EA2 Mock Exam 1 - Notes

Accounting Periods

• Short tax years can occur due to changes in accounting periods, such as using a 52- or 53-week year, but not due to changing accounting methods.
• Farmers can elect to report insurance proceeds in the tax year following the year of crop damage, provided the income would normally be reported in a later year.

Farming Income and Expenses

• Farmers need to demonstrate the income would normally be reported later to elect reporting insurance proceeds in the following tax year.

Compensation

• Meals provided by a restaurant to waitstaff while they work are non-taxable fringe benefits.
• Waiting staff are not entitled to meal benefits on days off; these meals are included in gross income.
• The restaurant owner can deduct these while at work.

Travel Expenses

• Travel expenses are deductible only if directly related to the taxpayer's business.
• Taxpayers may claim travel expenses even if the family lives at a temporary duty location.

Bad Debts

• Cash-basis taxpayers don't include accounts receivable in income, thus no deduction for uncollectible accounts.
• Worthless corporate securities or personal loans to friends are not considered bad debts.
• Uncollectible business loans are deductible as business bad debts under Section 166.

Basis and Property Transactions - Basis

• Uniform Capitalization Rules dictate capitalizing a proper share of indirect costs (taxes included) related to property.
• Marketing, selling, advertising, and distribution expenses should be expensed, not capitalized.

Basis and Property Transactions - Adjustments to Basis

• Costs assessed in connection with a downtown business area conversion aren't deductible.
• Special assessments must be capitalized and depreciated.

Basis and Property Transactions - Like-Kind Exchanges

• Gain is recognized up to the amount of boot (cash or fair market value of other property).
• Loss is not recognized in a like-kind exchange, even when cash is involved.

Depreciation - Amortization

• Section 197 intangibles include rights (licenses, permits) from government entities, non-competition covenants, workforce in place, goodwill, and going concern value.
• A right to tangible property granted by a government agency is excluded from Section 197 regulations.

Depreciation - Depletion

• To deduct depletion, a taxpayer must have an economic interest in a natural resource.
• Taxpayers must look for mineral extraction and sales to demonstrate an economic interest in the mineral in place.

Depreciation - Depreciation Recapture

• Storage facilities, client files, and office equipment are examples of Section 1245 properties subject to depreciation or amortization.
• Buildings with elevators (or other structural components) are not Section 1245 property.

Credits, Losses, and Additional Taxes - General Business Credit (Sec. 38)

• The general business credit includes FICA credit for certain employer-paid tips, but excludes employer-paid FICA on employee tips used to meet the federal minimum wage.
• A nonrefundable tax credit is only for the employer's portion of FICA on employee cash tips above the minimum wage.
• Interpreter services for hearing impaired qualify for the Disabled Access Credit; building accessibility for disabled does not.

Credits, Losses, and Additional Taxes - Net Operating Loss (NOL)

• Rental property losses are business losses under Section 172.
• Self-employed contributions to retirement plans are non-business deductions, thus not included in NOL calculations.

Contributions to a Partnership - Partnership Defined

• Insurance companies, REITs, and tax-exempt organizations cannot be partnerships; they must be classified as corporations.

Contributions to a Partnership - Partnership Interest

• A partner's basis includes partnership liability if the liability increases partnership basis, gives rise to a current deduction, or creates a nondeductible non-capital expense.

Partnership Operations and Partner's Taxable Income

• Partnership returns are due 2 1/2 months after its fiscal year-end.

Disposition of a Partner's Interest - Sale of a Partnership Interest

• Selling partners must allocate unrealized receivables as ordinary income.
• Remaining realized gain is capital gain.

Corporations - Controlled Groups and Personal Service Corporations (PSCs)

• Members of a controlled group are taxed at a 21% rate.
• Only one $250,000 accumulated earnings deduction is available, divided equally among controlled group members.

Corporations - Additional Corporate Taxes

• The IRS considers accumulations under $150,000 reasonable for a service business.
• $250,000 or less is reasonable for other businesses (Publication 542).
• Accumulated Earnings Tax is 20%.
• Interest is calculated from the original due date, even without extensions.

