax year prior to the year when the adoption is finalized.000) × $408. None $11. $7.200 $ 4.000.390 e. their tax credit for the elderly. PTS: 1 REF: p. d.000. $136.000.200 in legal and adoption fees directly related to the adoption of an infant son born in a nearby state. $75. Thus. $7.960 c. the foreign tax credit cannot exceed the amount of foreign taxes paid ($100.500 d.000 $ 4. before considering any possible limitation due to their tax liability. e.500 (base amount) – $4. the total amount of the credit cannot exceed $11. is: a. 12-18 | Example 24 34. c. $750.000).000].

550 ($2. 12-22 20 . Which of the following statements regarding the adoption expenses credit is not true? a. 12-20 37. c. $2. ANS: D In 2007. ages 10 and 8 as dependents. the child tax credit is $1. $1. c. All of the above statements are true.820.000. unmarried. Assuming their AGI is $118.000 per eligible child in 2007. pays Heloise (a housekeeper) $4. e.200.000. None of the above. Caleb and Zoe’s child tax credit is: a.900 to care for his physically incapacitated mother so that he can be gainfully employed.000 maximum credit – $450 reduction). $0. Tom may claim a credit for child and dependent care expenses of: a. For married taxpayers. the credit reduction is $50 for every $1. The maximum credit must be reduced for higher-income taxpayers.000. b.000 and claims his mother as a dependent. b.550. $450. c. PTS: 1 REF: p.390. Therefore. d. e. $660. The adoption expenses credit is limited to no more than $10. 12-21 | Example 28 38. The adoption expenses credit starts to be phased out in 2007 beginning when a taxpayer’s modified AGI exceeds $170. d. d.36. ANS: C The maximum child tax credit is $1. Tom. $0.000)/$1.000. PTS: 1 REF: p. 12-21 | p.000 per dependent child under age 17. resulting in a reduction of $450 [($118. No adoption expenses credit is a available in 2007 if a taxpayer’s modified AGI exceeds $210. PTS: 1 REF: p.078. b.000 (rounded to 9) × $50] for Caleb and Zoe. $1.000 (or part thereof) of AGI above the threshold amount $110. not $10.050.820. He has AGI of $40. The adoption expenses credit is a nonrefundable credit. e. $1.200 – $110. None of the above. Caleb and Zoe are married and file a joint tax return claiming their two children. the credit is limited to no more than the indexed amount of $11. ANS: B $660 = 22% × $3.

050 $2.250 for each semester during 2007. If a taxpayer’s adjusted gross income exceeds $43. Devona’s qualifying tuition expenses and fees total $3.100) + (50% × $1.250 e.000 $2.500 for the fall semester.000.39. All of the above are correct. $2.650 b.000. PTS: 1 REF: p.250 d. c. The HOPE scholarship and lifetime learning credits available to Jermaine and Kesha for 2007 are: HOPE scholarship credit a. None of the above. the rate for the credit for child and dependent care expenses is 20%. Which of the following statements concerning the credit for child and dependent care expenses is not correct? a. $2. while Arethia’s qualifying tuition expenses and fees total $5. Jermaine and Kesha are married. If a taxpayer’s adjusted gross income exceeds $15.625 $5.000.000 for the lifetime learning credit (20% × $10. 12-24 | Example 32 21 .000 but is less than $17.650 [(100% × $1. ANS: D If AGI exceeds $15. the rate for the credit for child and dependent care expenses is 35%. Therefore. $1. The credit phase-out for higher-income taxpayers begins at an AGI level of $94. d. 12-22 40. Arethia’s expenses are eligible for the lifetime learning credit since she is beyond the first two years of post-secondary education. Lifetime learning credit $1. Both Devona and Arethia are claimed as dependents on their parents’ tax return. $1. e. 12-23 | p. have AGI of $75. the credit is less than 35%. No reduction for income level is required. and have two children. Devona is beginning her freshman year at State University during Fall 2007.100)] for the HOPE scholarship credit and $2. b. the available credit amounts are $1.000). file a joint tax return.000. and Arethia is beginning her senior year at Northeast University during Fall 2007 after having completed her junior year during the spring of that year. A taxpayer is not allowed both a deduction as a medical expense and the credit for child and dependent care expenses on the same amount. Full payment is made for the tuition and related expenses for both children during each semester.000 for married taxpayers filing joint returns. A taxpayer is not allowed both an exclusion from income and the credit for child and dependent care expenses on the same amount. PTS: 1 REF: p.650 c.250 ANS: B The HOPE scholarship credit is available for Devona since she is in her first two years of postsecondary education.

In addition to the children’s college expenses. The tax status of the property. Recognized gains and losses must be properly classified. d.000.000 on a joint return is limited to 10% times up to $2. $800. $2. Del’s room and board costs were $2. Owen did not incur room and board costs since he lived with his aunt and uncle during the year. Full payment is made for the tuition and related expenses for both children at the beginning of each semester.000 × 2)]. b. and Owen is beginning his senior year at Southwest University during Fall 2007. Therefore. c.000 on their joint return. $2. $400.41. while Owen’s qualifying tuition expenses were $4. the credit is equal to $400 [10% × ($2.000. The holding period of the property. and have two children. e. ANS: B The manner of the property’s acquisition generally has no impact on classification of the recognized gain or loss. beginning this year. 42. b. have AGI of $110.840. Bob and Sally are married. Compute the available education tax credits for Bob and Sally for 2007. Jim and Julie commit to making regular contributions to their IRAs.e. Which of the following is not one of those three characteristics? a. $2. Del is beginning her freshman year at State College during Fall 2007.990. b. $2. The manner of the property’s disposition. what is the amount of their credit for certain retirement plan contributions? a. Proper classification depends upon three characteristics. PTS: 1 REF: Example 34 43.500 for the Fall semester. Bob also spent $2. ANS: C The available credit for taxpayers reporting AGI of $35. c. they each make a $2.000 contribution to their traditional IRA. e. None of the above. Consequently. Owen completed his junior year during the Spring semester of 2006 (i. If their AGI is $35.000 for each eligible individual who makes a contribution.392.750 for the Fall semester. Both Del and Owen are claimed as dependents on their parents’ tax return.200 for the Fall 2007 semester. $598. PTS: 1 REF: p.500 on professional education seminars during the year in order to maintain his license as a practicing dentist. file a joint tax return. All of the above. e. c. The manner of the property’s acquisition. Bob attended the seminars during July and August 2007.. d. $200. None of the above. d. Realizing that providing for a comfortable retirement is up to them. he took a “leave of absence” during the 2006-2007 school year). 14-3 22 . Del’s qualifying tuition expenses and fees total $4. a.

He would like to acquire and hold stock as a capital asset. d. 14-7 23 .44. a. ANS: E If the property is depreciable. e.). c. e. d. stock acquired by a securities dealer is an ordinary asset because the stock is the dealer’s inventory. Since he is a dealer.). Since he is a dealer. and d. gain from disposition of the stock can be capital gain (option d. Personal use activity and investment activity assets are capital assets as long as the taxpayer’s efforts did not create the painting or the taxpayer did not receive the painting by gift from the creator of the painting (options b. b.). However. Designating the stock as an investment at any time before selling it is sufficient to characterize the loss as a capital loss (option c. the taxpayer is in the business of buying and selling paintings and the painting is an ordinary asset (option d. it is used in a business and is not a capital asset (option a. he cannot hold stock as a capital asset. Which of the statements below is correct? a. If the property is inventory. gain from the stock’s sale will be capital gain. c. PTS: 1 REF: p. c. PTS: 1 REF: p. 14-4 45. An individual taxpayer owns a landscape painting. b. It is personal use activity property for the taxpayer and he did not create it or receive it by gift from someone who did create it. It is investment use activity property for the taxpayer and he did not create it or receive it by gift from someone who did create it. The painting would not be a capital asset if it was held by the taxpayer in which of the following circumstances? a. and c. If Jeremiah clearly identifies the stock as held for investment by the close of business on the acquisition date. if the dealer designates the stock by the end of the business day of its acquisition as an investment.). Losses are capital losses if at any time the stock has been clearly identified by Jeremiah as held for investment. all the stock he acquires is a capital asset. It is used in his business and is depreciable property. then sell it to get a capital gain or loss. ANS: E Generally.). Jeremiah is a dealer in securities. and d. It is held as inventory by the taxpayer.

46. Rea is a songwriter. She wrote a song, copyrighted it, and sold it for $10,000 cash after holding the copyright for 14 months. The song had a zero tax basis. The purchaser was a national song brokerage company. Rea is not in the business of songwriting. The $10,000 received by Rea is: a. Long-term capital gain if she elects to treat the copyright as a capital asset. b. Short-term capital gain no matter what is the holding period. c. Ordinary gain because the song is treated as inventory. d. Long-term capital gain if she elects not to treat the copyright as a capital asset. e. None of the above. ANS: A Normally, the song creator does not have a capital asset. However, under § 1221(b)(3), the creator of a song may elect to have the copyright treated as a capital asset, not elect not to have it treated as a capital asset (options a. and d.). There is no rule automatically making the gain on the song copyright short-term capital gain (option b.). Since Rea is not in the business of creating songs, the song copyright is not inventory (option c.). PTS: 1 REF: p. 14-4 | p. 14-5 47. Sam operates a variety store as a sole proprietorship. Which of the following items are capital assets in the hands of Sam? a. The vacant lot next to his store that was purchased for use as a parking lot for his customers. b. Sixteen bicycles that have been in his inventory for over a year. c. A note receivable that was given to him by a customer in payment of the balance due on the customer’s account at the store. d. A corporate bond in which Sam invested some of the store’s excess cash. e. None of the above. ANS: D Section 1221 excludes all of the listed items from being capital assets except the bond. PTS: 1 REF: p. 14-3 | p. 14-4 48. Julia purchased vacant land in 2006 that she subdivided for resale as lots. All 10 of the lots were sold during 2007. The lots had a tax basis of $3,000 each and sold for $45,000 each. Julia made no substantial improvements to the lots. She acted as her own real estate broker; so there were no sales expenses for selling the lots. Which of the following statements is correct? a. Julia must hold the lots for at least five years before she is eligible for the special capital gain treatment of § 1237. b. Some of the gain from the sale of the ten lots is long-term capital gain. c. All of the gain from the sale of the ten lots is long-term capital gain. d. To be eligible for the special capital gain treatment of § 1237, Julia must be a real estate dealer. e. None of the above. ANS: A Julia must hold the land at least five years to be eligible for § 1237 treatment and must not be a dealer in lots. Since Julia does not satisfy this requirement, all of the gain is ordinary income. PTS: 1 REF: p. 14-7

