Test Questions & Answers Sole Proprietorships and LLCs Ch.10

Principles of Taxation for Business and Investment Planning, 23e (Jones)

Chapter 10 Sole Proprietorships, Partnerships, LLCs, and S Corporations

1) Haddie's Hats is a regular corporation. The business must file an income tax return each year to report its taxable income or loss and pay any related taxes.

Difficulty: 1 Easy

Topic: Sole Proprietorships

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

2) A partnership is an unincorporated business activity owned by at least two taxpayers.

Difficulty: 1 Easy

Topic: Sole Proprietorships

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.; 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

3) A corporate shareholder usually cannot be held personally liable for the debts arising from the corporate business.

Difficulty: 2 Medium

Topic: Sole Proprietorships

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

4) Gabriel operates his business as a sole proprietorship. This year the business incurred an operating loss. The loss can be used to offset other business income he earned during the year.

Difficulty: 2 Medium

Topic: Sole Proprietorships

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

5) Mr. Dilly has expenses relating to a qualifying home office of $14,320. The taxable income generated by the business before any deduction of home office expenses was $13,700. His allowable home office deduction is $14,320.

Difficulty: 1 Easy

Topic: Sole Proprietorships

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

6) Ms. Jack operates a service business as a sole proprietorship. Her taxable income for the current year will be less than $100,000. Ms. Jack is not eligible for the QBI deduction.

Difficulty: 1 Easy

Topic: Sole Proprietorships

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

7) Businesses must withhold payroll taxes from payments made to independent contractors and periodically remit such taxes to the state and federal governments.

Difficulty: 2 Medium

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

8) Matthew earned $150,000 in wages during 2019. FICA taxes withheld by his employer would have been $11,475.

Explanation: The social security portion of the payroll tax applies only to the first $132,900 at the rate of 6.2%.

Difficulty: 2 Medium

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

9) The FICA taxes authorized by the Federal Insurance Contribution Act is imposed upon all of the employee's wages for the year.

Difficulty: 1 Easy

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

10) Businesses are required by law to withhold federal income tax from the compensation paid to their employees.

Difficulty: 1 Easy

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

11) Partners may deduct on their individual income tax returns an amount equal to 100% of self-employment tax paid.

Difficulty: 1 Easy

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

12) In contrast to a partnership, every member of an LLC has limited liability for the LLC's debts.

Difficulty: 1 Easy

Topic: Limited Liability Companies

Learning Objective: 10-03 Explain how limited liability companies (LLCs) are treated for Federal tax purposes.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

13) A partnership deducts guaranteed payments paid to its partners in computing ordinary income, and partners report guaranteed payments received as ordinary income.

Difficulty: 2 Medium

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.; 10-05 Differentiate between a distributive share of partnership income and cash flow.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

14) All general partners have unlimited personal liability for the debts of the entity.

Difficulty: 1 Easy

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

15) The allocations made to a partner are reported on Schedule K-1 and are referred to as his or her distributive share of partnership items.

Difficulty: 1 Easy

Topic: Partnership Reporting Requirements; Partnerships

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.; 10-05 Differentiate between a distributive share of partnership income and cash flow.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

16) Drake Partnership earned a net profit of $400,000. Four partners share profits and losses equally. No cash was distributed. The partners will report taxable income from the partnership on their personal income tax returns for the year.

Difficulty: 2 Medium

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

17) A guaranteed payment may be designed to compensate a partner for personal services rendered to the partnership.

Difficulty: 1 Easy

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

18) Partners receiving guaranteed payments are not required to pay self-employment tax on such payments.

Difficulty: 2 Medium

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

19) On June 1, Jefferson had a basis in his partnership interest of $75,000. On June 2, he received a cash distribution from the partnership of $28,000. All of the cash distribution is taxable.

Difficulty: 1 Easy

Topic: Partnership Reporting Requirements; Adjusting the Basis of a Partnership Interest

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.; 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

20) A partner's distributive share of partnership profits will increase his or her tax basis in the partnership interest.

Difficulty: 1 Easy

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

21) A partner's distributive share of partnership nondeductible losses does not decrease his or her tax basis in the partnership interest.

Difficulty: 2 Medium

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

22) A partner's tax basis in his or her partnership interest is decreased by partnership distributions.

Difficulty: 1 Easy

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

23) Carter's share of a partnership's operating loss is $17,200. His tax basis in his partnership interest before any adjustment for this loss is $26,000. If Carter has no excess business loss, he may deduct the full partnership loss on his individual tax return.