Corporations - Estimated Tax Payments

• Corporations must pay estimated taxes unless their liability is less than $500.
• Payments are due on the 15th of the 4th, 6th, 9th, and 12th months.

Corporate Formation - Recognized Gain or Loss

• Section 351 non-recognition rules apply to >80% shareholders.
• Recognition is the lesser of fair market value (FMV) or boot received or realized gain.

Corporate Formation - Basis of Assets Transferred in an Exchange

• Section 351 applies to exchanges for >80% stock with $0 gain if the shareholders maintain control.
• Cost basis in stock is adjusted basis of transferred property minus liabilities assumed by the corporation.
• Exchanges not proportional are treated as proportional exchange followed by a gift.

Corporate Distributions - Earnings and Profits

• Corporations recognize gain on property distributions to shareholders if fair market value (FMV) exceeds adjusted basis (AB); shareholder's basis is the FMV of distributed property.

Corporate Redemptions and Liquidations - Redemptions

• 100% shareholders must account for inherited distributions with a stepped-up stock basis (FMV at transferor's death), dividends do not affect basis.

Corporate Redemptions and Liquidations - Partial Liquidation

• Partial liquidations require a plan and pro rata distribution of the redemption.
• Distribution can occur in the year following plan adoption.
• Corporate shareholders do not qualify for partial liquidation.

S Corporations - Operations

• S corporations cannot deduct charitable contributions; these are passed through to shareholders.
• Depreciation is a pass-through item to Schedule K-1.
• Shareholders' maximum deduction is limited to $1,160,000 under Section 179.

S Corporations - Distributions

• Dividends are reported on Form 1099-DIV, not Schedule K-1.
• Distributed appreciated property is valued at the distribution date's FMV, not the acquisition date.
• Property distributions require a statement with acquisition date, distribution date, FMV, and basis on Form 1120.

Credits, Losses, and Additional Taxes - Corporate Income Tax Liability and Reconciling Book to Taxable Income

• Taxable income is Net Income per Books + Federal Income Taxes + Excess Charitable Contributions + Excess Meals - Tax Exempt Interest.

Credits, Losses, and Additional Taxes - Net Operating Loss (NOL) and Capital Losses

• Net capital losses are carried back to the earliest allowable tax year.

Corporate Income, Losses, and Deductions - Related Party Transactions

• A loss disallowed when a sister sells stock to a third party can be deducted by the acquiring third party if it was disallowed previously due to a sale to a sister or brother.

Corporate Distributions - Stock Distributions

• Non-taxable stock dividends do not reduce corporation's earnings and profits (E&P).
• Disproportionate stock distributions are included in gross income.
• Stock distributions in lieu of money, preferred stock, convertible preferred stock, or unequal common/preferred stock distributions are included in gross income.

Decedent, Estate, and Trust Income Tax Returns - Income in Respect of a Decedent (IRD)

• Estate tax deduction is claimed in the same tax year IRD is included in recipient income.

Income Taxation of Estates and Trusts

• Detailed information about estate and trust income taxation. (Specific details not extracted here as the section title itself is not the best way to show specifics. Further information has to be extracted from "Income Taxation of Estates and Trusts").

Decedent, Estate, and Trust Income Tax Returns - Fraudulent Trusts

• Examples of abusive techniques: Income splitting, personal asset depreciation, and avoiding filing returns.
• Taxpayers are allowed to wire income overseas.

Retirement Plans for Small Businesses - Simplified Employee Pension (SEP)

• Self-employment net loss cannot be subtracted from wages or salary when determining compensation.

Retirement Plans for Small Businesses - Qualified Plans

• No contribution deduction if a qualified plan is not established.

Retirement Plans for Small Businesses - Retirement Distributions and Loans

• Persons providing services to a retirement plan are considered disqualified persons, not exempt from prohibited transaction rules.
• Disqualified persons receiving benefits are exempt from prohibited transactions rules.

Exempt Organizations

• Stock bonus, pension, or profit-sharing trusts under section 401 are exempt from annual information returns.
• Private foundations with gross receipts under $50,000 must file annual information returns.
• Foundations for public safety may qualify for tax-exempt status.
• Partnerships cannot qualify as exempt organizations.