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49. A worthless security had a holding period of 11 months when it became worthless on November 10, 2007. The investor who had owned the security had a basis of $10,000 for it. Which of the following statements is correct? a. The investor has a long-term capital loss of $10,000. b. The investor has a short-term capital loss of $10,000. c. The investor has a nondeductible loss of $10,000. d. The investor has a long-term capital gain of $10,000. e. None of the above. ANS: A Section 165(g)(1) provides that if a security becomes worthless during the tax year, the loss is treated as if it occurred on the last day of the tax year. On the last day of the tax year, the security would have been held for more than a year. PTS: 1 REF: p. 14-9 50. Sylvia purchased for $1,610 a $2,000 bond when it was issued two years ago. Sylvia amortized $200 of the original issue discount and then sold the bond for $1,800. Which of the following statements is correct? a. Sylvia has $10 of long-term capital loss. b. Sylvia has $190 of long-term capital gain. c. Sylvia has no capital gain or loss. d. Sylvia has $190 of long-term capital loss. e. None of the above. ANS: A Sylvia’s original basis of $1,610 is increased by the $200 of original issue discount amortization. Her basis is $1,810 when she sells the bond for $1,800; so her loss is $10 and is long term. PTS: 1 REF: p. 14-9 51. On July 1, 2007, Brandon purchased an option to buy 1,000 shares of General, Inc. at $30 per share. He purchased the option for $2,000. It was to remain in effect for five months. The market experienced a decline during the latter part of the year, so Brandon decided to let the option lapse as of December 1, 2007. On his 2007 tax return, what should Brandon report? a. A $2,000 long-term capital loss. b. A $2,000 short-term capital loss. c. A $2,000 § 1231 loss. d. A $2,000 ordinary loss. e. None of the above. ANS: B The lapse of the option is treated as a sale or exchange by § 1234(a)(2). Therefore, a shortterm capital loss of $2,000 is recognized. PTS: 1 REF: Concept Summary 14-1

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52. Which of the following events causes the purchaser of an option to add the cost of the option to the basis of the property to which the option relates? a. The option is exercised. b. The option is sold. c. The option lapses. d. The option is rescinded. e. None of the above. ANS: A If the option is exercised, the cost of the option becomes part of the basis of the property. Otherwise, the lapse of the option is treated as a sale or exchange. PTS: 1 REF: p. 14-10 53. Harold is a mechanical engineer and, while unemployed, invents a switching device for computer networks. He patents the device, but does not reduce it to practice. Harold has a zero tax basis for the patent. In consideration of $300,000 plus a $1 royalty per device sold, Harold assigns the patent to a computer manufacturing company. Harold assigned all substantial rights in the patent. Which of the following is correct? a. Harold automatically has long-term capital gain from the lump sum payment, but not from the royalty payments. b. Harold automatically has long-term capital gain from the royalty payments, but not from the lump sum payment. c. Harold automatically has long-term capital gain from both the lump sum payment and the royalty payments. d. Harold does not have automatic long-term capital gain from either the lump sum payment or the royalty payments. e. None of the above. ANS: C Since Harold meets the definition of a holder, he receives automatic long-term capital gain treatment for both the lump sum payment and the royalty payments. PTS: 1 REF: p. 14-11 | p. 14-12 54. Blue Company signs a 12-year franchise agreement with Fast Taco. Fast Taco retained significant powers, rights, and a continuing interest. Blue (the franchisee) makes noncontingent payments of $15,000 per year for the first five years of the franchise. Blue Company also pays a contingent fee of 2% of gross sales every month. Which of the following statements is correct? a. Blue Company may deduct the $15,000 per year noncontingent payments in full as they are made. b. Blue Company may deduct the monthly contingent fee as it is paid. c. Blue Company may deduct both the noncontingent annual fee and the contingent monthly fees as they are paid. d. Blue Company may not deduct either the noncontingent annual fee or the contingent monthly fees as they are paid. e. None of the above. ANS: B The contingent payments are deductible as they are made. The noncontingent payments must be capitalized and amortized over 15 years. PTS: 1 REF: p. 14-12 | p. 14-13

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Which of the statements below concerning sports franchises (e. b. Therefore.000 to cancel his lease and move out so that Mauve could demolish the building. the entire payment is capital gain. All of the above. 14-16 27 . Anise’s holding period begins on the day after the property is acquired. Mauve has an ordinary deduction of $1. None of the above. Anise. Player contracts are usually one of the major assets acquired with a sports franchise. 14-15 57.000 capital gain. Virgil was leasing an apartment from Mauve. Virgil has a zero basis for the lease.000 realized loss on the sale of the forklift to Anise and the loss is disallowed because Anise is a related taxpayer. e. Player contracts are amortizable over 15 years. PTS: 1 REF: p.000 capital loss. PTS: 1 REF: p.. Magenta has a $4. PTS: 1 REF: p. 2007. ANS: C When a loss is disallowed in a related party transaction. Begins on February 13. sold a forklift on February 12. the player contracts are amortized over 15 years even though the contracts may be for a shorter period. Includes Magenta’s holding period for the forklift. the Detroit Tigers) is correct? a. 2007. Magenta.000. c. for $3. 14-14 | Concept Summary 14-2 56. ANS: A Since the apartment was Virgil’s personal residence.g. Does not begin until Anise sells the forklift. Sports franchises are subject to the franchise rules of § 1253. e. c. Whether the gain is long term or short term depends upon how long Virgil has held the lease. Mauve paid Virgil $1.000 (its FMV) to its 100% shareholder. Virgil has a $1. None of the above. the franchise and other intangible assets acquired along with the franchise are 15-year § 197 intangibles. e. b. ANS: D Sports franchises are subject to the rules of § 1253 that apply to franchises generally. b.55. Inc. 14-14 | p. there is no carryover of holding period. Begins on February 12. Inc. the lease on the apartment was a capital asset because all personal use assets are capital assets.000 capital loss.000. d. None of the above. c. Mauve has a $1.000 capital gain. Magenta’s adjusted basis for the forklift was $7. Mauve has a $1. 2007. Anise’s holding period for the forklift: a. Therefore. d. d. 14-13 | p. Virgil has a $1. As a result: a. Under those rules.

000 capital loss deduction.000 net capital gain.000 28% gain – $7. d. b. At the time the short sale is made.000 short-term capital loss. $6. At the time the short sale is made. b and c e. d.000 28% gain. The mother had a tax basis of $566. the taxpayer does not deliver to the purchaser the shares sold short. ANS: A There is a net short-term capital loss of $1. 14-16 60. his holding period does not include his mother’s holding period for the residence. PTS: 1 REF: p. Mark has a $14. c. PTS: 1 REF: p. Which of the statements below is correct? a. Harry’s holding period for the residence is automatically long term. d. Mark has $14. Which of the statements below is correct? a.000 5%/15% gain) which is deductible for AGI as a capital loss deduction. In 2007. and $7. b. Mark has a $3. Mark has a $1.000 net capital loss. Therefore.58. e.000 5%/15% gain. Harry’s holding period for the residence includes his mother’s holding period for the residence. Mark has a $1.000 short-term capital loss – $6. Mark has a $6.000 capital loss deduction. the taxpayer delivers to the purchaser the shares sold short.000 at the date of her death. At the time the short sale is made. b. None of the above.000 net capital gain. Harry’s holding period for the residence does not include his mother’s holding period for the residence. c. None of the above. ANS: B A short sale occurs when a taxpayer sells borrowed property and repays the lender with substantially identical property either held on the date of the sale or purchased after the date of the sale. Which of the following is correct concerning short sales of stock? a. Harry inherited a residence from his mother when she died. At the time the short sale is made. c.000 for the residence when she died and the residence was worth $433. the taxpayer may already own the shares sold short. ANS: D Harry has an automatic long-term holding period because the residence is inherited property.000 ($14. e. 14-16 59. 14-20 28 . PTS: 1 REF: p. the taxpayer always already owns the shares sold short.

000 5%/15% long-term capital gain – $4.540 on $14. c. Jenny has a 2007 $7. 14-24 | Example 37 63.000 which includes $24. 14-23 | p. e. In 2007. No more than $14. None of Satesh’s taxable income is taxed at 5%. $1.000 qualified dividend income is added to the 5%/15% net long-term capital gain and the $17. Corrine is filing as head of household and has 2007 taxable income of $38. None of the above. In 2006.000 ($14.000 qualified dividend income. $2.000 capital loss deduction. and $7. c. Which of the following statements is correct? a.000 of Satesh’s taxable income is taxed at 5%.000 short-term capital loss). e. The $7.000 ($14. Jenny has a 2007 $18.000 of 5%/15% gain. Which of the statements below is correct? a.000 capital loss deduction. ANS: C The net long-term capital gain is $10.000 net capital loss. b.000 capital loss deduction). 14-24 29 . ANS: B The 2006 capital loss carryforward is $11. $3.000 of Satesh’s taxable income is taxed at 5%.700. d. PTS: 1 REF: p.000 regular taxable income + 5% of $24.000 carries forward as a short-term capital loss and is offset against the $18. 14-22 62.740 ($1.000 long-term capital gain.000 total is eligible for the 5%/15% alternative tax rate. Jenny has a $18.740.200.000 net short-term capital loss and deducted $3. What is the tax on her taxable income using the alternative tax method? a.000 net capital gain.300.000 net capital gain. The total tax is $2. Jenny has a 2007 $3. PTS: 1 REF: p. all of the $24. d. 14-23 | p. Satesh is single and has other taxable income of $15.000 2006 net capital loss – 2006 $3. d. No more than $17. b. All of Satesh’s taxable income is taxed at 5%.000 short-term capital loss.000 5%/15% gain is taxed at 5%. $14. The $11.000 of Satesh’s taxable income is taxed at 5%. Jenny had a $14. $5.000. Jenny has a 2007 $7. e. No more than $7. b. In 2007. Jenny has a 2007 $7.000 long-term capital gain).000 5%/15% long-term capital gain and no other capital gain or loss transactions. Satesh has $4.61. c. ANS: B Since Corrine’s total taxable income does not take her out of the 15% regular tax bracket. PTS: 1 REF: p.000 5%/15% long-term capital gain.000 as a capital loss deduction.