Difficulty: 1 Easy

Topic: Basis Limitation on Partnership Losses

Learning Objective: 10-07 Apply the basis limitation on the deduction of partnership losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

24) John's share of partnership loss was $60,000. He had only enough tax basis to deduct $34,000 of the loss. He may deduct the remaining loss against other income in the following year, regardless of what happens in the partnership.

Difficulty: 2 Medium

Topic: Basis Limitation on Partnership Losses

Learning Objective: 10-07 Apply the basis limitation on the deduction of partnership losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

25) If a partner's share of partnership losses exceeds basis, the excess is not deductible in the current year and cannot be carried forward for deduction in the future.

Difficulty: 1 Easy

Topic: Basis Limitation on Partnership Losses

Learning Objective: 10-07 Apply the basis limitation on the deduction of partnership losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

26) A limited liability company with one or more members is generally considered to be a partnership or S Corporation if the LLC has elected to do so for tax purposes.

Difficulty: 1 Easy

Topic: Limited Liability Companies

Learning Objective: 10-03 Explain how limited liability companies (LLCs) are treated for Federal tax purposes.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

27) A limited liability company that has only one member is generally treated as a disregarded entity for federal tax purposes.

Difficulty: 1 Easy

Topic: Limited Liability Companies

Learning Objective: 10-03 Explain how limited liability companies (LLCs) are treated for Federal tax purposes.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

28) A limited liability company is always taxed as a partnership, regardless of the number of its members.

Difficulty: 2 Medium

Topic: Limited Liability Companies

Learning Objective: 10-03 Explain how limited liability companies (LLCs) are treated for Federal tax purposes.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

29) A major advantage of an S corporation is the ability to specially allocate losses to specific members of the company.

Difficulty: 1 Easy

Topic: Limited Liability Companies

Learning Objective: 10-03 Explain how limited liability companies (LLCs) are treated for Federal tax purposes.; 10-08 Determine if a corporation is eligible to be an S corporation.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

30) Corporations cannot be shareholders in an S corporation.

Difficulty: 2 Medium

Topic: Eligible Corporations

Learning Objective: 10-08 Determine if a corporation is eligible to be an S corporation.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

31) If a business is formed as an S corporation, its income may be subject to double taxation.

Difficulty: 1 Easy

Topic: Tax Consequences to Shareholders

Learning Objective: 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

32) Tax savings achieved by operating a business through a pass-through entity, rather than as a C corporation, is an example of entity variable tax planning.

Difficulty: 2 Medium

Topic: Partnerships; Tax Consequences to Shareholders

Learning Objective: 10-05 Differentiate between a distributive share of partnership income and cash flow.; 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

33) The earnings of a C corporation are taxed only at the shareholder level.

Difficulty: 1 Easy

Topic: Eligible Corporations

Learning Objective: 10-08 Determine if a corporation is eligible to be an S corporation.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

34) The shareholders of an S corporation must pay self-employment tax on their share of the corporation's ordinary income.

Difficulty: 2 Medium

Topic: Tax Consequences to Shareholders

Learning Objective: 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

35) A shareholder in an S corporation can include only his or her own loans to the corporation in tax basis.

Difficulty: 1 Easy

Topic: Tax Consequences to Shareholders; Basis Limitation of S Corporation Losses

Learning Objective: 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.; 10-10 Apply the basis limitation on the deduction of S corporation losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

36) A shareholder in an S corporation includes in tax basis his or her share of the corporation's liabilities.

Difficulty: 1 Easy

Topic: Tax Consequences to Shareholders; Basis Limitation of S Corporation Losses

Learning Objective: 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.; 10-10 Apply the basis limitation on the deduction of S corporation losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

37) Randolph Scott operates a business as a sole proprietorship. This year his net profit was $10,570. For tax purposes this amount should be reported on:

A) Schedule C, Statement of Profit or Loss from Business

B) The first page of Form 1040 as other income

C) A separate tax return prepared for the business operation

D) Schedule E, Statement of Rent and Royalty Income

Difficulty: 2 Medium

Topic: Sole Proprietorships

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

38) Aaron James has a qualifying home office. The office is 500 square feet and the entire house is 2,500 square feet. Use the following information to determine his allowable home office deduction:

A) $5,240

B) $4,140

C) $4,260

D) $21,800

Explanation: ($12,000 + $4,000 + $2,500 + $2,200) × 20% = $4,140. $4,140 + $1,100 depreciation = $5,240.

