Regulation 4 PassMaster Questionsgh

Becker CPA Review, PassMaster Questions

Lecture: Regulation 4

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CPA PassMaster QuestionsRegulation 4 Export Date: 10/30/08




Partnership Taxation CPA-01695 Type1 M/C A-D Corr Ans: C PM#1 R 4-01

1. CPA-01695 ARE R03 #6 Page 12

Thompson's basis in Starlight Partnership was $60,000 at the beginning of the year. Thompson materially participates in the partnership's business. Thompson received $20,000 in cash distributions during the year. Thompson's share of Starlight's current operations was a $65,000 ordinary loss and a $15,000 net long-term capital gain. What is the amount of Thompson's deductible loss for the period? a. $15,000 b. $40,000 c. $55,000 d. $65,000 CPA-01695 Explanation Choice "c" is correct. A partner's deductible loss is limited to his basis plus any amounts that he is personally liable for ("at risk" provision).

Thompson's basis would be calculated as follows:

Beginning basis $ 60,000 Plus: Net LT capital gain 15,000 Less: Cash distribution (20,000) Basis for determining allowable loss deduction $ 55,000

Thompson would be allowed to take a loss deduction for $55,000 of the $65,000 ordinary loss passed through to him from the partnership. The remaining $10,000 would be carried forward until additional basis became available.

Choice "a" is incorrect. This choice assumes a partner can take a loss to the extent of capital gain income.

Choice "b" is incorrect. This choice does not take into account the additional basis Thompson receives for the pass through income (net long-term capital gain).

Choice "d" is incorrect. Thompson's loss is limited to his basis plus any liabilities that he is personally liable for. His basis is calculated as above for this determination and the question does not indicate he should receive any additional basis for any liabilities. CPA-01696 Type1 M/C A-D Corr Ans: C PM#2 R 4-01

2. CPA-01696 ARE R03 #10 Page 18

Stone and Frazier decided to terminate the Woodwest Partnership as of December 31. On that date, Woodwest's balance sheet was as follows: Cash $2,000 Equipment (adjusted basis) 2,000 Capital - Stone $3,000 Capital - Frazier 1,000

The fair market value of the equipment was $3,000. Frazier's outside basis in the partnership was $1,200. Upon liquidation, Frazier received $1,500 in cash. What gain should Frazier recognize? a. $0 b. $250 c. $300 d. $500 CPA-01696 Explanation Choice "c" is correct. In a complete liquidation of a partnership, the partner's basis in property received is the same as the adjusted basis of his partnership interest reduced for any monies actually received and is




generally a nontaxable event. However, if a partner receives only money that exceeds his basis in the partnership, gain or loss is recognized. In this instance, Frazier's basis in his partnership interest was $1,200. He received $1,500 in cash in the liquidation. Frazier's gain is calculated as follows:

Amount realized $1,500 Basis in partnership interest (1,200) Gain recognized $ 300

Note: Don't be confused by the term "outside basis." The term outside basis merely refers to the differences that may exist between the partner's share of the basis of the assets in the hands of the partnership (inside basis) and his basis in his partnership interest. Choice "a" is incorrect. If Frazier had received property other than cash, gain would not have been recognized.

Choice "b" is incorrect. This choice appears to utilize Frazier's book capital of $1,000 (which is wrong) and 50% of the fair market value of the equipment to calculate gain of $500. However, use of that capital balance as his basis and the fact that the question does not indicate that Frazier received anything other than the cash as a distribution make this choice incorrect.

Choice "d" is incorrect. This choice erroneously uses Frazier's capital on the partnership's balance sheet as his basis in his partnership. CPA-01713 Type1 M/C A-D Corr Ans: B PM#8 R 4-01

3. CPA-01713 ARE Nov 95 #27 Page 3

Barker acquired a 50% interest in Kode Partnership by contributing $20,000 cash and a building with an adjusted basis of $26,000 and a fair market value of $42,000. The building was subject to a $10,000 mortgage, which was assumed by Kode. The other partners contributed cash only. The basis of Barker's interest in Kode is: a. $36,000 b. $41,000 c. $52,000 d. $62,000 CPA-01713 Explanation Choice "b" is correct. A partner's basis in a newly formed partnership is determined as follows:

Cash contribution $ 20,000 Adjusted basis of non-cash property 26,000 Share of partnership liabilities assumed by other partners $10,000 50% (5,000) Net total $ 41,000

Choice "a" is incorrect. You must subtract the share of the partnership liabilities assumed by the other partners.

Choice "c" is incorrect. For the contributed property, the fair market value is ignored. The partnership assumes the partner's adjusted basis. In addition, you must subtract the share of the partnership liabilities assumed by the other partners is subtracted.

Choice "d" is incorrect. For the contributed property, the fair market value is ignored. The partnership assumes the partner's adjusted basis. CPA-01715 Type1 M/C A-D Corr Ans: D PM#9 R 4-01

4. CPA-01715 ARE Nov 95 #28 Page 3

At partnership inception, Black acquires a 50% interest in Decorators Partnership by contributing property with an adjusted basis of $250,000. Black recognizes a gain if: I. The fair market value of the contributed property exceeds its adjusted basis.




II. The property is encumbered by a mortgage with a balance of $100,000. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01715 Explanation Choice "d" is correct. The fair market value of property (high or low) is irrelevant in determining Black's basis in Decorators. The partner's adjusted basis is used.

Since the mortgage does not exceed Black's basis, he will not recognize a gain on the contribution of the encumbered property to Decorators. CPA-01721 Type1 M/C A-D Corr Ans: A PM#11 R 4-01

5. CPA-01721 ARE Nov 95 #30 Page 6

On January 4, 1994, Smith and White contributed $4,000 and $6,000 in cash, respectively, and formed the Macro General Partnership. The partnership agreement allocated profits and losses 40% to Smith and 60% to White. In 1994, Macro purchased property from an unrelated seller for $10,000 cash and a $40,000 mortgage note that was the general liability of the partnership. Macro's liability: a. Increases Smith's partnership basis by $16,000. b. Increases Smith's partnership basis by $20,000. c. Increases Smith's partnership basis by $24,000. d. Has no effect on Smith's partnership basis. CPA-01721 Explanation Choice "a" is correct. A partner's basis in the partnership is increased by the partner's share of partnership liabilities (Smith is a 40% partner). Macro is obligated on the $40,000 mortgage; 40% x $40,000 = $16,000. Even though the partnership is obligated to repay the mortgage, as a partner Smith is jointly and severally liable on the debt.

Choices "b", "c", and "d" are incorrect. A partner's basis in the partnership is increased by the partner's share of partnership liabilities. CPA-01735 Type1 M/C A-D Corr Ans: B PM#12 R 4-01

6. CPA-01735 ARE Nov 95 #31 Page 16

Hart's adjusted basis in Best Partnership was $9,000 at the time he received the following nonliquidating distributions of partnership property:

Cash $ 5,000 Land

Adjusted basis 7,000 Fair market value 10,000

What was the amount of Hart's basis in the land? a. $0 b. $4,000 c. $7,000 d. $10,000 CPA-01735 Explanation Choice "b" is correct. Hart must reduce his $9,000 original basis by the $5,000 cash distribution to a basis of $4,000. Smith's basis in the land is the lesser of the land's basis in the partnership's hands ($7,000) or Hart's remaining basis in his partnership interest in Best ($4,000 after the cash distribution).




Choice "a" is incorrect. Hart's basis in the land is greater than zero. Hart's basis must first be reduced by the cash received.

Choice "c" is incorrect. Hart's basis in the land can not be greater than his remaining basis in his partnership interest after deducting the cash received.

Choice "d" is incorrect. The fair market value of the land is not considered in determining Hart's basis in the land. CPA-01737 Type1 M/C A-D Corr Ans: D PM#13 R 4-01

7. CPA-01737 ARE Nov 95 #32 Page 16

Stone's basis in Ace Partnership was $70,000 at the time he received a nonliquidating distribution of partnership capital assets. These capital assets had an adjusted basis of $65,000 to Ace and a fair market value of $83,000. Ace had no unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. What was Stone's recognized gain or loss on the distribution? a. $18,000 ordinary income. b. $13,000 capital gain. c. $5,000 capital loss. d. $0. CPA-01737 Explanation Choice "d" is correct. A partner does not ordinarily recognize income on a nonliquidating partnership distribution of property other than money. The distribution of property with an adjusted basis of $65,000 to Stone from Ace will reduce Stone's basis in Ace partnership to $5,000 ($70,000 - $65,000). The fair market value of the property (high or low) is not relevant.

Choice "a" is incorrect. The fair market value of the property is not relevant.

Choice "b" is incorrect. A partner does not ordinarily recognize income on a nonliquidating partnership distribution of property other than money. In addition, the fair market value of the property is not relevant.