Sam is filing as single and has 2007 taxable income of $48.125. All of the above. 14-24 65. His taxable income is $185.809. individuals may not (a). Ryan’s taxable income without the net capital gain will be taxed at greater than 25%. not short-term.000. His total tax is $6. What is the tax on his taxable income using the alternative tax method? a. Corporations may carryforward capital losses indefinitely. The net capital gain is taxed at no greater than 15%. Ryan (a single person) has $35. e. Which of the following comparisons is correct? a. c. Corporations have a five-year carryforward limit. 14-26 | p. e. not 20%. Which of the following is correct? a. d. d. d.64. None of the above. PTS: 1 REF: p.000 which includes $23.000) + [($31. $12.386. Individual long-term capital losses carryover as long-term.125 {$3.000 of 5%/15% gain. Therefore.000. e.850 end of single 15% bracket – $25. $4. but his regular taxable income does not. PTS: 1 REF: p.000 regular taxable income ($48. ANS: D The net capital gain is subject to special tax treatment. None of the above.000) × . Corporations’ alternative tax rate on long-term capital gains is 35%. individuals may not. individuals may only carryforward capital losses for five years.05] + [($48. ANS: B Sam’s taxable income takes him out of the 15% regular tax bracket.850) × . None of the above. b. a portion of the 5%/15% gain is taxed at 5% and a portion is taxed at 15%. c. Both corporation and individual long-term capital losses carryover as short-term capital losses. c. The tax rate on the net capital gain cannot exceed 15%. 14-24 66.000 – $31.15]}. Corporations may carryback capital losses. $6.000 – $23. b. PTS: 1 REF: p. 14-28 30 . The taxable income without the net capital gain puts Ryan in the 28% bracket.359 tax on $25. $6. The net capital gain will be subject to special tax treatment.000 net capital gain (all 5%/15% gain). ANS: A Corporations may carryback capital losses. Both corporations and individuals may use an alternative tax rate on net capital gains. b. For 2007. individuals may carryforward capital losses indefinitely.

b. Land used in the business and held more than one year.. A capital asset. None of the above.000 long-term capital gain included in its $185. All of the above.000 taxable income. b. Tan. ANS: B The machine was depreciable property used in a business and held one year or less. A § 1231 asset. so it was an ordinary asset. d. d. but then discovers that it is not suitable for Green’s business. it yields the same tax result as the regular computation method. Tan’s regular tax on taxable income will be the same as its tax using an alternative tax on net capital gains approach. Which of the following assets held by a manufacturing business is not a § 1231 asset? a. Green sells the machine 10 months after it was acquired. An ordinary asset. Consequently. Inventory.000 loss on the disposition. Tan’s regular tax on taxable income will be greater than its tax using an alternative tax on net capital gain approach. There is a $10. Which of the following is correct? a. d. 14-31 31 . e. Inc.000 net capital gain is not taxable. PTS: 1 REF: p. This unusual result is caused by the fact that the alternative tax rate and the maximum regular tax rate are both 35%. A machine used in the business and held more than one year. 14-28 68. Green Company acquires a new machine for use in its manufacturing operations. c. ANS: B Although there is an alternative tax on net capital gains for corporations. ANS: A Inventory is an ordinary asset. places it in service. Tan’s $50. e. PTS: 1 REF: p.67. e. PTS: 1 REF: p. b. A factory building used in the business and held more than one year. c. it was: a. When the machine was disposed of. None of the above. has a 2007 $50. c. Tan will benefit from an alternative tax on net capital gains computation. An inventory asset. 14-30 69.

Inc.000 long-term capital gain and $22. d. d. 14-31 71. 14-33 73. the loss is treated as an ordinary loss.. Which of the following assets held by a cash basis law firm is not a § 1231 asset? a. None of the above. PTS: 1 REF: p.000 net § 1231 loss in 2006. Capital gain. For 2007.000 2007 net § 1231 gain is treated as long-term capital gain.000 long-term capital gain and $22. An office building used in the business and held more than one year. 14-34 32 .000 and had a $22. e. ANS: C The 2006 § 1231 loss is a lookback loss and converts $22. Vertical’s net § 1231 gain is treated as: a. A machine held more than one year and used in a business is destroyed in a fire. A desk used in the business and held more than one year..70. b. The machine was a long-term nonpersonal use asset. c. c. So there is a loss from its destruction. 14-32 72. None of the above. ANS: A An account receivable is an ordinary asset.000 and had a $22. c. b. $23. e. PTS: 1 REF: p. $45. PTS: 1 REF: p. $23.000 net § 1231 gain in 2006. has a 2007 net § 1231 loss of $45. The loss is not usable. An account receivable from a client. b. Inc.000 remaining of the $45. e. The loss is subject to special netting rules. For 2007. Vertical. e. has a 2007 net § 1231 gain of $45. $45.000 capital gain. Vertigo.000 ordinary gain. b. Ordinary loss. 14-33 | p. Capital loss. All of the above. d.000 of the 2007 net § 1231 gain into ordinary gain. A computer used in the business and held more than one year.000 ordinary loss. c. The $23. Which of the statements below is correct concerning these facts? a.000 ordinary gain. 14-31 | p. Ordinary gain. PTS: 1 REF: p. The machine was not insured. The machine was a long-term personal use asset. Vertigo’s net §1231 loss is treated as: a. ANS: A Since there is a 2007 net § 1231 loss. a and d ANS: E Property used in a business is a nonpersonal use asset and the loss due to casualty is subject to a special netting rule for nonpersonal use property casualty gains and losses. d.

$600 LTCG and $300 ordinary gain.000 ordinary gain. has a 2007 net § 1231 gain of $45.000. None of the above.000 is treated as ordinary gain.400 LTCG and $300 ordinary gain. The following assets in Jack’s business were sold in 2007: Asset Office Equipment Automobile ABC Stock (capital asset) Holding Period 6 years 8 months 2 years Gain/(Loss) $1.000 capital gain.000 ordinary loss.200. 14-33 | p. d. The sale of the stock results in a $1. In 2007 (the year of sale). None of the above. For 2007.000 and had a $52. PTS: 1 REF: p.500 LTCG and $800 ordinary loss. Verway.400 The office equipment had a zero adjusted basis and was purchased for $8. The sale of the auto results in an ordinary loss of $800 because the auto was not held for the long-term holding period. e. $45. Verway’s net § 1231 gain is treated as: a.000 capital loss.000 net § 1231 gain is less than the $52. $2. $45.000 net § 1231 loss in 2006. d. 14-33 to 14-37 33 . c. b. 14-34 75.74. $45. The § 1245 gain of $1.700 LTCG.100 ($ 800) $1. e. Inc. The ABC stock was purchased for $1.100 offsets the $800 ordinary loss for a net ordinary gain of $300.000 and sold for $1.000 2006 § 1231 lookback loss. PTS: 1 REF: p.200. ANS: B Since the 2007 $45. b. $45.100 § 1245 gain.400 LTCG.800 and sold for $3. Jack should report what amount of net capital gain and net ordinary income? a. c. $1. ANS: C The sale of the office equipment results in a $1. The automobile was purchased for $2. the entire $45. $1.

14-33 to 14-36 34 . d. Spencer will have a net capital loss no matter which land parcel he sells. Spencer has an investment in two parcels of vacant land. None of the above. ANS: B Since parcel 2 is a § 1231 asset. PTS: 1 REF: p. The real property sale results in a net §1231 loss of $1. 14-33 to 14-37 77.76. An individual had the following gains and losses during 2007 on property held for the longterm holding period: sale of Orange common stock ($8. None of the above. PTS: 1 REF: p. ANS: D The sale of the Orange stock produces a $8. destruction of real property used in the taxpayer’s business by fire ($1.000 LTCG. its gain will be treated as ordinary income due to the § 1231 lookback and none of the gain will be treated as long-term capital gain.800.000 fire loss is treated as an ordinary loss because there are no casualty gains against which it can be netted. c. The real property $1. Which of the following is correct? a.000 gain). Thus. The gain that would be recognized exceeds the short-term capital loss Spencer already has. Spencer will have a net capital gain if he sells either parcel 1 or parcel 2. Spencer will have a net capital loss if he sells parcel 1. which is fully includible in gross income. The sale of real property loss would be netted against the stock sale gain.000 loss). e. The sale of real property is a § 1231 loss. The fire loss would reduce the stock sale gain. d. Spencer already has short-term capital loss for the year he would like to offset with capital gain. Selling parcel 1 will yield a capital gain that will more than offset the existing short-term capital loss. Which of the statements below is correct? a. the existing short-term capital loss will not be offset by any gain and a net capital loss will result. resulting in a net capital gain. The fire loss would reduce the real property sale loss. c. Spencer will have a net capital loss if he sells parcel 2.800 loss). Parcel 1 is a capital asset and parcel 2 is a § 1231 asset. Spencer has § 1231 lookback loss that exceeds the gain from the disposition of either land parcel. b. Spencer only wants to sell one land parcel and each of them would yield the same amount of gain. e. sale of real property used in the taxpayer’s business ($1. b.

The machinery was completely destroyed by fire and Red received $10.000 cost – $21.400 § 1245 recapture gain. d. $10. The machinery had been acquired on April 1. PTS: 1 REF: p. Since it was sold at a gain and the selling price exceeded the original cost. $40.000 of insurance proceeds for the machine and did not replace it. This was Red’s only casualty or theft event for the year. 14-37 80. A § 1231 gain of $3.000 § 1231 loss.000 § 1231 gain. 2005 for $49.200 casualty loss.000 § 1231 gain. 14-37 79. e. d.000 sale price – $21.000 insurance proceeds – $14. $34.000 of ordinary income. d.000 and had an adjusted basis of $21.800 § 1245 recapture gain.200 adjusted basis). 14-39 35 . $4. However. what should Copper Corporation report? a. it was a § 1231 asset.000 and $3. $6. it was a § 1231 asset. $40.000 on December 23. $6. $40. Since the recognized gain is less than the depreciation taken of $9. all of the loss is initially a casualty loss. $10. $14.200 loss ($10. A § 1231 gain of $6.800 ($49.200 § 1231 loss.000 at the date of the sale. $0 § 1231 loss.000 on December 31. Blue Company sold machinery for $55.000 of ordinary income. c. $0 § 1231 gain.000 gain ($55. since it was disposed of at a $4.200. and § 1231 loss from this transaction are: a.000 and its adjusted basis was $14. A § 1231 gain of $6. Red initially has: a.000 original cost) is § 1231 gain.000 and $3.000 adjusted basis).200 adjusted basis) is gain recaptured by § 1245 and the remaining $6. None of the above.000.400 § 1245 recapture gain. The machinery had been purchased on January 2. The § 1231 gain. 2005 for $49. For 2007.000 cost – $14. b. The machinery had been acquired on April 1.78.000 ($27. § 1245 recapture gain. e. None of the above.000 and its adjusted basis was $14.000 ($30. ANS: A Since the machine was held more than 12 months and was depreciated. PTS: 1 REF: p. Copper Corporation sold machinery for $27. PTS: 1 REF: p. $0 § 1231 loss. 2007. $4. None of the above. ANS: C Since the machine was held more than 12 months and was depreciated. § 1245 depreciation recapture applies.000.200.000 § 1245 recapture gain. 2007. Ordinary income of $6. $0 § 1231 gain. b.200 § 1231 loss. As a result of this event. 2004 for $30. all of the depreciation taken of $34. b. $0 § 1231 loss. 2007.000 selling price – $49. c. Red Company had an involuntary conversion on December 23.400 § 1245 recapture gain. ANS: A The recognized gain from the disposition of the machinery is $6. e. c.000 adjusted basis) and the asset is depreciable equipment used in a business.

200. e. $14. PTS: 1 REF: p. Depreciable intangible personal property. 14-40 36 . As a result of this event. $4.000 and its adjusted basis was $14. Casualty gain.200 ordinary loss.800 § 1245 recapture gain. Depreciable real property. However.800 gain ($30. d. d. None of the above. all of the gain is initially § 1245 depreciation recapture gain and not casualty gain. e. Section 1250 gain.000 § 1231 gain. b. since it was disposed of at a $15. Since the disposition of the asset was by casualty and depreciation recapture does not apply.200 adjusted basis). The building was depreciated using straight-line depreciation. 14-39 82. Depreciable tangible personal property. c. b. Inventory. PTS: 1 REF: p. The machinery was completely destroyed and Orange received $30.200 § 1245 recapture gain. 2007. Casualty loss.81. The building was insured and the insurance proceeds exceeded the building’s adjusted basis. e. d. None of the above. the initial characterization of the gain is casualty gain. ANS: B Since the machine was held more than 12 months and was depreciated. This was Orange’s only casualty or theft event for the year. $30. Orange has: a. A business building owned by an individual is destroyed by fire. b. The gain from disposition of the building is initially: a. 14-38 | p. PTS: 1 REF: p. The building was not replaced. Section 1250 property is: a.000 insurance proceeds – $14. $15. ANS: A There is no § 1250 depreciation recapture because straight-line depreciation was used. None of the above. 2005 for $49. c. Orange Company had machinery destroyed by a fire on December 23. The machinery had been acquired on April 1. c. 14-31 | p. Section 1231 gain. it was a § 1231 asset.000 of insurance proceeds for the machine and did not replace it. The insurance proceeds did not exceed the original cost of the building. ANS: A Section 1250 property is depreciable real property (principally buildings and their structural components). 14-39 83.

$322. 2007. d. Section 1250 gain.000 gain from the disposition [$322. All of the above are correct. PTS: 1 REF: p. 14-46 85. the depreciation recapture potential has no effect on the amount of the charitable contribution deduction. $400. Which of the following statements is correct? a. d.000 sale price – ($400.000 gain. ANS: C The maximum unrecaptured § 1250 gain is the $104. When corporate depreciable property is distributed as a dividend. ANS: B Depreciation recapture potential is extinguished when property is received as an inheritance. Section 1231 gain.000. When depreciable property is gifted to another individual taxpayer.000 depreciation taken.000 and straight-line depreciation of $104. Section 1245 gain. PTS: 1 REF: p. 14-43 86.000. she would have a $33. 14-41 | p.000. there is no § 1250 recapture. ANS: B The gain is § 1231 gain.000. Section 1239 gain.000 had been taken on the building.84. $104. c. PTS: 1 REF: p. since Kari is an individual. the depreciation recapture potential is extinguished. c. $26. is recognized by the corporation when property is distributed by a corporation and a gain would have been recognized if the property had been sold. Also.000.000. If Kari sold the property.14-42 | p. When depreciable property is inherited by a taxpayer.000 depreciation taken)]. Since straight-line depreciation was used. there is no “ordinary gain adjustment” under § 291.000 cost – $104. Section 1239 would not apply because there is no reason to conclude that the property would be sold to a related taxpayer. the depreciation recapture potential is extinguished. carries over when the property is received by gift. 14-40 | p. b. c. Kari owns depreciable residential rental real estate which has accumulated depreciation (all from straight-line) of $45. b. When depreciable property is contributed to charity. 14-44 to 14-46 37 . the depreciation recapture potential is generally not recognized. The initial characterization of the gain would be: a. b. and reduces the charitable contribution deduction amount. None of the above. What is the maximum unrecaptured § 1250 gain from the disposition of this building? a. d. e. e. e. A retail building used in the business of a sole proprietor is sold on March 10. The building was acquired in 1997 for $400. for $322. That maximum is reduced to the $26. None of the above.

000 § 1231 gain is absorbed by the $13. Section 1239 (relating to the sale of certain property between related taxpayers) does not apply unless the property: a. Is a capital asset. The net long-term capital gain is: a.000 § 1231 lookback loss.000 § 1231 lookback loss.000 of the $15.000 § 1231 gain. $30. b. Is real property. A nontaxable reorganization. ANS: B Section 1239 produces the conversion of the transferor’s capital gain into ordinary income if the property is depreciable in the hands of the related transferee. 14-46 89. 14-46 88. ANS: D None of the § 1231 gain survives to be treated as long-term capital gain. a $15.000 § 1231 loss. Is depreciable in the hands of the transferee. d.000.87. An individual has a $10. 14-45 | p.000.000 of § 1245 gain is ordinary income. An exchange of depreciable business equipment for like-kind business equipment with gain realized. b. A nontaxable incorporation under § 351. e. PTS: 1 REF: p. Was depreciated by the transferor. but not recognized. $40. and a $15.000 § 1231 loss and the remaining $2. a $4. None of the above.000. c. $13. e. $17. a $13. e. c.000 is treated as ordinary gain because of the $4.000 long-term capital gain. None of the above. ANS: E All of the transactions involve a carryover of basis and do not extinguish the § 1245 depreciation recapture potential.000. Which of the following would extinguish the § 1245 recapture potential? a. A nontaxable contribution to a partnership under § 721. d. The $10. $15.000 § 1245 gain. c. PTS: 1 REF: Concept Summary 14-8 38 . None of the above. d. PTS: 1 REF: p. b.

and d. G&S is not a seasonal business. are incorrect because a specific sequence is provided for determining the tax year of partnerships (i. ANS: A Answer b. is correct. Whether the tax year is 52 weeks or is 53 weeks is not elective. a. ANS: D The tax year-end must be the same day of the week in all years. 16-3 91. 16-3 to 16-5 39 . 2007.5 × 9 = 4.5 × 3 = 1. c. which was formed on July 1. (2) principal partners. Whether the particular tax year includes 52 weeks or 53 weeks is not elective. d.5 . and (3) least aggregate deferral method. and Silver’s tax year ends September 30. c. Thus. All of the above are correct. G&S must use a tax year ending December 31st. The limited liability company. The year-end must be the same day of the week in all years. None of the above. Some tax years will include more than 366 calendar days. With a 52-53 week year. Thus. PTS: 1 REF: p. b. G&S may elect its tax year without regard to the partners’ tax years. 16-4 . None of the above is correct. Gold uses a calendar tax year. Year-end September 30 December 31 PTS: 1 REF: p. c. is correct. The partnership. The C corporation.e. a. All of the above have the same options. which form of business provides the greater number of options in regard to the tax year? a. the limited liability company is normally taxed as a partnership): (1) majority interest partners. 371 days (53 × 7) may be included in a tax year.90. In regard to choosing a tax year for a retail business owned by individuals. e. b. e.5 92. Which of the following statements regarding a 52-53 week tax year is not correct? a. c. is correct. d. d. Answer c. is incorrect because S corporations generally must use a calendar tax year. Gold Corporation and Silver Corporation are equal partners in the G&S Partnership. ANS: C A tax year ending September 30th will result in the least aggregate deferral. The S corporation. PTS: 1 REF: p. G&S must use a tax year ending June 30th. G&S must use a tax year ending September 30th. b. e. Thus.. b.

a. ANS: D The IRS has issued Revenue Ruling 87-57 to objectively determine the entity’s natural business year. 2008 is limited to $135. 2008 is limited to $120. The corporation paid the shareholder-employee a salary of $15.000. a personal services corporation. PTS: 1 REF: p. None of the above. 2008 is limited to $60.000. d. During the fiscal year ending September 30. The corporation must switch to a calendar year.000 during the period beginning October 1. e. The accountant is already overburdened with calendar year tax returns and could not timely file the partnership’s return. The company’s income does not fluctuate a great deal from year to year.000[(12 – 3)/3] = $60. In the case of a partnership whose partners all use a calendar year. The corporation salary expense for the fiscal year ending September 30. e.93. The corporation salary expense for the fiscal year ending September 30. and the employees do not want to work on New Year’s Eve. 2007 through December 31. b. The sole shareholder of the corporation is a calendar year taxpayer. None of the above.000 salary. the shareholder-employee received $120. c. 2007.000 + $15.000. adopted a fiscal year ending September 30th. 2007 calculated as follows: $15. PTS: 1 REF: p. The business has a natural business year that ends June 30th. c. Purple Corporation. A December 31st inventory would be required if a calendar year was used. a reason that is acceptable to the IRS for using a tax year ending June 30th would be: a. b. 16-6 | Example 6 40 .000. 16-5 94. 2007 through December 31. 2007. The corporation salary expense for the fiscal year ending September 30. ANS: C The corporation can deduct only the annualized amount paid in the period from October 1. d.

Godfrey can reduce his 2008 Federal income tax by $1.000 × 15%). Godfrey must amend his 2007 return..000.000 of state income tax.. e. He included the refund in his 2007 gross income in accordance with the tax benefit rule (i. ANS: D The tax year in which the $4. PTS: 1 REF: pp.000 payment is made (2008) applies for the deduction even though the deduction is an adjustment to income taxed at a lower rate. None of the above is permitted to use the cash method.000.e. c. A medical doctor with average annual gross receipts of $2. None of the above.000 × 35%). Therefore. d.000 payment in 2008 will reduce his 2008 Federal income tax by $600 ($4. Godfrey received a $5.000. but his marginal tax bracket in 2008 is 35%. for a. In 2008. A retail business with average annual gross receipts of $800. The cash method can be used in b. He will itemize his deductions on his 2008 return.95.000. and c.000 refund of his 2006 state income tax.400 ($4. d. a. ANS: D Generally. e. because the medical doctor and insurance agency are service entities. The $4. sales and cost of goods sold for the retail business must be reported by the accrual method because inventories are material. Godfrey’s 2006 state income tax return was audited and he was required to pay an additional $4. b.000. b. the small business exception applies. can use the cash method. c. The $4. the retailer in a. 16-10 to 16-12 41 . However. All of the above are permitted to use the cash method. In 2007.000 payment in 2008 is not deductible. Which of the following is permitted to use the cash method of accounting? a. PTS: 1 REF: p. Godfrey was in the 15% tax bracket in 2006 and 2007. 16-9 | Example 12 96. because the state income tax had been deducted on his 2006 Federal income tax return). An insurance agency with average annual gross receipts of $2.

d. 16-12 42 .000. d.000. ANS: D I is not true because contractors may be required to use the completed contract method or the percentage of completion method. None of the above is true. II. Earned by an incorporated public accounting firm with gross receipts in excess of $5. Only I and III must use the accrual method. c. The accrual method generally must be used to report income: I. III. III is not true because a public accounting firm is a personal services corporation.000. a. c. All of the above are true. The grocery store can use the cash method under the small business exception (average annual gross receipts of $1. Earned by a partnership with a corporate partner. All of the above must use the accrual method. II.000 or less). PTS: 1 REF: pp. III.000 or less). From long-term construction contracts. b.000. Which of the following must use the accrual method of accounting? I. 16-12 to 16-15 98. e. An incorporated law firm with average annual gross receipts of $1. None of the above must use the accrual method.000.000. The incorporated law firm is not required to use the accrual method under the small business exemption (average annual gross receipts are $5. PTS: 1 REF: p.97. a. An incorporated property management company with average annual gross receipts of $50. Only I must use the accrual method.200.000. Only II and III are true. Only II is true. ANS: D The incorporated property management company must use the accrual method. Only III must use the accrual method. b. Only III is true. An unincorporated grocery store with average annual gross receipts of $900. e.000.