Choice "c" is incorrect. A partner does not ordinarily recognize income on a nonliquidating partnership distribution of property other than money. CPA-01739 Type1 M/C A-D Corr Ans: B PM#14 R 4-01

8. CPA-01739 ARE Nov 95 #33 Page 7

On January 3, 1994, the partners' interests in the capital, profits, and losses of Able Partnership were:

% of capital, profits, and losses Dean 25% Poe 30% Ritt 45%

On February 4, 1994, Poe sold her entire interest to an unrelated party. Dean sold his 25% interest in Able to another unrelated party on December 20, 1994. No other transactions took place in 1994. For tax purposes, which of the following statements is correct with respect to Able? a. Able terminated as of February 4, 1994. b. Able terminated as of December 20, 1994. c. Able terminated as of December 31, 1994. d. Able did not terminate. CPA-01739 Explanation Choice "b" is correct. Among other events, a partnership terminates for income tax purposes when 50% or more of its interests change hands within 12 months. That threshold was reached for Able on December 20, at which time the partnership terminated for income tax purposes.




Choice "a" is incorrect. On February 4th, only 30% of the interests in the partnership changed hands.

Choice "c" is incorrect. The end of the taxable year is not the termination date, rather it is the date on which the actual sale or other terminating event occurs.

Choice "d" is incorrect. The partnership does terminate when 50% or more of its interests change hands within 12 months. CPA-01741 Type1 M/C A-D Corr Ans: C PM#15 R 4-01

9. CPA-01741 ARE Nov 95 #34 Page 7

Curry's sale of her partnership interest causes a partnership termination. The partnership's business and financial operations are continued by the other members. What is (are) the effect(s) of the termination? I. There is a deemed distribution of assets to the remaining partners and the purchaser. II. There is a hypothetical recontribution of assets to a new partnership. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01741 Explanation Choice "c" is correct.

Rule: When a partnership is terminated for tax purposes and its remaining partners decide to carry on the partnership business in a (deemed) new partnership, tax law treats this as a distribution of the prior partnership's assets followed by a recontribution of the (deemed) distributed assets to the new partnership.

Choices "a", "b", and "d" are incorrect, per the above rule. CPA-01749 Type1 M/C A-D Corr Ans: D PM#18 R 4-01

10. CPA-01749 ARE May 95 #28 Page 12

Alt Partnership, a cash basis calendar year entity, began business on October 1, 2004. Alt incurred and paid the following in 2004:

Legal fees to prepare the partnership agreement $23,000 Accounting fees to prepare the representations in offering materials 15,000

Alt elected to amortize costs. What was the maximum amount that Alt could deduct on the 2004 partnership return? a. $0 b. $300 c. $4,600 d. $5,300 CPA-01749 Explanation Choice "d" is correct. Eligible expenditures up to $5,000 can be deducted in the first year (with overall limitations.) Additional expenditures are amortized over 180 months beginning with the date they begin business. Legal fees to prepare the partnership agreement ($23,000) are eligible for this treatment, but sales and promotional expenses ($15,000) are not deductible or amortizable.

The first year deduction is calculated as follows:

23,000 immediate deduction 18,000 / 180 months = $100 per month x 3 = 300 + 5,000 = $5,300




CPA-01751 Type1 M/C A-D Corr Ans: A PM#19 R 4-01

11. CPA-01751 ARE May 95 #29 Page 12

A guaranteed payment by a partnership to a partner for services rendered may include an agreement to pay: I. A salary of $5,000 monthly without regard to partnership income. II. A 25 percent interest in partnership profits. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01751 Explanation Choice "a" is correct.

I. A guaranteed payment is a salary or other payment to a partner that is not calculated with respect to partnership income.

II. Since the 25% interest is calculated with respect to partnership profits, it is not a guaranteed payment.

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

CPA-01753 Type1 M/C A-D Corr Ans: C PM#20 R 4-01

12. CPA-01753 ARE May 95 #30 Page 16

Curry's adjusted basis in Vantage Partnership was $5,000 at the time he received a nonliquidating distribution of land. The land had an adjusted basis of $6,000 and a fair market value of $9,000 to Vantage. What was the amount of Curry's basis in the land? a. $9,000 b. $6,000 c. $5,000 d. $1,000 CPA-01753 Explanation Choice "c" is correct. A partner who receives a distribution of non-cash property from a partnership takes the partnership's basis as his basis, but in no case an amount greater than his basis in his partnership interest. In this case Curry would ordinarily take a $6,000 basis in the land, but since his basis in the partnership interest is only $5,000, that is the basis of the land in his hands. Curry's partnership interest now has a basis of zero.

Choices "a", "b", and "d" are incorrect. Each of these uses the wrong basis (the basis a partner takes in a nonliquidating distribution). CPA-01755 Type1 M/C A-D Corr Ans: D PM#21 R 4-01

13. CPA-01755 ARE Nov 94 #57 Page 12

White has a one-third interest in the profits and losses of Rapid Partnership. Rapid's ordinary income for the 1993 calendar year is $30,000, after a $3,000 deduction for a guaranteed payment made to White for services rendered. None of the $30,000 ordinary income was distributed to the partners. What is the total amount that White must include from Rapid as taxable income in his 1993 tax return? a. $3,000 b. $10,000 c. $11,000 d. $13,000 CPA-01755 Explanation




Choice "d" is correct.

Rule: Partnership income is taxable to a partner whether or not it is distributed. White's share of Rapid's 1993 income is the sum of the $3,000 guaranteed payment and one-third of the partnership's net income of $30,000 ($10,000), for a total of $13,000.

Choices "a", "b", and "c" are incorrect, per the above rule. CPA-01757 Type1 M/C A-D Corr Ans: C PM#22 R 4-01

14. CPA-01757 ARE May 94 #26 Page 3

On January 2, 1993, Black acquired a 50% interest in New Partnership by contributing property with an adjusted basis of $7,000 and a fair market value of $9,000, subject to a mortgage of $3,000. What was Black's basis in New at January 2, 1993? a. $3,500 b. $4,000 c. $5,500 d. $7,500 CPA-01757 Explanation Choice "c" is correct. A contributing partner's basis is the adjusted basis of assets contributed, plus any gain recognized on the contribution, less debt relief.

Basis $7,000 Debt relief ($3,000 50%) (1,500) Basis $5,500

Choices "a", "b", and "d" are incorrect. A contributing partner's basis is the adjusted basis of assets contributed, plus any gain recognized on the contribution, less debt relief. CPA-01760 Type1 M/C A-D Corr Ans: A PM#23 R 4-01

15. CPA-01760 ARE May 94 #27 Page 6

Gray is a 50% partner in Fabco Partnership. Gray's tax basis in Fabco on January 1, 1993, was $5,000. Fabco made no distributions to the partners during 1993 and recorded the following:

Ordinary income $20,000 Tax exempt income 8,000 Portfolio income 4,000

What is Gray's tax basis in Fabco on December 31, 1993? a. $21,000 b. $16,000 c. $12,000 d. $10,000 CPA-01760 Explanation Choice "a" is correct. A partner's basis is increased by the partner's share of partnership ordinary income, separately stated income, and tax exempt income. $5,000 + 50% x ($20,000 + $8,000 + $4,000) = $21,000.

Choice "b" is incorrect. Gray's basis is increased by $16,000, but the question asks what his total basis is on 12/31/93.

Choice "c" is incorrect. Gray's basis is increased by 50% of $20,000 + $4,000, or $12,000, but it is also increased by 50% of tax exempt income. This increase is added to the beginning tax basis.




Choice "d" is incorrect. Gray's basis is increased by 50% of ordinary income or $10,000, but it is also increased by tax exempt and portfolio income. This increase is added to the beginning tax basis. CPA-01762 Type1 M/C A-D Corr Ans: D PM#24 R 4-01

16. CPA-01762 ARE May 94 #28 Page 12

On January 2, 1993, Arch and Bean contribute cash equally to form the JK Partnership. Arch and Bean share profits and losses in a ratio of 75% to 25%, respectively. For 1993, the partnership's ordinary income was $40,000. A distribution of $5,000 was made to Arch during 1993. What is Arch's share of taxable income for 1993? a. $5,000 b. $10,000 c. $20,000 d. $30,000 CPA-01762 Explanation Choice "d" is correct. Partners are taxed on their share of partnership income whether distributed or not. Arch must report 75% x $40,000, or $30,000.

Choice "a" is incorrect. Partners are taxed on their share of partnership income, not distributions.

Choice "b" is incorrect. Arch has a 75% ownership interest.

Choice "c" is incorrect. Arch and Bean have a 75-25 profit (loss) ratio, not 50-50. CPA-01766 Type1 M/C A-D Corr Ans: C PM#25 R 4-01

17. CPA-01766 ARE May 94 #29 Page 12

Guaranteed payments made by a partnership to partners for services rendered to the partnership, that are deductible business expenses under the Internal Revenue Code, are: I. Deductible expenses on the U.S. Partnership Return of Income, Form 1065, in order to arrive at

partnership income (loss). II. Included on schedules K-1 to be taxed as ordinary income to the partners. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01766 Explanation Choice "c" is correct. Guaranteed payments to partners are deductible on Form 1065, Line 10, to arrive at partnership ordinary income. On Schedule K-1, guaranteed payments are shown as income on Line 5 and flow through as ordinary income.