However. is incorrect because prepaid income may be recognized before all of the services are performed.000 for actual claims filed in 2007 and paid in January 2008 can be deducted in 2007 under the recurring item exception. Is not recognized until cash is received. Ivory has elected to use the recurring item exception to economic performance. and $10. None of the above. At the end of 2007. 16-12 100. Also. $11. Ivory Fast Delivery Company. 16-13 | p. From services is never recognized until the services are performed. in January 2008. $15. claims for $12.000 was paid on these claims by March 2008. In the case of an accrual basis taxpayer.000 of claims in January 2008. and paid the other $11. Often the claim is not filed until a month after the delivery. e.000. c. ANS: D Answer b. e. PTS: 1 REF: p. an item of income: a.000.000 of the claims. b. approximately 80% of the claims are paid by Ivory. d.000 were filed for deliveries made in 2007. an accrual basis taxpayer. Ivory can accrue as an expense for 2007: a. PTS: 1 REF: p. $23. The claims filed in January 2008 for 2007 services cannot be deducted in 2007 because the claims had not be filed in 2007 and therefore. the all-events test was not satisfied by the end of 2007. b.000. d. the $11. ANS: A The all-events test is not satisfied until the customer makes a claim that Ivory acknowledged as a valid claim that it will pay. In the past. None of the above. Under the all-events test. Is not recognized if the customer can return the goods. 16-14 43 .99.000. frequently has claims for damages to property the company delivered. $27.000 in claims had been filed. c. The company refused to pay $4. $15. Is recognized when all the events have occurred to fix the taxpayer’s right to receive the income and the amount of the income can be determined with reasonable accuracy.

Pink should deduct $19. the company received a bill of $600 for office supplies that had been purchased and used in November. Pink should deduct $18. 16-14 44 ..000.000) under the recurring item exception. e. and the taxes are paid within 8 1/2 months after the close of the tax year. b. Pink Corporation is an accrual basis taxpayer that uses the recurring item exception to the economic performance test for all relevant years. Pink should deduct $22.000 (6% × $300.e.000 on its year 2006 state income tax liability. PTS: 1 REF: p. During 2007. In December 2007.000 of 2007 state income tax was paid in March 2008. Assuming Color uses the recurring item exception to economic performance.000 as state income taxes for 2007.. 16-13 | p. is an accrual basis taxpayer. For 2007. The remaining $3. the company received a claim from a customer for $500. the corporation’s income subject to state income tax was $300. None of the above. $1. The $4.000 and the state corporate tax rate was 6%. In January 2008. Pink should deduct $15. 16-12 to 16-15 102. $2. d. the company’s deductions for 2007 as a result of the above are: a. The taxes are recurring. PTS: 1 REF: pp. e. Color Inc. ANS: C The all-events test was not satisfied in 2007 for the $900 claim for defective merchandise. The economic performance test was satisfied for the office supplies when they were delivered (i. In March 2007. None of the above.000 as state income taxes for 2007. The merchandise was defective and Color paid the customer in January 2008. Color paid the customer the $900 in February 2008. c. the corporation paid $15. c. The bill was not paid until January 2008.000 as state income taxes for 2007.100. the corporation paid $4. Also in December 2007. $600. ANS: C Pink can deduct $18.000 as state income taxes for 2007. the other party provided the property). The all-events test was satisfied in 2007 for the $500 customer claim and the economic performance test was also satisfied when the payment was made within 8 1/2 months after year end.101.000 on its state income tax liability for that year. $500. b. allowing the deduction will result in an accurate matching of revenues and expenses.000 paid in 2007 on 2006 taxes is deducted in 2006 under the recurring item exception. the company received a claim for $900 for defective merchandise purchased in 2007. As a result of the above: a. d.

None of the above. The $50. an allowance for estimated warranty costs) are not allowed for income tax purposes because allowing the deduction would: a. All of the refunds from 2006 sales were for claims filed in 2006 and were paid in January and February 2007.000 in claims from 2006 sales should have been deducted in 2006 under the recurring item exception. c. The $12.000 was paid by Gray in February 2008. is incorrect because the reason for creating reserves is to match revenues and expenses better.000 in refunds from 2006 sales. b. 16-13 | p. $392.000 claims paid in 2007 for 2007 sales are deductible in that year. Gray Company. e. Also in January 2008. Generally. None of the above. PTS: 1 REF: p. c. Result in a mismatching of revenues and expenses. The all-events test was not satisfied for the $30. This $30. At the end of 2007. Gray can deduct: a. e..g.000 paid in January 2008 for sales in 2007 can be deducted in 2007 under the recurring item exception. the company had $12. Violate the economic performance requirement.000 in 2007.000 of claims for 2007 sales that were received in January 2008 and paid in February 2008. Violate the doctrine of constructive receipt. the company received an additional $30.000 for claims involving sales. In 2007. deductions for additions to reserves (e. b.000 in refund claims for sales in 2007 for which payment had been approved. d. a calendar year taxpayer. $442. With respect to the above.000 consisted of $350.000 in refunds from 2007 sales and $50. ANS: D a.103. $362. allows customers to return defective merchandise for a full refund within 30 days of the purchase.000 in claims for sales in 2007. 16-15 45 . The $400.000 in 2007. the company refunded $400. Economic performance (payment) occurred within 8 1/2 months after the end of 2007. These claims were paid in January 2008. The all-events test was satisfied in 2007 when claims for $12. 16-14 104.000 in 2007. Reduce the costs of companies selling defective products. ANS: B The $350. $350.000 were approved. d.000 in 2007. PTS: 1 REF: p.

When the IRS requires a taxpayer to change accounting methods: a. d. c.000.500 negative § 481 adjustment which reduces 2007-2010 taxable income. are incorrect because the IRS will require that the change be made as of the beginning of the earliest open tax year. PTS: 1 REF: p. At the beginning of the year. The company should change its accounting method in 2007. d. e. with a $37.000 reserve can be used to absorb bad debts until the account balance is zero. with a $150. the $90. the balance in the allowance account is $90.000 negative § 481 adjustment which reduces 2007 taxable income. no adjustment to the reserve account will be required if the balance is consistent with prior bad debt experience. ANS: B This is a voluntary change in accounting method with a negative § 481 adjustment. None of the above. b. If the IRS examines the taxpayer’s return and requires the taxpayer to change accounting methods. a. If the taxpayer voluntarily changes methods. The taxpayer generally is required to make the change as of the beginning of the current tax year. the $90. e. c.000. and c. In 2007. The company should change its accounting method in 2007. but incorrectly. All of the above are correct.105. The adjustments due to the change can be spread over subsequent years. ANS: A Answers b.000 positive § 481 adjustment which increases 2007 taxable income. This caused the ending inventory for 2006 to be overstated by $150. b. d. 16-18 46 . If the IRS examines the taxpayer’s return. 16-16 to 16-18 107. c. used an allowance for bad debts. 16-16 | p. a. b. The company should change its accounting method in 2007 and recognize a $150. e. 16-17 | Example 23 106.000 adjustment can be spread over the current and three following years. If the taxpayer voluntarily changes methods. None of the above. The taxpayer may be subject to penalties and interest. The taxpayer has consistently. ANS: B REF: p. PTS: 1 REF: p. the taxpayer will be required to recognize an additional $90. The company should amend its 2006 tax return. None of the above is correct. Swan Company discovered that it had for the past 10 years capitalized as a production cost certain expenses that are properly classified as administrative expenses.000 of income (one-half in the current year and one-half in the following year) as the adjustment due to the change in accounting methods.

The taxpayer may add $15. the taxpayer voluntarily changed from the cash to the accrual method of accounting.000 75. The change resulted in a positive $60. The relevant account balances as of January 1. Because the change is voluntary.000 – $75.108. The taxpayer voluntarily changed from the cash to the accrual method of accounting. d. The adjustment increases income. The taxpayer must add $15. the taxpayer may spread the adjustment over 4 years (the current tax year and the three following tax years).000 to 2007 income.000 to the income for the year of the change and to the incomes for each of the three following years. PTS: 1 REF: p. The company has a positive adjustment to income of $120.000 adjustment to income. PTS: 1 REF: p. 16-17 109. The company has a $120. b.000 to income for the year of the change. 16-16 | p.000 each to 2008-2010 income. None of the above. c. because inventories were material to the taxpayer’s business. 2007 were as follows: Accounts receivable Inventory Accounts payable for merchandise $ 90. and $30. At the beginning of 2007.000 positive adjustment to income that must be allocated equally to 2007-2009. ANS: D This is a voluntary change from a correct method to another correct method. b. e. The company has a positive adjustment to income that can be allocated as follows: $30. c. d. The company has a negative adjustment to income of $120.000 that must be taken in 2007 income.000 105. a. The taxpayer must amend all prior open years and compute income by the accrual method and pay the additional tax.000 a. e. ANS: C The change is voluntary and results in a positive $120. the taxpayer can spread the adjustment over the current year and the three following years. The taxpayer must add the $60.000 to income for the year of the change and add $15. Under these circumstances.000 that must be recognized in 2007.000 + $105. None of the above. 16-16 | p.000 ($90.000) adjustment to income.000 to the incomes for each of the three preceding years. 16-17 47 .