Choices "a", "b", and "d" are incorrect. Each of these does not address both rules correctly. CPA-01768 Type1 M/C A-D Corr Ans: C PM#26 R 4-01

18. CPA-01768 ARE May 94 #30 Page 6

At the beginning of 1993, Paul owned a 25% interest in Associates partnership. During the year, a new partner was admitted and Paul's interest was reduced to 20%. The partnership liabilities at January 1, 1993, were $150,000 but decreased to $100,000 at December 31, 1993. Paul's and the other partners' capital accounts are in proportion to their respective interests. Disregarding any income, loss or drawings for 1993, the basis of Paul's partnership interest at December 31, 1993, compared to the basis of his interest at January 1, 1993, was: a. Decreased by $37,500.




b. Increased by $20,000. c. Decreased by $17,500. d. Decreased by $5,000. CPA-01768 Explanation Choice "c" is correct. Paul's partnership interest consists of his capital plus his share of liabilities. Paul's share of liabilities on January 1, 1993, was 25% x $150,000, or $37,500. On December 31, 1993, Paul's share was 20% x $100,000, or $20,000; a decrease during the year of $17,500.

Choices "a", "b", and "d" are incorrect. Paul's basis in his partnership interest consists of his capital account plus his share of liabilities. CPA-01769 Type1 M/C A-D Corr Ans: B PM#27 R 4-01

19. CPA-01769 ARE May 94 #31 Page 16

Day's adjusted basis in LMN Partnership interest is $50,000. During the year Day received a nonliquidating distribution of $25,000 cash plus land with an adjusted basis of $15,000 to LMN and a fair market value of $20,000. How much is Day's basis in the land? a. $10,000 b. $15,000 c. $20,000 d. $25,000 CPA-01769 Explanation Choice "b" is correct. In a nonliquidating distribution, the partner takes the partnership basis for assets distributed. This basis cannot exceed the partner's partnership interest.

Choice "a" is incorrect. This is Day's remaining basis in the partnership, not the basis for the land.

Choices "c" and "d" are incorrect. In a nonliquidating distribution, the partner takes the partnership basis for assets distributed. CPA-01772 Type1 M/C A-D Corr Ans: A PM#28 R 4-01

20. CPA-01772 PII Nov 93 #48 Page 3

Pert contributed land with a fair market value of $20,000 to a new partnership in exchange for a 50% partnership interest. The land had an adjusted basis to Pert of $12,000 and was subject to a $4,000 mortgage, which the partnership assumed. What is the adjusted basis of Pert's partnership interest? a. $10,000 b. $12,000 c. $18,000 d. $20,000 CPA-01772 Explanation Choice "a" is correct. Pert's adjusted basis in the partnership is equal to the $12,000 adjusted basis of the land he contributed to the partnership less the 50% allocable percentage of the $4,000 mortgage assumed by the other partners.

Land basis $12,000 50%* $4,000 mortgage (2,000) Pert's basis in the partnership $10,000

* Other partners' percentage ownership

Choice "b" is incorrect. The amount of the liability assumed by the other partners must be subtracted from the adjusted basis.




Choice "c" is incorrect. Use the land's $12,000 adjusted basis as the starting point, not its $20,000 fair market value.

Choice "d" is incorrect. Use the land's $12,000 adjusted basis as the starting point, not its $20,000 fair market value, and subtract the percentage of the liability assumed by the other partners. CPA-01775 Type1 M/C A-D Corr Ans: B PM#30 R 4-01

21. CPA-01775 PII Nov 93 #51 Page 14

The method used to depreciate partnership property is an election made by: a. The partnership and must be the same method used by the "principal partner." b. The partnership and may be any method approved by the IRS. c. The "principal partner." d. Each individual partner. CPA-01775 Explanation Choice "b" is correct. Under entity theory, the partnership elects the depreciation method to be used and may use any method approved by the IRS.

Choice "a" is incorrect. The method need not be the same as that used by the principal partner.

Choice "c" is incorrect. The election is not made by the principal partner.

Choice "d" is incorrect. The election is not made by each individual partner. CPA-01778 Type1 M/C A-D Corr Ans: C PM#31 R 4-01

22. CPA-01778 PII Nov 93 #52 Page 7

Under Section 444 of the Internal Revenue Code, certain partnerships can elect to use a tax year different from their required tax year. One of the conditions for eligibility to make a Section 444 election is that the partnership must: a. Be a limited partnership. b. Be a member of a tiered structure. c. Choose a tax year where the deferral period is not longer than three months. d. Have less than 75 partners. CPA-01778 Explanation Choice "c" is correct. Sec. 444 permits a partnership to elect a tax year different from the required tax year if the deferral period (i.e., the number of months between the beginning of the tax year and the end of the required tax year) is 3 months or less.

Choice "a" is incorrect. The partnership need not be a limited partnership.

Choice "b" is incorrect. The partnership need not be a member of a tiered structure.

Choice "d" is incorrect. The partnership need not have less than 75 partners. CPA-01788 Type1 M/C A-D Corr Ans: D PM#32 R 4-01

23. CPA-01788 PII Nov 93 #53 Page 12

In computing the ordinary income of a partnership, a deduction is allowed for: a. Contributions to recognized charities. b. The first $100 of dividends received from qualifying domestic corporations. c. Short-term capital losses. d. Guaranteed payments to partners. CPA-01788 Explanation




Choice "d" is correct. Guaranteed payments to partners are deductible in arriving at the partnership's ordinary income. Ordinary income is the "taxable income" of the partnership excluding all items required to be separately-stated. Charitable contributions, dividend income, and capital losses are all separately-stated items.

Choice "a" is incorrect. Charitable contributions are not deducted to arrive at ordinary income. They are a separately stated item.

Choice "b" is incorrect. Dividend income is not deducted to arrive at ordinary income. It is a separately stated item.

Choice "c" is incorrect. Net short-term capital losses are not deducted to arrive at ordinary income. They are a separately stated item. CPA-01790 Type1 M/C A-D Corr Ans: A PM#33 R 4-01

24. CPA-01790 PII Nov 93 #54 Page 5

When a partner's share of partnership liabilities increases, that partner's basis in the partnership: a. Increases by the partner's share of the increase. b. Decreases by the partner's share of the increase. c. Decreases, but not to less than zero. d. Is not affected. CPA-01790 Explanation Choice "a" is correct. When a partner's share of partnership liabilities increases, that partner's basis in the partnership increases by his share of the increase. Since the partner has unlimited liability, the partnership liabilities are treated as if the partner personally borrowed the money and then contributed it to the partnership.

Choice "b" is incorrect. It increases, not decreases, the partner's basis by his share of the increase in the liabilities.

Choice "c" is incorrect. It increases, not decreases, the partner's basis by his share of the increase in the liabilities.

Choice "d" is incorrect. The partner's basis is affected; it increases by the partner's share of the increase in liabilities. CPA-01797 Type1 M/C A-D Corr Ans: A PM#37 R 4-01

25. CPA-01797 PII Nov 93 #58 Page 7

Cobb, Danver, and Evans each owned a one-third interest in the capital and profits of their calendar-year partnership. On September 18, 1991, Cobb and Danver sold their partnership interests to Frank and immediately withdrew from all participation in the partnership. On March 15, 1992, Cobb and Danver received full payment from Frank for the sale of their partnership interests. For tax purposes, the partnership: a. Terminated on September 18, 1991. b. Terminated on December 31, 1991. c. Terminated on March 15, 1992. d. Did not terminate. CPA-01797 Explanation Choice "a" is correct. A partnership terminates for tax purposes if within a 12-month period there is a sale or exchange of at least 50% of the total interest in partnership capital and profits. In this case, the partnership terminates September 18, 1991, the date that 2/3 interest in the partnership is sold to new partner Frank.




Choice "b" is incorrect. The partnership terminated on the date that at least 50% of the partnership interest was sold, not the end of the partnership year in which the sale occurred.

Choice "c" is incorrect. The partnership terminated on the date that at least 50% of the partnership interest was sold, not the date of full payment between the old and new partners.

Choice "d" is incorrect. The partnership terminated on the date that at least 50% of the partnership interest was sold. CPA-01803 Type1 M/C A-D Corr Ans: D PM#39 R 4-01

26. CPA-01803 PII Nov 93 #60 Page 20

On June 30, 1993, Berk retired from his partnership. At that time, his capital account was $50,000 and his share of the partnership's liabilities was $30,000. Berk's retirement payments consisted of being relieved of his share of the partnership liabilities and receipt of cash payments of $5,000 per month for 18 months, commencing July 1, 1993. Assuming Berk makes no election with regard to the recognition of gain from the retirement payments, he should report income therefrom of: 1993 1994 a. $13,333 $26,667 b. $20,000 $20,000 c. $40,000 -- d. -- $40,000 CPA-01803 Explanation Choice "d" is correct. Payments made in liquidation of the interest of a retiring partner are considered a distribution by the partnership. Therefore, a retiring partner continues as a partner until his interest has been completely liquidated by partnership distributions:

Berk's partnership basis on 6/30/93 $ 80,000 $5,000 x 6 months, 1993 cash distributions nontaxable, basis reduction (30,000) Relief of debt (30,000) Berk's partnership basis on 12/31/93 20,000 $5,000 x 12 months, 1994 distributions (60,000) Negative basis (40,000) Capital gain to eliminate negative basis 40,000 Berk's basis on 12/31/94, liquidated $ 0

Choices "a", "b", and "c" are incorrect. Payments made in liquidation of the interest of a retiring partner are considered a distribution by the partnership. Therefore, a retiring partner continues as a partner until his interest has been completely liquidated by partnership distributions. CPA-04733 Type1 M/C A-D Corr Ans: B PM#40 R 4-01

27. CPA-04733 Released 2005 Page 16

Owen's tax basis in Regal Partnership was $18,000 at the time Owen received a nonliquidating distribution of $3,000 cash and land with an adjusted basis of $7,000 to Regal and a fair market value of $9,000. Regal did not have unrealized receivables, appreciated inventory, or properties that had been contributed by its partners. Disregarding any income, loss, or any other partnership distribution for the year, what was Owen's tax basis in Regal after the distribution? a. $9,000 b. $8,000 c. $7,000 d. $6,000 CPA-04733 Explanation




Choice "b" is correct. In a nonliquidating distribution, the partner's basis is reduced first by the amount of cash received and then by the adjusted basis of any property received. Thus, Owen's basis after the distribution is determined as follows:

Owen's beginning basis $18,000 Cash received (3,000) Basis of property received (7,000) Owen's adjusted basis after the distribution $ 8,000

Choices "a", "c", and "d" are incorrect per the above explanation. CPA-04761 Type1 M/C A-D Corr Ans: B PM#41 R 4-01


Bailey contributed land with a fair market value of $75,000 and an adjusted basis of $25,000 to the ABC Partnership in exchange for a 30% interest. The partnership assumed Bailey's $10,000 recourse mortgage on the land. What is Bailey's basis for his partnership interest? a. $15,000 b. $18,000 c. $65,000 d. $75,000 CPA-04761 Explanation Choice "b" is correct. A partner's original basis for a partnership interest acquired by a contribution is the amount of cash plus the adjusted basis of any property contributed less the amount of incoming partner's liabilities assumed by the other partners. Bailey's basis is calculated as follows: Adjusted Basis of property contributed $25,000 Less: The amount of Bailey's debt assumed by the other partners: 70% of $10,000 (7,000)

Bailey's Basis $18,000 Choices "a", "c", and "d" are incorrect, per the above explanation.

CPA-05276 Type1 M/C A-D Corr Ans: D PM#58 R 4-01


A partnership had four partners. Each partner contributed $100,000 cash. The partnership reported income for the year of $80,000 and distributed $10,000 to each partner. What was each partner's basis in the partnership at the end of the current year? a. $170,000 b. $120,000 c. $117,500 d. $110,000 CPA-05276 Explanation RULE: The basis in a partnership is increased by investment, pro-rata share of income, and liabilities for which the partner is personally liable. The basis of a partnership is decreased by distributions, pro-rata share of losses, and liabilities for which the partner is personally relieved of.

Choice "d" is correct. Per the above rule, each partner's basis in the partnership is $110,000 at the end of the current year, calculated as follows:

Contributions $100,000




Pro-rata income allocation 20,000 [$80,000 / 4 partners]

Distributions received ( 10,000)

Basis at year-end $110,000

Choice "a" is incorrect. The partnership reported income of $80,000, and this amount must be allocated pro-rata to each partner. The mistake made here is that the entire $80,000 was included for each partner as an increase in basis when it should only have been of that amount (or $20,000). Applying all other facts correctly, this answer was calculated as $100,000 + $80,000 - $10,000 = $170,000.

Choice "b" is incorrect. The distribution of $10,000 must be deducted from the basis of each partner. Applying all other facts correctly, this answer was calculated as $100,000 + $20,000 = $120,000.

Choice "c" is incorrect. Each partner received a distribution of $10,000. Therefore, the total distributions for the partnership were $40,000. The mistake made here was that the $10,000 distribution was incorrectly assumed to be the total distribution made by the partnership. $10,000 divided by 4 = $2,500. Applying all the other facts correctly, this answer was calculated as $100,000 + $20,000 - $2,500 = $117,500. CPA-05295 Type1 M/C A-D Corr Ans: B PM#59 R 4-01


Kerr and Marcus form KM Partnership with a cash contribution of $80,000 from Kerr and a property contribution of land from Marcus. The land has a fair market value of $80,000 and an adjusted basis of $50,000 at the date of the contribution. Kerr and Marcus are equal partners. What is Marcus's basis immediately after formation? a. $0 b. $50,000 c. $65,000 d. $80,000 CPA-05295 Explanation RULE: Generally, no gain or loss is recognized on the contribution of property to a partnership in return for a partnership interest. The basis of the partnership interest is the basis of the property in the hands of the partner upon contribution. The partnership takes on the contributor's basis of the contributed property; however, if the fair market value of the property differs from the basis, the amount of the unrealized gain or loss at the date of contribution is specially allocated to the contributing partner upon the sale of that contributed property.

Choice "b" is correct. Per the above rule, Marcus' basis in the partnership immediately after formation is $50,000, which is Marcus' basis in the land at the date of contribution.

Choice "a" is incorrect. Marcus has a basis in the partnership in the amount of Marcus' basis in the property upon contribution.

Choice "c" is incorrect. Per the above rule, Marcus' basis in the partnership immediately after formation is $50,000, which is Marcus' basis in the land at the date of contribution.

Choice "d" is incorrect. Per the above rule, Marcus' basis in the partnership immediately after formation is $50,000, which is Marcus' basis in the land at the date of contribution. The basis is not the fair market value at the date of contribution. CPA-05298 Type1 M/C A-D Corr Ans: B PM#60 R 4-01


Smith received a one-third interest of a partnership by contributing $3,000 in cash, stock with a fair market value of $5,000 and a basis of $2,000, and a new computer that cost Smith $2,500. Which of the following amounts represents Smith's basis in the partnership?




a. $10,500 b. $7,500 c. $5,500 d. $3,000 CPA-05298 Explanation RULE: Generally, no gain or loss is recognized on the contribution of property to a partnership in return for partnership interest. The basis of the partnership interest is the basis of the property in the hands of the partner upon contribution. The partnership takes on the contributor's basis of the contributed property; however, if the fair market value of the property differs from the basis, the amount of the unrealized gain or loss at the date of contribution is specially-allocated to the contributing partner upon the sale of that contributed property.

Choice "b" is correct. Applying the rule above, Smith's basis in the partnership upon contribution is calculated as follows:

Cash contributed $3,000

Basis of stock contributed 2,000

Basis of computer contributed 2,500

Basis in partnership $7,500

Choice "a" is incorrect. This answer assumes that the fair market value of the stock ($5,000) is used to calculate the basis of the partnership, but this is an incorrect assumption (the basis of $2,000 is used).

Choice "c" is incorrect. This answer neglected to include in the basis of the partnership the $2,000 basis of the stock contributed.

Choice "d" is incorrect. This answer neglected to include in the basis of the partnership the property contributed to the partnership and only considered the cash contributed. CPA-05518 Type1 M/C A-D Corr Ans: B PM#60 R 4-01


Walker transferred property used in a sole proprietorship to the WXYZ partnership in exchange for a one-fourth interest. The property had an original cost of $75,000, an adjusted tax basis to Walker of $20,000, and fair market value of $50,000. The partnership has no liabilities. What is Walker's basis in the partnership interest? a. $0 b. $20,000 c. $50,000 d. $75,000 CPA-05518 Explanation Choice "b" is correct. Generally, no gain or loss is recognized on a contribution of property to a partnership in return for a partnership interest. The partner's original basis for a partnership interest acquired by contribution of property is the adjusted tax basis of the property (unless the property is subject to excess liability, which is not the case in this question).

Choice "a" is incorrect. Walker's adjusted tax basis in the property is $20,000. There are no partnership liabilities, and the facts do not indicate that the property was subject to excess liability. The facts in the question do not support a zero basis in the partnership interest.

Choice "c" is incorrect. The $50,000 fair market value is not used to determine the initial basis in the partnership interest; however, upon the sale of the property, the fair market value will be used in the calculation of the special allocation to the contributing partner of the built-in gain on the sale.




Choice "d" is incorrect. The $75,000 original cost of the property is not used to determine the contributing partner's basis. The amount to use is the adjusted tax basis (cost less depreciation or other basis reduction) upon contribution. CPA-05519 Type1 M/C A-D Corr Ans: B PM#61 R 4-01


Olson, Wayne, and Hogan are equal partners in the OWH partnership. Olson's basis in the partnership interest is $70,000. Olson receives a liquidating distribution of $10,000 cash and land with a fair market value of $63,000, and a basis of $58,000. What is Olson's basis in the land? a. $58,000 b. $60,000 c. $63,000 d. $70,000 CPA-05519 Explanation Choice "b" is correct.