000 due on the date of the sale and $225. The installment method applies to which of the following sales with payments being made in the year following the year of sale? a.000 × ($100.000 – $150. A cash basis individual’s sale of General Electric common stock. c. 16-18 112. b. The remaining $100. d. b.000 – $50. Helen sold property and reported her gain by the installment method. ANS: C The total gain is $150. e. c. 16-18 | p.000 (plus interest at the Federal rate) due in 2009. PTS: 1 REF: p.000/$300. 16-19 to 16-21 48 .000 [$75. b. e. By an investor who sold IBM Corporation common stock.000 ($200.000)] installment sale gain and $50. A manufacturer’s sale of fully-depreciated equipment. ANS: E The inventory in a. Her basis in the property was $150. By an appliance dealer who sold inventory. e.000 of depreciation recapture that is not eligible for installment reporting.).000 cost less $50. 16-19 111. An automobile dealer’s sale of an SUV. with $75. None of the above. In the year of sale. PTS: 1 REF: pp.000 × ($100.000 is collected in 2009: $225.000 ($300. By an investor who sold real estate at a loss. PTS: 1 REF: p. None of the above. All of the above. d.000.000 gain will be spread over the collection of the $300.000 – $25. $25. the publicly-traded securities in b. $50. This includes $50. $75. and the § 1245 depreciation recapture in c.000).000 ($150. The installment method applies where a payment will be received after the tax year of the sale: a. are not eligible for the installment method.).110. $150.000) must be recognized when the $225. Therefore. Publicly-traded securities are ineligible for the installment method (answer d. By an investor who sold real estate at a gain... c.000.000. $75. None of the above. In 2007. Helen’s recognized installment sale gain in 2009 is: a.000 is collected. d.000 of depreciation). $0. Helen sold the property for $300.000 (the contract price). The remaining gain of $75. ANS: A The installment method does not apply to realized losses (answer b.000).000/$300.) or to inventory (answer c.000.000 depreciation recapture must be recognized in the year of sale.

None of the above. his gain in the year of sale is $125. c. PTS: 1 REF: p. Hal must recognize $21.000. b. The interest rate on the note was equal to the Federal rate. Hal can elect to treat the $36. thus. Hal must recognize $60.000 ($200.000 – $40.600 gain in the year of sale.000 cash and a note for $64.000 – $75. Answer d. Hal’s cost of the land was $40. the contract price is $600.600 PTS: 1 REF: pp.000. a CPA.000. Hal sold land held as an investment with a fair market value of $100. Unless Hal elects not to use the installment method. Todd. are incorrect. The note bore interest of 11% when the applicable Federal rate was 7%.000 that was due in two years. d. is incorrect because the note of $400. sold land for $200.000.000). If Todd uses the accrual basis to report the income from his practice.000.113.000 gain in the year of sale. Todd’s basis in the land was $75. None of the above. e. d.000 gain in the year of sale.000. answers a. ANS: C The contract price is $600.000 would be included in the amount realized for the cash basis sale. The installment method can be used to report the gain on the land regardless of the method of accounting the taxpayer uses to report the income from his trade or business. a. Because of the buyer’s good credit record and the high interest rate on the note. a. b.000.000 down payment plus the face amount of the note of $400.000 = $21.000 as a recovery of capital. ANS: D Under the installment method. he cannot use the installment method to report the gain on the sale of the land.000 for $36.000 plus a note for $400. he cannot use the installment method to report the gain from the sale of the land.000)/$100. Hal must recognize $70. and b. 16-18 to 16-21 114. The fair market value of the note was $360. If Todd uses the installment method to report the gain. e. Hal thought the fair market value of the note was at least $74. Hal’s recognized gain in the year of sale is as follows: [($100. 16-20 49 . If Todd does not use the installment method.000.000] × $36. the $200. If Todd uses the cash basis to report the income from his practice. c.

c.000 + $14. 16-20 50 .000 buyer’s note). d.000 × $6. e.400. the gross profit percentage is $400.000 and encumbered by a mortgage for $28. 16-20 116. The selling price is the total consideration received by the buyer.000 does not exceed the adjusted basis of $60. sold real property that he owned with an adjusted basis of $60.000 selling price less $200. 600/800 = 75%. The first note was payable two years from the date of sale and each succeeding note became due at two-year intervals. sold land that he owned with an adjusted basis of $400.000 cash received plus the $450. None of the above.000 mortgage.000 ($800. $6. ANS: B The realized gain on the sale is $48. Pedro did not "elect out" of the installment method for reporting the transaction. The contract price is $600. $0.000 amount realized – $28. PTS: 1 REF: p. Pedro.000. ANS: B The gross profit percentage is the gain divided by the contract price. b. $2.000 ($200. None of the above. assume the $28.115. $3.000/$600.000). Juan’s selling price is $800.000 each (plus interest at the Federal rate).000 ($108.000 = $3. What is the gross profit percentage? a. not a dealer.000 Since the mortgage assumed of $28. 400/450 = 88. If Pat pays the 2009 note as promised.000 basis).000 to Pat in 2007.000 mortgage assumed). what is the recognized gain to Pedro in 2009 (exclusive of interest)? a. The contract price is the selling price less the seller’s obligations assumed by the buyer. there is no deemed payment problem in 2007.000 on the date of the sale. PTS: 1 REF: p.000 that was encumbered by a mortgage for $200.67%. e.000 ($800.000. not a dealer in real property. d. 400/800 = 50%. Juan.000 cash. Therefore.600.67%. c. The recognized gain is calculated as follows for 2009: $48. exclusive of interest. Juan’s gross profit is $400. The terms of the sale required Pat to pay $14.000 (plus interest at the Federal rate) due in the following year.600 $80. The terms of the sale required the buyer to pay Juan $150.000 mortgage assumed by the buyer).000 less $400. The contract price is $80.000 + $28. 16-19 | p.89%. b.000 mortgage assumed plus the $150.000 – $60. 400/600 = 66. and give Pedro eleven notes for $6. The buyer assumed Juan’s mortgage and gave Juan a note for $450.000 = 66. 16-19 | p.000 ($66.000.

The note was due in 2008 with accrued interest at the Federal rate. The gain on the land of $50. c.000. $255. c. 16-18 | p. $145. PTS: 1 REF: p. e.000 in 2007.000 to equipment. d. 16-19 | p. b. Norma should treat the $100.117. Therefore.000 and the $100.000. PTS: 1 REF: p. ANS: A The sale does not qualify for the installment method if the stock is listed on the New York stock exchange.000 received as a recovery of capital. Norma cannot use the installment method to report her gain if the stock is listed on the New York Stock Exchange. Inc.000 gain on the equipment is all § 1245 depreciation recapture and therefore is ineligible for the installment method.000 but it was fully depreciated. common stock for $100. Charlotte had a $0 basis in the goodwill.000 gain in 2007 and she will not be liable for interest on the taxes deferred under the installment method if the stock is not publicly traded.000 ($100. Norma’s basis in the stock was $250. b.000 gain from the sale of the goodwill are eligible for the installment method.000 cash and a note receivable for $900. ANS: B The $150. d.000 + $50.000 to land. $0. This was Norma’s only installment sale transaction.000. Norma sold Zinc. and $100. $110. 16-19 51 .000 to goodwill. the amount of gain eligible for installment sales treatment is $150.000. the land cost $60. In 2007. Norma must recognize $75. None of the above. 16-20 118.000 gain in 2007 and she will be liable for interest on taxes deferred under the installment method. What is the amount of the gain eligible for installment sales treatment? a.000). e. Norma must recognize $75. Charlotte sold her unincorporated business for $360.000. and the equipment originally cost $250. The installment method is denied for reporting the gains on stocks and securities if they are traded on an established market. Which of the following statements is correct? a.. None of the above. $150. The sales contract allocated $150.000.

000 seller’s mortgage assumed by the buyer). e.000 accumulated straight-line depreciation).119.000 payments × 66. Albert received $100.667 $66. PTS: 1 REF: pp. In b.000 due in two years.000 ($300.333 d.67% gross profit percentage $100. Which of the following statements is correct? a.000 $180. The contract price is $180. no interest is imputed. Jay sold land (a capital asset) to an unrelated party for $20. His basis in the land was $40. If the Federal rate is 7%. ANS: B Alternative b. Albert’s basis in the building was $180. b.67% = $66.000 $66. The Federal rate was 6%.630. He sold a building in the current year for $300. 16-20 | p. The entire recognized gain of $66.000 ($300.000. d. 16-18 to 16-24 120. If the principal amount is less than $2. Albert’s gain taxed as ordinary income and at the 25% rate in the year of sale are what amounts? Ordinary Gain a. interest will be imputed at 10%. All of the above. PTS: 1 REF: p.000 cash at closing. Assuming he did not elect out of the installment method.000 – $120.000 Unrecaptured § 1250 Gain Taxed at 25% $0 $100.000 = 66. $120. $33.000 cost – $220.8 million (adjusted for inflation amount for 2006 is $4. $100.000 ($400.667 $0 ANS: D The total realized gain is $120.000 due in two years.000). interest will be imputed at that rate. the buyer assumed Albert’s mortgage for $120. and the buyer gave Albert a 6% note for $80.000. None of the above. Albert is in the 35% marginal tax bracket.. 9% interest can be charged. c.000 cash and a 9% note for $100. is correct. 16-21 | Concept Summary 16-1 52 .670 recognized gain There is no § 1250 depreciation recapture because the straight-line method was used. If the Federal rate is 9%.000 adjusted basis).300).000 b.000 amount realized – $180. interest will not be imputed. This unrecaptured § 1250 gain is taxed at the 25% alternative tax rate.670 is unrecaptured § 1250 gain because it is less than the depreciation (straight line) that was deducted ($220. If the Federal rate is 6%. $0 c.000. $120. $0 e. because the stated rate (9%) is greater than the Federal rate.

000 × $75.000 cash. e. $120. b. PTS: 1 REF: p.000 ($180. Interest will not be imputed because the contract is for less than five years. In 2008. what gain must Father recognize in 2008? a.000) are attributed to Father. Taylor sold a capital asset on the installment basis and did not charge interest on the deferred payment due in three years. ANS: E REF: pp. ANS: B Father’s realized gain is $180.000.000 = $45.000 as follows: $180. b. Father’s basis was $120. the gain is reduced by the amount of the newly created interest income. Father recognized gain of $45. after paying $24. Lineal descendants. The payment is first allocated to interest and then to principal. d. d.000 The proceeds of the sale by Son in 2008 (to the extent of $225. $135. Related-party installment sales include all of the following except the first seller’s: a.000. Father is deemed to have received payment of the $225. Interest will be imputed. 16-22 53 .121. Controlled corporations. $60. However. e. None of the above.000 – $45.000 interest but nothing on the principal. thus increasing the capital gain. Therefore.000.000.000 $300.000 amount realized – $120. In 2007. 16-21 to 16-23 123. As a result of the second disposition. This results in the recognition of the remaining realized gain of $135. ANS: B When the interest is imputed.000 adjusted basis). with interest. a. The timing of the income is affected because the gain without any interest would be reported in proportion to the payments collected each year. 16-21 122. 16-20 | p. the total price is reduced and the interest accrues based on the balance of the outstanding receivable. Son sold the land for $300. All of the above would be considered related parties. Partnerships in which the seller has an interest.000. c. $180.000 cash and an installment note for $225. e. In 2007. Interest will be imputed.000. thus creating ordinary income. b. c. Therefore. Brothers and sisters. Interest will be imputed. c. d. Father sold land to Son for $75. 16-21 | p. thus reducing the seller’s total income from the transactions.000 receivable from Son when the second sale occurred.000 ($300. PTS: 1 REF: p.000) of gain in 2008. the interest payments will decrease as more is paid on principal. the selling price is reduced by the amount of the imputed interest. None of the above.