In a liquidating distribution, the partner's basis for the distributed property is the same as the adjusted basis of his partnership interest (as the partner is simply exchanging his partnership interest for the distributed assets), reduced by any monies received in the same transaction.

Olson's basis before distribution $70,000 Less: Cash received (10,000) Remaining basis in partnership 60,000 Less: Allocate basis to land (60,000) Liquidated partnership basis $ 0

Choice "a" is incorrect. This would be the answer if the distribution were a non-liquidating distribution (which would then mean that partner would still have a partnership interest with a basis of $2,000 ($60,000 - $58,000 land basis).

Choice "c" is incorrect. The fair market value of the asset is not considered in a liquidation.

Choice "d" is incorrect. The allocable basis must first be reduced by the amount of cash received. CPA-05535 Type1 M/C A-D Corr Ans: A PM#62 R 4-01


The at-risk limitation provisions of the Internal Revenue Code may limit: I. A partner's deduction for his or her distributive share of partnership losses. II. A partnership's net operating loss carryover. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-05535 Explanation Choice "a" is correct. A partner's tax deduction for his or her distributive share of partnership losses is limited to the partner's adjusted basis in the partnership, which is increased by any partnership liabilities that he or she is personally liable for (called the "at-risk" provision). Any unused loss can be carried forward and used in a future year when basis becomes available; therefore, the at-risk limitation does not limit a partner's net operating loss carryover.

Choices "b", "c", and "d" are incorrect, based on the above discussion.






On December 31, after receipt of his share of partnership income, Clark sold his interest in a limited partnership for $30,000 cash and relief of all liabilities. On that date, the adjusted basis of Clark's partnership interest was $40,000, consisting of his capital account of $15,000 and his share of the partnership liabilities of $25,000. The partnership has no unrealized receivables or substantially appreciated inventory. What is Clark's gain or loss on the sale of his partnership interest? a. Ordinary loss of $10,000. b. Ordinary gain of $15,000. c. Capital loss of $10,000. d. Capital gain of $15,000. CPA-05536 Explanation Choice "d" is correct. A partner who sells his interest in a partnership has a recognized gain or loss that is measured by the difference between the amount realized for the sale and the adjusted basis of the partnership interest. If there are any partnership liabilities allocated to the interest and transferred to the buyer, they are considered part of the amount realized. Any gain that represents a partner's share of "hot assets" (unrealized receivables of appreciated inventory) is treated as ordinary income if cash is taken. Clark's capital gain on the sale is calculated as follows:

Amount realized on the sale:

Cash $30,000

Liabilities relieved of 25,000 $55,000

Less:

Basis in the partnership (40,000)

CAPITAL [Note *] gain on sale $15,000

* Note: The facts tell us that the partnership had no unrealized receivables or substantially appreciated inventory; therefore, there are no "hot assets" to cause Clark to categorize any of the gain as ordinary income. The entire gain is capital gain.

Choice "a" is incorrect. This answer option incorrectly excludes the partnership liabilities that Clark is relieved of as part of the amount realized [$30,000 cash received - $40,000 basis = $10,000 loss]. Further, as the partnership has no unrealized receivables or appreciated inventory, ordinary income recognition is not applicable.

Choice "b" is incorrect. This answer option correctly calculates the gain on the sale as $15,000, but it incorrectly categorizes the gain as ordinary, when there are no unrealized receivables or appreciated inventory items that would cause ordinary income recognition to be applicable.

Choice "c" is incorrect. This answer option incorrectly excludes the partnership liabilities that Clark is relieved of as part of the amount realized [$30,000 cash received - $40,000 basis = $10,000 loss]. However, the classification of the gain as capital is correct because the partnership has no unrealized receivables or appreciated inventory that would cause ordinary income recognition to be applicable. CPA-05540 Type1 M/C A-D Corr Ans: B PM#64 R 4-01


Reid, Welsh, and May are equal partners in the RWM partnership. Reid's basis in the partnership interest is $60,000. Reid receives a liquidating distribution of $61,000 cash and land with a fair market value of $14,000 and an adjusted basis of $12,000. What gain must Reid recognize upon the liquidation of his partnership interest? a. $0 b. $1,000




c. $13,000 d. $15,000 CPA-05540 Explanation Choice "b" is correct. With a liquidating distribution, the partner's basis for the distributed property is the same as the adjusted basis of his partnership interest, first reduced by any monies received. The partner will recognize gain only to the extent that money received exceeds the partner's basis in the partnership.

Basis before liquidating distribution $60,000 Less: Cash received (61,000) Cash received in excess of basis (1,000) Gain to be recognized 1,000 Basis after gain recognition $ - 0 -

** NOTE: The basis of the land to Reid is zero, as Reid has no remaining basis in the partnership to allocate to the land (i.e., Reid has exchanged his entire interest in the partnership for the cash and the land).

Choice "a" is incorrect. Gain is recognized because the cash received exceeded the basis in the partnership before the liquidation.

Choice "c" is incorrect. This answer option incorrectly assumes that the adjusted basis of the land reduced the basis in the partnership before the cash received reduced the basis. As mentioned above, cash received must first reduce the basis before any allocation of basis can be made to the remaining non-cash property [$60,000 - $12,000 = $48,000; $48,000 - $61,000 = ($13,000) in excess of basis].

Choice "d" is incorrect. This answer option incorrectly assumes that the fair market value of the land (fair market value would not be used even if cash were not received, however) reduced the basis in the partnership before the cash received reduced the basis. As mentioned above, cash received must first reduce the basis before any allocation of basis can be made to the remaining non-cash property [$60,000 - $14,000 = $46,000; $46,000 - $61,000 = ($15,000) in excess of basis]. Estate, Trust, and Gift Taxation CPA-01822 Type1 M/C A-D Corr Ans: C PM#5 R 4-02

37. CPA-01822 ARE Nov 95 #35 Page 22

A distribution to an estate's sole beneficiary for the 1994 calendar year equaled $15,000, the amount currently required to be distributed by the will. The estate's 1994 records were as follows:

Estate income $40,000 Taxable interest

Estate disbursements $34,000 Expenses attributable to taxable interest

What amount of the distribution was taxable to the beneficiary? a. $40,000 b. $15,000 c. $6,000 d. $0 CPA-01822 Explanation Choice "c" is correct. The amount of income an estate beneficiary reports from the estate is limited by the estate's distributable net income, $6,000 in this case. Because the estate distributed $15,000 to the beneficiary, all $6,000 of its distributable net income is taxed to the beneficiary, and the estate will have no taxable income to report. The $9,000 ($15,000 - $6,000) the beneficiary received in cash over the amount of taxable income is treated as a nontaxable distribution of principal.




Choice "a" is incorrect. The estate income must be reduced by the estate disbursements.

Choice "b" is incorrect. The entire distribution to the beneficiary is not taxable to the beneficiary. Some of the distribution is treated as a distribution of principal.

Choice "d" is incorrect. Some of the distribution to the beneficiary is taxable to the beneficiary. Only part of the distribution is treated as a distribution of principal. CPA-01824 Type1 M/C A-D Corr Ans: C PM#6 R 4-02

38. CPA-01824 ARE Nov 95 #36 (Adapted) Page 28

Steve and Kay Briar, U.S. citizens, were married for the entire calendar year. During the year, Steve gave a $30,000 cash gift to his sister. The Briars made no other gifts in the year. They each signed a timely election to treat the $30,000 gift as made one-half by each spouse. Disregarding the unified credit and estate tax consequences, what amount of the current year gift is taxable to the Briars? a. $30,000 b. $24,000 c. $6,000 d. $0 CPA-01824 Explanation Choice "c" is correct. A married couple can elect to treat taxable gifts as made half by each spouse for gift tax purposes. Every donor receives a $12,000 per person, per year, exclusion from the gift tax. Mr. and Mrs. Briar split Mr. Briar's $30,000 gift to his sister, for an effective gift of $15,000 each. Then each of them receives a $12,000 exclusion to reduce the taxable gift to $3,000. Because there are two deemed gifts, one from each spouse, the total taxable gift, ignoring the unified tax credit and the potential estate tax consequences, is $6,000.

Choice "a" is incorrect. The entire gift is not taxable to the Briars. An exclusion is available to the Briars.

Choice "b" is incorrect. Because the Briars split the gift to his sister, each of them receives a $12,000 exclusion to reduce the taxable gift.

Choice "d" is incorrect. Since the gift is greater than $24,000, some of the gift is taxable to the Briars. CPA-01828 Type1 M/C A-D Corr Ans: A PM#7 R 4-02

39. CPA-01828 ARE May 95 #31 Page 22

Lyon, a cash basis taxpayer, died on January 15, 1994. In 1994, the estate executor made the required periodic distribution of $9,000 from estate income to Lyon's sole heir. The following pertains to the estate's income and disbursements in 1994:

1994 Estate Income $20,000 Taxable interest 10,000 Net long-term capital gains allocable to corpus

1994 Estate Disbursements $5,000 Administrative expenses attributable to taxable income

For the 1994 calendar year, what was the estate's distributable net income (DNI)? a. $15,000 b. $20,000 c. $25,000 d. $30,000 CPA-01828 Explanation Choice "a" is correct. A trust's distributable net income includes the taxable income of the trust ($20,000 interest income less $5,000 expenses, or $15,000). By definition, it does not include the $10,000 net long-term capital gains allocated to corpus.




Choice "b" is incorrect. The administrative expenses reduce the DNI.

Choice "c" is incorrect. Net long-term gain allocable to corpus is not included in DNI. The administrative expenses reduce the DNI.

Choice "d" is incorrect. Net long-term gain allocable to corpus is not included in DNI. CPA-01882 Type1 M/C A-D Corr Ans: B PM#8 R 4-02

40. CPA-01882 ARE May 95 #32 Page 23

Lyon, a cash basis taxpayer, died on January 15, 1994. In 1994, the estate executor made the required periodic distribution of $9,000 from estate income to Lyon's sole heir. The following pertains to the estate's income and disbursements in 1994:

1994 Estate Income $20,000 Taxable interest 10,000 Net long-term capital gains allocable to corpus

1994 Estate Disbursements $5,000 Administrative expenses attributable to taxable income

Lyon's executor does not intend to file an extension request for the estate fiduciary income tax return. By what date must the executor file the Form 1041, U.S. Fiduciary Income Tax Return, for the estate's 1994 calendar year? a. Wednesday, March 15, 1995. b. Monday, April 17, 1995. c. Thursday, June 15, 1995. d. Friday, September 15, 1995. CPA-01882 Explanation Choice "b" is correct.

Rule: Form 1041 is due on the 15th day of the fourth month after the close of its taxable year.

Lyon's calendar 1994 return would normally be due on April 15, 1995. Because that was a Saturday, the return is not due until the next day that is not a Saturday, a Sunday, or a legal holiday. That day is Monday, April 17, 1995.

Choices "a", "c", and "d" are incorrect, per the above rule. CPA-01886 Type1 M/C A-D Corr Ans: C PM#9 R 4-02

41. CPA-01886 ARE May 95 #33 Page 23

A distribution from estate income, that was currently required, was made to the estate's sole beneficiary during its calendar year. The maximum amount of the distribution to be included in the beneficiary's gross income is limited to the estate's: a. Capital gain income. b. Ordinary gross income. c. Distributable net income. d. Net investment income. CPA-01886 Explanation Choice "c" is correct. Distributable net income is the upper limit on the amount of income that a beneficiary has to include in income from a trust distribution.

Choice "a" is incorrect. The beneficiary might have ordinary income to report, and since capital gains are often allocated to corpus, the beneficiary might not have to report capital gains.




Choice "b" is incorrect. The beneficiary does not have to report an amount greater than the distributable net income of the trust, but distributable net income, as its name implies, allows deductions for expenses of the trust, so that it is less than the gross income.

Choice "d" is incorrect. The beneficiary normally is limited in reporting income to the amount of distributable net income, but that figure includes both net investment income plus other income of the trust. Furthermore, distributable net income does not include capital gains allocated to trust corpus, which could be a part of net investment income. CPA-01887 Type1 M/C A-D Corr Ans: B PM#10 R 4-02

42. CPA-01887 ARE Nov 94 #56 Page 28

Bell, a cash basis calendar year taxpayer, died on June 1, 1993. In 1993, prior to her death, Bell incurred $2,000 in medical expenses. The executor of the estate paid the medical expenses, which were a claim against the estate, on July 1, 1993. If the executor files the appropriate waiver, the medical expenses are deductible on: a. The estate tax return. b. Bell's final income tax return. c. The estate income tax return. d. The executor's income tax return. CPA-01887 Explanation Choice "b" is correct. If the proper waiver is filed, medical expenses paid for the decedent by her executor within one year of her death can be deducted on the decedent's final income tax return.

Choice "a" is incorrect. The expenses would normally be deducted on the estate tax return, but under these facts the executor has made a proper election to deduct the expenses on the decedent's final income tax return. The expenses cannot be deducted both places.

Choice "c" is incorrect. The estate does not get a deduction for medical expenses on its income tax return.

Choice "d" is incorrect. The executor cannot deduct the decedent's medical expenses on his own income tax return. Although the executor paid them, he did so in a representative capacity on the decedent's behalf. CPA-01893 Type1 M/C A-D Corr Ans: D PM#13 R 4-02

43. CPA-01893 PII Nov 93 #39 (Adapted) Page 28

What amount of a decedent's taxable estate is effectively tax-free if the maximum unified estate and gift tax credit is taken? a. $12,000 b. $780,800 c. $1,000,000 d. $2,000,000 CPA-01893 Explanation Choice "d" is correct. The maximum amount that can be transferred tax-free is $2,000,000 (2006-2008).

Choice "a" is incorrect. $12,000 is the annual gift tax exclusion per donee for gifts of a present interest.

Choice "b" is incorrect. The $780,800 is the unified estate and gift tax credit amount (or the amount of the tax avoided) for a tax-free transfer of $2,000,000.

Choice "c" is incorrect. This is the limit on lifetime gifts that can be exempted from gift tax.





44. CPA-01896 PII Nov 93 #40 (Adapted) Page 28

Which of the following is(are) deductible from a decedent's gross estate? I. Expenses of administering and settling the estate. II. State inheritance or estate tax. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01896 Explanation Choice "c" is correct. Both expenses of administering and settling the estate and state inheritance (or estate) tax are deductible from the gross estate.

Choice "a" is incorrect. State inheritance or estate taxes are deductible from the gross estate.

Choice "b" is incorrect. Expenses of administering and settling the estate are deductible from the gross estate.

Choice "d" is incorrect. Both expenses of administering and settling the estate and state inheritance (or estate) tax are deductible from the gross estate.

CPA-04732 Type1 M/C A-D Corr Ans: B PM#17 R 4-02

45. CPA-04732 Released 2005 Adapted Page 28

Don and Linda Grant, U.S. citizens, were married for the entire calendar year. During the year, Don gave a $60,000 cash gift to his sister. The Grants made no other gifts in the year. They each signed a timely election to treat the $60,000 gift as one made by each spouse. Disregarding the unified credit and estate tax consequences, what amount of the current year gift is taxable to the Grants for gift tax purposes? a. $0 b. $36,000 c. $48,000 d. $60,000 CPA-04732 Explanation Choice "b" is correct. A donor (person giving a gift) may exclude the first $12,000 of gifts made to each donee. A gift by either spouse may be treated as made one-half by each; this gift splitting creates a $24,000 exclusion per donee. Therefore, $60,000 - $24,000 = $36,000 is the amount of taxable gift made by the Grants.

Choice "a" is incorrect. Gifts to a sibling to not qualify for an unlimited gift exclusion.

Choice "c" is incorrect. The Grants elected to split the gift, therefore, a $24,000 exclusion, not a $12,000 exclusion, applies.

Choice "d" is incorrect. This gift is subject to the annual exclusion which is $24,000 when gift-splitting is elected by a married couple.



Carter purchased 100 shares of stock for $50 per share. Ten years later, Carter died on February 1 and bequeathed the 100 shares of stock to a relative, Boone, when the stock had a market price of $100 per share. One year later, on April 1, the stock split 2 for 1. Boone gave 100 shares of the stock to another of Carter's relatives, Dixon, on June 1 that same year, when the market value of the stock was $150 per share. What was Dixon's basis in the 100 shares of stock when acquired on June 1?




a. $5,000 b. $5,100 c. $10,000 d. $15,000 CPA-05274 Explanation Choice "a" is correct. This question combines the rules of estate taxation and gift taxation. Carter's investment in the stock was $50 per share when he died. Upon Carter's death, the stock received a step-up in basis to the fair market value at the date of death (or six months later, if the alternate lower valuation data was elected). Therefore, the stock's basis was $100 per share when it was transferred to Boone. [Note that no capital gain was reportable for the step-up in basis from $50 to $100; however, Carter's estate included the stock at its fair market value of $100/share for estate tax purposes and likely paid a large amount of estate tax on that.] Further, regardless of how long Carter owned the stock (i.e., it could have only been owned for one day), it was automatically deemed long-term property upon Carter's death. So, Boone had 100 shares of stock at a basis of $100/share when Boone received the inheritance. Then, there was a 2-for-1 stock split on April 1 of the following year. This transaction caused Boone to now have double the amount of shares (or, 200 shares) at half the basis per share (or, $50/share). [Note that the total basis remains unchanged (i.e., $100 x 100 shares = $10,000 and $50 x 200 shares = $10,000).] When Boone gifted the stock to Dixon (note: it would not have mattered if Dixon had not been a relative), the donee (Dixon) received the stock at the carryover basis of the donor (Boone). The 100 shares gifted to Dixon were shares from after the stock split; therefore, they have a basis of $50 per share, or a total basis of $5,000 for the 100 shares. [Note that Boone still has 100 shares at a basis of $50 as well.]