a.000 in the year of sale and gave Kathy a note for $900. Section 453(g) provides generally that the installment method is not available. e.124.000 and the balance in the accumulated depreciation account was $400. Inc. Kathy. 16-23 | Example 29 125. None of the above. (2) and (3). paid $100. c. (1) and (2). None of the above. However. e. d. Kathy. 16-23 54 . b. Kathy generally cannot report the gain by the installment method. ANS: A Gifts are treated as taxable dispositions of installment obligations. (2) Transfer to the transferor’s 100% owned corporation. The apartment building cost $500. PTS: 1 REF: p. a and b are true. Kathy sold an apartment building to her 100 percent controlled corporation. PTS: 1 REF: p. b. (2).000 plus adequate interest due in 2009. ANS: C The related party sale of depreciable property results in a penalty. the installment method can be used. (3) Transfer to a partnership for an interest in partnership capital and profits. (1).000. a. and (3). c. (1) only. Inc. if the taxpayer can establish that tax avoidance was not a principal purpose of the transaction. Which of the following is (are) a taxable disposition of an installment obligation? (1) Transfer to a relative as a gift. a and b are false. Kathy can use the installment method only if tax avoidance was not a principal purpose of the transaction. d. In 2007.

b. e. None of the above is true.000. Gold’s basis in the stock was $2. e. Answer c. Answer b. In the case of a small home construction company that builds under long-term contracts. The completed contract method must be used. PTS: 1 REF: p.126. c. payable in three years with interest at the Federal rate. 16-27 55 .000. is correct because publicly traded property is not eligible for installment reporting. ANS: D The major tax advantage of the completed contract method is the ability to defer income.000 gain ($8. Gold must recognize $18. d. If the Ruby Corporation stock is not traded on an established market. Assume that Gold Corporation will report the gain by the installment method where the method is permitted.000 × 90%).000.200. is correct because the gain is 90% of the selling price and when $8.000 in the year of the sale and a note for $12. 16-26 | p.000. All of the above are true. is correct because outstanding installment obligations at the close of the tax year exceed $5 million. the company was required to recognize $7. a. ANS: D Answer a.000 was collected. None of the above is true. If the Ruby Corporation stock is not traded on a national exchange. PTS: 1 REF: pp. If the Ruby Corporation stock is traded on a national exchange. b. 16-19 to 16-21 127.200. The percentage of completion method should be used to defer income. c. Gold must recognize a $7. The percentage of completion method must be used. Gold Corporation sold its 40% of the Ruby Corporation common stock. The completed contract method defers income recognition. generally: a. Gold must pay interest on a portion of the deferred taxes.000. d. Gold received $8.000 gain in the year of sale.000.000.000 gain in the year of sale.000.

000. As a result of the transfer: a. None of the above is true. d.000. Less than.000 – $300. if the actual costs are ____ the estimated costs.000 = $60.000 in 2007. ANS: D The profit on the contract recognized in 2007 was calculated as follows: $150. 16-28 130.000). PTS: 1 REF: pp. PTS: 1 REF: p. Under the percentage of completion method. b. Robin will receive interest (under the look-back method) on the overpayment of taxes in 2007.000 of income in 2007. The contract was completed in 2008 and the cost incurred that year was $400.000 loss in 2008. 18-4 | p. Greater than. and interest must be paid.000. b.000. PTS: 1 REF: p. 16-25 to 16-28 129.000 and fair market value of $400. Eve transfers property (basis of $120. ANS: B Under the lookback method. All of the above are true. c. Robin should report a $10. a. c.128. d.000). The estimated cost of the contract in 2007 was $600. Robin must report a $10. 18-5 56 .000 $750. Under the percentage of completion method: a. Eve recognizes a gain of $50.000) and a long-term note (worth $50. d.000 loss in 2008 and will receive interest on the overpayment of taxes. The actual cost incurred in 2007 was $300.” Thus. Eve recognizes a gain of $230. Robin should report $60. e. e. The contract price was $750. None of the above. the taxpayer is deemed to have underpaid prior years’ taxes.000 ($750.000. Eve recognizes no gain. ANS: D A long-term note is treated as “boot. the taxpayer must pay interest on the underpayment of prior years’ taxes.000 – $400. Eve is taxed on the value of the note received. Robin Construction Company began a long-term contract in 2007. Equal to or greater than.000. Eve recognizes a gain of $280.000 × $300.000 The total profit on the contract was $50. None of the above. c. e. Equal to.000. b. Because Robin reported profit on the contract of $60.000) to Green Corporation for 80% of its stock (worth $350. executed by Green Corporation and made payable to Eve.

as well as to a newly formed corporation.000. Brown Corporation has two other shareholders.000 of which was personal and the balance of $9. PTS: 1 REF: p. PTS: 1 REF: Example 12 132. Bill and Bob. with a tax basis of $40. Ann has no recognized gain. 18-9 | p.000 [$240. her basis in the Black Corporation stock is $240. a. c. e.131.000 in the property. Black Corporation’s basis in the property is $250. § 357(b) taints all liabilities even though some are supported by a bona fide business purpose. for 100 shares of its stock. Ann has a basis of $200. Black Corporation has a basis of $241.000 that is the amount of the boot she is treated as having received.000 (boot received) + $10.000.000.000 in the land. Ann transferred land worth $200. Tara’s basis in the Black Corporation stock is $241.000 in her 100 shares in Brown Corporation. With respect to the transfer: a. Tara incorporates her sole proprietorship.000 and a fair market value of $300. Tara receives all of the stock in Black Corporation.000 (gain recognized by Tara)]. None of the above.000 in her 100 shares in Brown Corporation. $1. In return for these transfers. Black Corporation has a basis of $240. In terms of the $10.000 (gain recognized)].000 [$240. ANS: C The transfer does not qualify under § 351 as Ann has only a 1/3 interest in Brown Corporation. The requirements of § 351 apply to transfers to an existing corporation.000 (basis of the property given up) – $10.000 in liabilities. b. Thus.000. b. d. an existing entity. Tara’s basis in the Black Corporation stock is $249. c.000. d. e. Also transferred was $10. Ann has a basis of $40. The assets transferred have an adjusted basis of $240.000 being business related.000 (Tara’s basis in the property) + $10.000 in the property. to Brown Corporation. transferring it to newly formed Black Corporation.000 boot. each of whom holds 100 shares. 18-10 57 . ANS: E Tara has a recognized gain of $10. Brown Corporation has a basis of $160. None of the above.

White Corporation’s basis in the building is $15. $10. b. e. e. He transfers the following items to newly created Wren Corporation.000 (fair market value of the automobile) and has additional gain of $5.000 is recognized under § 351(b).000) and an automobile (fair market value of $5. Mary receives 80% of White Corporation’s stock (worth $65. Mary has no recognized gain.000) to White Corporation. 18-8 to 18-11 134.000.000 (cash)]. a cash basis taxpayer. Tim.000 (taken out 15 years ago) on the building. None of the above.000 (Mary’s recognized gain)]. Tim has no recognized gain.000 135. Wren Corporation’s basis in the building is $115.000. PTS: 1 REF: p. In addition. PTS: 1 REF: p. b.000 (building) + $20.000.000 [$15.000 and fair market value of $90.000. there is an outstanding mortgage of $20.133.000. d. In return.000 135.000) exceed the basis of all assets transferred [$110. Mary’s recognized gain is $5. 18-4 | p. Mary receives boot of $5. 18-9 to 18-12 58 . White Corporation’s basis in the building is $25.000 Fair Market Value $ 20.000 110. c.000. Since the sum of these amounts is less than the realized gain of $75. which White Corporation assumes.000). None of the above. ANS: A As a result of the transfer. incorporates his sole proprietorship.000 (excess of the mortgage over the basis of the building).000 (Mary’s basis in the building) + $10. Mary transfers a building (adjusted basis of $15.000 (Tim’s basis) + $5. With respect to this transaction: a.000.000 (gain recognized by Tim)].000 Cash Building Mortgage payable (secured by the building and held for 15 years) With respect to this transaction: a. Adjusted Basis $ 20. c. d.000 [$110. Tim has a recognized gain of $5. ANS: D Under § 357(c) Tim recognizes gain to the extent liabilities (mortgage payable of $135. Mary’s recognized gain is $10. Wren Corporation’s basis in the building is $110. Tim has a recognized gain of $25.000 160.

000. Cardinal has a basis of $30. e. b. d. Kim recognizes no taxable gain on the transfer.000.000 in the installment obligation. PTS: 1 REF: p.000. 18-4 | p.135. Kim owns 100% of the stock of Cardinal Corporation. a. ANS: A An installment obligation qualifies as “property” under § 351. Kim has a taxable gain of $180.000 and fair market value of $200. Kim recognizes no gain on the transfer. None of the above. In the current year Kim transfers an installment obligation. for additional stock in Cardinal worth $200. c. tax basis of $30. Kim has a basis of $200.000. 18-11 59 . Kim has a taxable gain of $170.000 in the additional stock she received in Cardinal Corporation. Thus.

000) $ 60. Warbler Corporation has the same basis in the assets received as Rick does in the stock. a.000 $330. ANS: A Rick has a realized gain of $60.000 (basis of property transferred) – $75.000) or the boot received ($75.000 (gain recognized)].000 in cash plus 90% of Warbler Corporation’s only class of stock outstanding (fair market value of $225.000 75.000 30.000 30.000 30.000 determined as follows.136.000 [$270. Rick transferred the following assets and liabilities to Warbler Corporation. d. Amount realized— Fair market value of the stock in Warbler Corporation Cash received Liability transferred Less: Basis of property transferred Realized gain $225.000 Fair Market Value $225.000 (270.000 (gain recognized)].000 [$270.000. Adjusted Basis $210.000 (boot received) – $30.000).000 45. None of the above.000. the recognized gain is $60. Rick has a recognized gain of $60. Rick’s basis in the Warbler Corporation stock is $225.000 15. e.000 Because recognized gain cannot exceed the lesser of the realized gain ($60. c.000. 18-4 | p. b. 18-11 60 .000.000 (basis in the property transferred) + $60.000 75.000 Building Equipment Automobile Mortgage (held for four years) on building In return Rick received $75. Rick’s basis in the stock of Warbler Corporation is $270. Warbler Corporation’s basis in the property transferred is $330. PTS: 1 REF: p.000 30.000).000 (liability transferred) + $60. Rick has a recognized gain of $75.