Choices "b", "c", and "d" are incorrect, per the above discussion. CPA-05524 Type1 M/C A-D Corr Ans: D PM#20 R 4-02

47. CPA-05524 Released 2007 (Adapted) Page 24

Which of the following is an attribute exclusively of a complex trust? a. It distributes income to more than one beneficiary. b. It has a grantor that is not an individual. c. It has a beneficiary that is not an individual. d. It distributes corpus. CPA-05524 Explanation Choice "d" is correct. Complex trusts may accumulate current income, distribute principal, and provide for charitable contributions. Simple trusts may only make distributions from current income (not corpus, or principal), must distribute all income currently, and may not make charitable contributions. Either trust may have more than one beneficiary, have a grantor that is not an individual, or have beneficiaries that are not individuals.

Choice "a" is incorrect. Both complex and simple trusts may distribute income to more than one beneficiary.

Choice "b" is incorrect. Both complex and simple trusts may have a grantor that is not an individual.

Choice "c" is incorrect. Both complex and simple trusts may have a beneficiary that is not an individual. CPA-05544 Type1 M/C A-D Corr Ans: C PM#21 R 4-02


Brown transfers property to a trust. A local bank was named trustee. Brown retained no powers over the trust. The trust instrument provides that current income and $6,000 of principal must be distributed annually to the beneficiary. What type of trust was created? a. Simple. b. Grantor. c. Complex.




d. Revocable. CPA-05544 Explanation Choice "c" is correct. A complex trust may distribute principal, so this is the type of trust that was created.

Choice "a" is incorrect. A simple trust may not distribute principal, and the facts tell us that $6,000 of principal must be distributed annually to the beneficiary. Therefore, a simple trust could not have been created.

Choice "b" is incorrect. A grantor trust could not have been created, as it requires that a person transfer property to a trust and retain certain powers over the trust (or treat the trust as being owned by the transferor for income tax purposes). In this case, Brown does transfer property, but Brown retained no powers over the trust.

Choice "d" is incorrect. A revocable trust was not created because Brown retained no powers over the trust and, thus, no right to revoke it. Tax Return Preparer Issues CPA-02063 Type1 M/C A-D Corr Ans: B PM#1 R 4-03

49. CPA-02063 ARE R02 #5 Page 32

A taxpayer filed his income tax return after the due date but neglected to file an extension form. The return indicated a tax liability of $50,000 and taxes withheld of $45,000. On what amount would the penalties for late filing and late payment be computed? a. $0 b. $5,000 c. $45,000 d. $50,000 CPA-02063 Explanation Choice "b" is correct. The penalty for failure to file a tax return by the due date is 5% per month or fraction of month (up to a maximum of 25%) on the amount of tax shown as DUE on the return. The penalty for failure to pay by the due date (1/2% per month) is also based on the amount DUE on the return.


50. CPA-02080 ARE R99 #15 Page 33

Vee Corp. retained Water, CPA, to prepare its 20X4 income tax return. During the engagement, Water discovered that Vee had failed to file its 20X0 income tax return. What is Water's professional responsibility regarding Vee's unfiled 20X0 income tax return? a. Prepare Vee's 20X0 income tax return and submit it to the IRS. b. Advise Vee that the 20X0 income tax return has not been filed and recommend that Vee ignore filing

its 20X0 return since the statute of limitations has passed. c. Advise the IRS that Vee's 20X0 income tax return has not been filed. d. Consider withdrawing from preparation of Vee's 20X4 income tax return until the error is corrected. CPA-02080 Explanation Choice "d" is correct. The CPA should consider withdrawing from the preparation of Vee's 20X4 income tax return until the error (i.e., the non-filing of the 20X0 tax return) has been corrected.

Rule: Upon discovery of an error in a previously-filed return or the client's failure to file a required return, the CPA should promptly notify the client (either orally or in writing) of the error, noncompliance, or omission and advise the client of the appropriate measures to be taken (e.g., advise the client to file the




tax return). If the client does not rectify the error, the CPA should consider withdrawing from the engagement.

Choice "a" is incorrect, as the CPA has no responsibility (without a formal client engagement) or the authority to prepare and file a client's tax return.

Choice "b" is incorrect, as a CPA cannot advise a client to disobey the law because it violates a CPA's ethical responsibilities.

Choice "c" is incorrect, as a CPA has no responsibility to advise the IRS of any client wrongdoing. CPA-02093 Type1 M/C A-D Corr Ans: C PM#5 R 4-03

51. CPA-02093 ARE May 95 #16 Page 32

An accuracy-related penalty applies to the portion of tax underpayment attributable to: I. Negligence or a disregard of the tax rules or regulations. II. Any substantial understatement of income tax. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-02093 Explanation Choice "c" is correct. Accuracy-related penalties apply to the portion of tax underpayments attributable to negligence or disregard of tax rules and regulations as well as to any substantial understatement of income tax.


52. CPA-02105 ARE Nov 94 #55 Page 33

A tax return preparer is subject to a penalty for knowingly or recklessly disclosing corporate return information, if the disclosure is made: a. To enable a third party to solicit business from the taxpayer. b. To enable the tax processor to electronically compute the taxpayer's liability. c. For peer review. d. Under an administrative order by a state agency that registers tax return preparers. CPA-02105 Explanation Choice "a" is correct. Use of a taxpayer's return information to assist a third party to solicit business subjects a return preparer to penalty.

Choice "b" is incorrect. Disclosure can properly be made in this case by a return preparer without penalty.

Choice "c" is incorrect. Disclosure can properly be made in this case by a return preparer without penalty.

Choice "d" is incorrect. Disclosure can properly be made in this case by a return preparer without penalty.


53. CPA-02187 May 94 #19 Page 33

A tax return preparer may disclose or use tax return information without the taxpayer's consent to: a. Facilitate a supplier's or lender's credit evaluation of the taxpayer.




b. Accommodate the request of a financial institution that needs to determine the amount of taxpayer's debt to it, to be forgiven.

c. Be evaluated by a quality or peer review. d. Solicit additional nontax business. CPA-02187 Explanation Choice "c" is correct. A tax return preparer may disclose or use tax return information without the taxpayer's consent to be evaluated by a quality or peer review.

Choices "a", "b", and "d" are incorrect, they would all require the taxpayer's consent.


54. CPA-02189 May 94 #20 Page 32

Which, if any, of the following could result in penalties against an income tax return preparer?

I. Knowing or reckless disclosure or use of tax information obtained in preparing a return. II. A willful attempt to understate any client's tax liability on a return or claim for refund. a. Neither I nor II. b. I only. c. II only. d. Both I and II. CPA-02189 Explanation Choice "d" is correct. Both I and II. Knowing or reckless disclosure or use of tax information obtained in preparing a return, and a willful attempt to understate any clients tax liability on a return or claim for refund could both result in penalties against an income tax return preparer.


55. CPA-02191 Nov 95 #26 Page 32

A penalty for understated corporate tax liability can be imposed on a tax preparer who fails to: a. Audit the corporate records. b. Examine business operations. c. Copy all underlying documents. d. Make reasonable inquiries when taxpayer information appears incorrect. CPA-02191 Explanation Choice "d" is correct. A penalty for understated corporate tax liability can be imposed on a tax preparer who fails to make reasonable inquiries when taxpayer information appears incorrect.

Choices "a", "b", and "c" are incorrect. A tax return preparer is not required to:

Audit the corporate records. Examine the business operations. Copy all underlying documents.


56. CPA-02193 R98 #20 Page 33

To avoid tax return preparer penalties for a return's understated tax liability due to an intentional disregard of the regulations, which of the following actions must a tax preparer take? a. Audit the taxpayer's corresponding business operations. b. Review the accuracy of the taxpayer's books and records.




c. Make reasonable inquiries if the taxpayer's information is incomplete. d. Examine the taxpayer's supporting documents. CPA-02193 Explanation Choice "c" is correct. A tax preparer must make reasonable inquiries if the taxpayer's information is incomplete.

Rule: A compensated preparer is liable for a penalty if his understatement of taxpayer liability on a return or claim for refund is due to negligent or intentional disregard of rules and regulations. A preparer is not required to obtain supporting documentation unless he has reason to suspect the accuracy of the taxpayer's figures; however, the preparer must make reasonable inquiries if the taxpayer's information appears incorrect or incomplete.

Choices "a", "b", and "d" are incorrect, per the above rule. CPA-04753 Type1 M/C A-D Corr Ans: B PM#11 R 4-03


In preparing a client's current-year individual income tax return, a tax practitioner discovers an error in the prior year's return. Under the rules of practice prescribed in Treasury Circular 230, the tax practitioner: a. Is barred from preparing the current year's return until the prior-year error is rectified. b. Must advise the client of the error. c. Is required to notify the IRS of the error. d. Must file an amended return to correct the error. CPA-04753 Explanation Choice "b" is correct. Upon discovery of an error in a previously-filed return or the client's failure to file a required return, the tax practitioner should promptly notify the client (either orally or in writing) of the error, noncompliance, or omission and advise the client of the appropriate measures to be taken (e.g., advise the client to file the tax return). If the client does not rectify the error, the tax practitioner should consider withdrawing from the engagement.

Choice "a" is incorrect. The tax practitioner is not barred from preparing the current year's return.

Choice "c" is incorrect. The tax practitioner is not required to notify the IRS of the error.

Choice "d" is incorrect. The tax practitioner is not required to file an amended return but should consider withdrawing from the engagement is the client refuses to do so.

Sarbanes-Oxley Act of 2002 CPA-04650 Type1 M/C A-D Corr Ans: C PM#1 R 4-04

58. CPA-04650 Reg C05 #1 Page 35

Under the provisions of the Sarbanes-Oxley Act of 2002, the lead audit or coordinating partner and the reviewing partner must rotate off the audit: a. Each year. b. Every three years. c. Every five years. d. Every seven years. CPA-04650 Explanation Choice "c" is correct. The lead audit or coordinating partner and the reviewing partner must rotate off the audit every five years. Thus, choices "a", "b", and "d" are incorrect.





59. CPA-04651 Reg C05 #2 Page 35

Under the provisions of the Sarbanes-Oxley Act of 2002, which of the following is/are correct regarding the Audit Committee of a Public Company? I. Each member of the Audit Committee must be a member of the Board of Directors of the issuer. II. The Audit Committee is directly responsible for the compensation of the work of any registered public

accounting firm employed by that issuer. a. I only. b. II only. c. Neither I nor II. d. Both I and II. CPA-04651 Explanation Only choice "d" is correct. Each member of the audit committee of an issuer is required to be a member of the issuers board of directors. Equally, the audit committee does have responsibility for overseeing the appointment, compensation and work done by the audit firm.


60. CPA-04652 Reg C05 #3 Page 34

Under the provisions of the Sarbanes-Oxley Act of 2002, registered public accounting firms are required to prepare and maintain audit work papers and other information related to any audit report for a period of: a. One year. b. Three years. c. Five years. d. Seven years. CPA-04652 Explanation Choice "d" is correct. Registered public accounting firms are required to maintain audit work papers and supporting documentation for a period of seven years. Thus, choices "a", "b", and "c" are incorrect.

Ethics and Professional Responsibilities CPA-01476 Type1 M/C A-D Corr Ans: C PM#1 R 4-05

61. CPA-01476 Lw R03 #1 Page 45

Which of the following statements best describes the ethical standard of the profession pertaining to advertising and solicitation? a. All forms of advertising and solicitation are prohibited. b. There are no prohibitions regarding the manner in which CPAs may solicit new business. c. A CPA may advertise in any manner that is not false, misleading, or deceptive. d. A CPA may only solicit new clients through mass mailings. CPA-01476 Explanation Choice "c" is correct. Under Rule 502 of the Code of Professional Conduct, advertising that is not false, misleading or deceptive is permitted by the CPA.

Choice "a" is incorrect. Advertising that is informative and objective is allowed under Rule 502.

Choice "b" is incorrect. Rule 502 states that false, misleading or deceptive advertising is not allowed.




Choice "d" is incorrect. Mass mailings are not the only form of advertising allowed. Be careful of choices including the words "all, always, must, only, and never." CPA-01477 Type1 M/C A-D Corr Ans: C PM#2 R 4-05

62. CPA-01477 Lw R03 #2 Page 41

Under the ethical standards of the profession, which of the following situations involving nondependent members of an auditor's family is most likely to impair the auditor's independence? a. A parent's immaterial investment in a client. b. A first cousin's loan from a client. c. A spouse's employment with a client. d. A sibling's loan to a director of a client. CPA-01477 Explanation Choice "c" is correct. Under Rule 101 of the Code of Professional Conduct, independence requirements extend to the member's spouse, dependent children, and dependent relatives. A spouse working for a client is considered part of the class of "members" subject to independence requirements.

Choices "a", "b", and "d" are incorrect. These choices do not, by definition, fall within the "member" class. CPA-01478 Type1 M/C A-D Corr Ans: A PM#3 R 4-05

63. CPA-01478 Lw R03 #3 Page 40

Under the ethical standards of the profession, which of the following investments in a client is not considered to be a direct financial interest? a. An investment held through a nonclient regulated mutual fund. b. An investment held through a nonclient investment club. c. An investment held in a blind trust. d. An investment held by the trustee of a trust. CPA-01478 Explanation Choice "a" is correct. Under Rule 101 of the Code of Professional Conduct regarding independence, the concept is the amount of control or the appearance of control that a member can exert over the investment that can impair independence. While it is still not desirable to even own shares in a nonclient regulated mutual fund that has investments in the client company, this answer choice is the best given the choices. The member does not control which stocks the mutual fund is investing in.

Choices "b", "c", and "d" are incorrect. The member can exert control upon which investments are purchased by the investment club or by the trustees in trusts that could be revocable. CPA-01480 Type1 M/C A-D Corr Ans: B PM#4 R 4-05

64. CPA-01480 Lw R03 #4 Page 42

Burrow & Co., CPAs, have provided annual audit and tax compliance services to Mare Corp. for several years. Mare has been unable to pay Burrow in full for services Burrow rendered 19 months ago. Burrow is ready to begin fieldwork for the current year's audit. Under the ethical standards of the profession, which of the following arrangements will permit Burrow to begin the fieldwork on Mare's audit? a. Mare sets up a two-year payment plan with Burrow to settle the unpaid fee balance. b. Mare commits to pay the past due fee in full before the audit report is issued. c. Mare gives Burrow an 18-month note payable for the full amount of the past due fees before Burrow

begins the audit. d. Mare engages another firm to perform the fieldwork, and Burrow is limited to reviewing the

workpapers and issuing the audit report. CPA-01480 Explanation




Choice "b" is correct. Under Rule 101 of the Code of Professional Conduct regarding independence, a member's independence is impaired with respect to a client who is more than one year overdue in the payment of professional fees. An attestation engagement, such as an audit, requires independence of mind and in appearance. Fees from prior work must be paid in full before the issuance of a report on the following year's work.

Choices "a" and "c" are incorrect. Neither of these answers would provide for the fees to be paid before the issuance of the report on the current year financial statements.

Choice "d" is incorrect. Burrow would not accept an engagement of this type, and the fees related to the prior year work would not be paid before the issuance of the current year report. CPA-01483 Type1 M/C A-D Corr Ans: B PM#6 R 4-05

65. CPA-01483 Lw R02 #2 Page 40

On June 1, 2000, a CPA obtained a $100,000 personal loan from a financial institution client for whom the CPA provided compilation services. The loan was fully secured and considered material to the CPA's net worth. The CPA paid the loan in full on December 31, 2000. On April 3, 2001, the client asked the CPA to audit the client's financial statements for the year ended December 31, 2001. Is the CPA considered independent with respect to the audit of the client's December 31, 2001, financial statements? a. Yes, because the loan was fully secured. b. Yes, because the CPA was not required to be independent at the time the loan was granted. c. No, because the CPA had a loan with the client during the period of a professional engagement. d. No, because the CPA had a loan with the client during the period covered by the financial statements. CPA-01483 Explanation Choice "b" is correct. A member's independence is impaired if a member has a loan with a client and that loan is preferential in relationship to "other borrowers." Since this loan was fully secured and there was no indication of a "preference," it appears to be in the ordinary course of business. Furthermore, the CPA was no longer a debtor of the financial institution at the time of the audit engagement. A CPA must be independent when providing auditing and attestation services, not compilation services.

Choice "a" is incorrect. The mere fact that the loan was secured would not itself make the CPA independent if the loan were outstanding during the engagement.

Choice "c" is incorrect because the loan was paid off before the audit engagement began; the CPA need not be independent while rendering compilation services.

Choice "d" is incorrect. The fact that the CPA had a loan with the client during the period covered in the client's financial statements itself does not impair independence. CPA-01484 Type1 M/C A-D Corr Ans: C PM#7 R 4-05

66. CPA-01484 Lw R96 #1 Page 48

Which of the following services may a CPA perform in carrying out a consulting service engagement for a client? I. Review of the client-prepared business plan. II. Preparation of information for obtaining financing. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01484 Explanation Choice "c" is correct. Under the AICPA Statements on Standards for Consulting Services, a CPA is allowed to perform "consultations," which includes reviewing and commenting on a client-prepared




business plan. The standards also allow CPAs to perform "transaction" services, an example of which is the preparation of information for obtaining financing. CPA-01486 Type1 M/C A-D Corr Ans: C PM#8 R 4-05

67. CPA-01486 Lw Nov 95 #1 Page 45

According to the ethical standards of the profession, which of the following acts is generally prohibited? a. Purchasing a product from a third party and reselling it to a client. b. Writing a financial management newsletter promoted and sold by a publishing company. c. Accepting a commission for recommending a product to an audit client. d. Accepting engagements obtained through the efforts of third parties. CPA-01486 Explanation Choice "c" is correct. A CPA may not accept a commission for recommending a product to a client if the CPA audits or reviews that client's financial statements.

Choice "a" is incorrect. A CPA may resell a product to a client.

Choice "b" is incorrect. Thi

Regulation 4 PassMaster Questionsgh

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