). 18-4 | p.000 built-in loss) and $15.000 carryover basis reduced by the $30.000 and fair market value of $150. Although cash was involved. e. d. Dove Corporation issues 200 shares of stock.). e. PTS: 1 REF: p. As a result of these transfers: a. Hunter has a recognized loss of $30.000. 18-4 | p. Hunter may not recognize the realized loss of $30.000. b. Tan Corporation will have a basis in the land of $45. Neither Hunter nor Warren has any recognized gain or loss. Sarah and Tony (mother and son) form Dove Corporation with the following investments: cash by Sarah of $55.) does not prevent § 351 from applying. 100 each to Sarah and Tony. His basis in the stock is $35. As such. c. Hunter transfers equipment (basis of $210. therefore. c. land by Tony (basis of $35.000 and fair market value of $180.000.000.).000. It is not. Tony does not recognize a gain (choice b.000 of cash. None of the above.137. a. Since § 351 applies and no boot was received.000 and fair market value of $45.000). Tony recognizes a gain of $10.000.000 as in choice c. ANS: D The fact that the stock was not in proportion to the value of the property transferred (choice a. None of the above. each receives stock in Dove worth $50. 18-3 | p. Hunter and Warren form Tan Corporation. 18-12 | Example 21 61 .000 in the equipment transferred by Hunter ($210.000 plus $5.000.000) while Warren transfers land (basis of $15. As a result of the transfer. boot within the meaning of the § 351. but Warren has a recognized gain of $30. Each receives 50% of Tan’s stock.000 as in choice d. Thus. PTS: 1 REF: p. the basis of the stock implicitly gifted by Sarah to Tony (not $50.000.). b.).000.000 in the land (not $45. ANS: B This fact pattern clearly comes within the scope of § 351.000 (choice a.000) and $30. it was given and not received by Warren (choice c. Tony’s basis in the stock of Dove Corporation is $50. Section 351 may apply because stock need not be issued to Sarah and Tony in proportion to the value of the property transferred. Tan Corporation will have a basis of $180. 18-11 | Example 6 138. d. and Warren has a recognized gain of $135. Section 351 cannot apply since Sarah should have received 110 shares instead of only 100. Hunter has no recognized loss.

000 in the stock in the newly formed corporation [$105. 18-10 | p. a sole proprietor.000 and fair market value of $300. There was a note payable to the bank in the amount of $95. The note was issued for the purchase of computers and other business equipment. Because the trade accounts payable give rise to a deduction. The assets of the proprietorship had a basis of $105.139. None of the above. and the basis of the assets to the corporation is $105. The basis of the assets to the corporation is $300. they are not considered to be liabilities for purposes of § 357(c).000.000 (liabilities assumed by the corporation)]. e.000. PTS: 1 REF: p.000. a. Dawn has a gain on the transfer of $15. Dawn has no gain on the transfer. 18-11 62 .000. Later. Dawn has a zero basis in the stock she receives. c. she incorporates her business and transfers the assets of the business to the corporation in return for all the stock in the corporation plus the corporation’s assumption of the liabilities of her proprietorship. liabilities do not exceed basis. the cash basis payables are not considered in the computation of Dawn’s stock basis.000 that the corporation assumes. All the receivables and the unpaid trade payables are transferred to the newly formed corporation. Dawn has a basis of $10. d. was engaged in a service business and reported her income on a cash basis. In addition.000 (basis in the assets transferred to the corporation) – $95.000. The trade accounts payable totaled $25. Dawn. b. thus. ANS: C Dawn has a basis of $10.000 in the stock she receives.

Joe and Kay form Gull Corporation.000) $ 20. Kay transfers property with a basis of $50.000 100. Kay has income of $10. c.000 Cardinal Corporation will have a basis of $140. Amount realized: Stock Note Release of mortgage Less: Basis of land Realized gain Recognized gain ($30. e.000. Gull Corporation deducts the $10.000 as organizational costs. Gull Corporation has a business deduction under § 162 of $10. None of the above. Gull capitalizes $10.000 + $40.000.000. b. a.000 $ 70. c.000. the note payable to Carl does not qualify for nonrecognition under § 351. None of the above. This amount would be gain under § 357(c).000 for 200 shares in Gull Corporation.000 $160. thus.000. Carl will have a gain on the transfer of $30. is worth $160.140.000. d.000.000 in the land [$70. The land.000. Cardinal Corporation will have a basis in the land transferred by Carl of $70.000 in the property transferred by Kay. ANS: C Gull Corporation has a basis of $50. She agrees to accept 200 shares in Gull Corporation for the property and for providing bookkeeping services to the corporation in its first year of operation.000 (gain recognized by Carl with respect to the transfer of the land)].000 as a business expense. Carl transfers land to Cardinal Corporation for 90% of the stock in Cardinal Corporation worth $20. Gull Corporation has a basis of $240. PTS: 1 REF: Example 23 63 .000.000 and fair market value of $240.000. b. PTS: 1 REF: p.000. 18-4 | p.000 40. ANS: A The mortgage on the land exceeds Carl’s basis in the land by $30. Carl will have a gain on the transfer of $70.000 (70. The value of Kay’s services is $10. In addition.000.000 in the property it received from Kay. 18-10 141.000 (Carl’s basis in the land) + $70.000 plus a note payable to Carl in the amount of $40.000 on the exchange. which has a basis to Carl of $70. d.000 and the assumption by Cardinal Corporation of a mortgage on the land in the amount of $100.000) $ 90. Cardinal Corporation will have a basis in the land transferred by Carl of $160. Carl would have additional gain of $40. Neither Joe nor Kay recognize gain on the exchanges. Joe transfers cash of $250. e. With respect to the transfer: a.

Two of these individuals. d.142.480. Mary transfers property. Crow will have a business deduction of $120. c. Walt must recognize income of $100. The value of Mary’s services is $120. and d. Four individuals form Chickadee Corporation under § 351.000 40. basis of $80. Walt must recognize income of $130. PTS: 1 REF: Example 23 143..600.000.000 -0240.000. e. Jane has no income.480. and agrees to serve as manager of Crow for one year. PTS: 1 REF: p.000 370. c.400. With respect to the transfers: a.000. b. None of the above. Neither Jane nor Walt recognize income.000. Jane must recognize income of $40.000) $360. The depreciation recapture rules do not apply to Walt because he does not recognize income from the transaction.. None of the above. basis of $200. Jane and Walt.).000. Mary will not recognize gain. Walt has no income. a. Earl transfers property.000 for the value of the services Mary will render. Earl and Mary form Crow Corporation. Crow Corporation has a basis of $1. Earl will recognize a gain of $1. in return Mary receives 50 shares of Crow.000 Both Jane and Walt receive stock in Chickadee Corporation equal to the value of their investments.000. b.000 and value of $1.000 in the property it received from Mary. the value of the services she will render to Crow. for 50 shares in Crow Corporation. made the following contributions: Adjusted Basis From Jane— Cash Patent From Walt— Equipment (depreciation claimed of $100. ANS: D Earl will not recognize gain on the transfer.000. 18-15 | Example 2 | Example 3 64 . e.000 Fair Market Value $360. Jane has no income.000.000 and value of $1.000. c. Crow will have a business deduction of $120. Mary will have income of $120. d. ANS: B Both Jane and Walt are protected by § 351 and have no income to recognize (choices a.

000 and a § 1231 gain of $10. Adam transfers cash of $300. If Grouse pays George interest of $6.000 principal payment on the note: a.000 in the equipment and it will have no depreciation recapture if it later disposes of the equipment in a taxable transaction. After the transfer. Grouse has net taxable income of $40.300. b.000. Leonard has ordinary income of $50.000.000.000 and land worth $200.000. PTS: 1 REF: Example 28 146. a newly formed corporation. In the first year of operation.000 to Grouse Corporation. thus. Leonard has ordinary income of $50. George transfers cash of $150.000) for additional stock in Green Corporation. Green Corporation has a basis of $40. Adam has no taxable income from the distribution. Grouse Corporation has an interest expense deduction of $6. Camel Corporation reduces its basis in the land to $150.000. d. With respect to the transfer: a. Leonard owns 90% of the stock.000 on the equipment prior to transferring it to Green Corporation.000. However. In the first year of operation. 18-17 65 .000.144. George has dividend income of $7.000 plus interest at the rate of 9% per annum. If Camel distributes $50.000. None of the above.000 to Camel Corporation for 100% of the stock in Camel. Camel has net taxable income of $70. ANS: A Adam will have a taxable dividend of $50.000. payable in equal annual installments of $7. e. c. b. None of the above.000 payment because dividends are not deductible by the distributing corporation. Leonard had claimed depreciation of $50. d. ANS: E The transfer comes under § 351.000 and debt in the amount of $70. for 100% of the stock in Grouse worth $80. e.300 and $7. The interest will be ordinary income to George and produce a deduction to Grouse Corporation. PTS: 1 REF: Example 25 145. PTS: 1 REF: p.000 to Adam: a. d. Camel will not be permitted a deduction for the $50. c. The basis of the equipment to Green is $40. Leonard transfers equipment (basis of $40.000. None of the above. ANS: D The payment will be treated as a payment on the debt.000 and fair market value of $100. e. c. b. when Green Corporation later disposes of the equipment in a taxable transaction. Camel Corporation has a tax deduction of $50. George has dividend income of $13. Grouse Corporation does not have a tax deduction with respect to the payment. it must take into account the § 1245 recapture potential originating with Leonard. Adam has taxable income of $50.000.300. Green Corporation has ordinary income of $50. Leonard has no recognized gain and no depreciation to recapture.000.

Five years later. Shawn transfers property (basis of $40.000 and fair market value of $35. e.500 ordinary and $22.000. only $10. ANS: B REF: Example 31 148. Shawn’s basis in the Condor stock is $40. The transfer qualifies as a nontaxable exchange under § 351. A capital loss of $10. $22.000 and a capital loss of $5.500 capital. c. the remaining $5. Kristen’s loss is: a. Kristen transferred property (basis of $26.000 and fair market value of $22.000. With respect to the sale. $3. Shawn has: a.000. An ordinary loss of $10. Three years later. 18-21 | Example 31 66 . b.500 ordinary and $3. e. Pheasant Corporation goes bankrupt and its stock becomes worthless. None of the above. the basis in the stock is $35. When the stock is sold for $25.000 loss is a capital loss.000 ordinary.000.000 and an ordinary loss of $5. PTS: 1 REF: p. c. None of the above.000. Shawn sells the Condor stock for $25. d.000 qualifies as an ordinary loss.500) for § 1244 stock. d.000.000 capital. Kristen’s basis in the Pheasant stock is $26.500 capital. therefore. An ordinary loss of $15. $26. When Pheasant Corporation was formed under § 351.000. who is single. owned the stock as an investment. ANS: B For purposes of § 1244 treatment. Kristen. $26.000.000) to Condor Corporation in exchange for § 1244 stock. A capital loss of $15. b.147.000.

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