Difficulty: 2 Medium

Topic: Sole Proprietorships

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

39) Rebecca has a qualifying home office. The room is 600 square feet and the entire house is 3,000 square feet. Use the following information to determine her allowable home office deduction:

A) $3,300 home office deduction.

B) $16,500 home office deduction.

C) $3,500 home office deduction.

D) $4,100 home office deduction.

Explanation: $10,000 + $3,300 + $2,000 + $1,200 = $16,500. $16,500 × 20% = $3,300. $3,300 + $800 depreciation = $4,100; however, there is only $3,500 of income to offset the home office deduction.

Difficulty: 3 Hard

Topic: Sole Proprietorships

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

40) Which of the following statements regarding sole proprietorships is false?

A) A sole proprietorship has no legal identity separate from that of its owner.

B) Sole proprietorships are the most common form of business entity in the U.S.

C) The cash flow generated by a sole proprietorship belongs to the owner.

D) The assets and liabilities of a sole proprietorship are held in the name of the business, not the owner.

Difficulty: 1 Easy

Topic: Sole Proprietorships

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

41) Which of the following statements regarding the home office deduction is true?

A) In order to qualify for the deduction, a portion of the taxpayer's home must be used regularly and exclusively to meet with clients or customers.

B) A home office deduction is not allowed for using the home office for administrative or management activities only.

C) The home office deduction is limited to the taxable income of the business before the deduction.

D) A depreciation deduction is not allowed for a home office.

Difficulty: 2 Medium

Topic: Sole Proprietorships

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

42) Which of the following statements regarding a sole proprietorship is false?

A) A sole proprietorship is an unincorporated business operated by one individual.

B) Taxable income from a sole proprietorship is reported on Schedule D of the proprietor's individual income tax return.

C) Sole proprietors are entitled to deduct 50 percent of self-employment tax paid.

D) None of the above statements are false.

Difficulty: 1 Easy

Topic: Sole Proprietorships; Employment Taxes

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.; 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

43) Janice earned $175,000 of qualified business income this year from her sole proprietorship and has taxable income, before any QBI deduction, of $150,000. Janice is permitted a QBI deduction of

A) $35,000

B) $30,000

C) $25,000

D) $0

Explanation: The taxable income limitation reduces Janice's QBI deduction to 20% × $150,000.

Difficulty: 2 Medium

Topic: Sole Proprietorships; Employment Taxes

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

44) Armond earned $10,000 of profit from a sole proprietorship in 2019. If he also has $140,000 of salary income, how much self-employment tax will he owe?

A) $1,530

B) $1,413

C) $290

D) $268

Explanation: Because Armond's salary is above the 2019 social security base amount, he owes only the Medicare portion of the self-employment tax, equal to $268 = $10,000 × 92.35% × 2.9%.

Difficulty: 2 Medium

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

45) Which of the following amounts are not subject to self-employment tax?

A) General partner's share of partnership income

B) Limited partner's share of partnership income

C) Sole proprietor's income from business activity

D) Guaranteed payment to general partner

Difficulty: 2 Medium

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.; 10-04 Explain the flow-through of partnership items to the partners.; 10-05 Differentiate between a distributive share of partnership income and cash flow.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

46) During 2019, Scott Howell received a salary of $135,000. The social security base amount for 2019 was $132,900. How much payroll tax should have been withheld from Scott's salary for 2018?

A) $0

B) $10,328

C) $9,823

D) $10,198

Explanation: $135,000 × 1.45% = $1,958 Medicare + $132,900 × 6.2% = $8,240 Social Security. Total = $10,198.

Difficulty: 2 Medium

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

47) Kelly operates a sole proprietorship with qualified business income of $920,000. Her business paid W-2 wages of $250,000 and owns depreciable tangible property with an unadjusted basis of $410,000. Compute Kelly's allowable QBI deduction before the taxable income limitation.

A) $184,000

B) $125,000

C) $72,750

D) $0

Explanation: Tentative deduction is $184,000 ($920,000 x 20%). However, deduction is limited to greater of $125,000 ($250,000 W-2 wages x 50%) or $72,750 ($250,000 W-2 wages x 25% + $410,000 property x 2.5%).

Difficulty: 2 Medium

Topic: QBI Deduction

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

48) Sue's 2019 net (take-home) pay was $23,205. Her only payroll deductions were for payroll taxes and federal income tax. Federal income tax withholdings totaled $4,500. What was the amount of her gross wages for the year?

A) $25,127

B) $30,000

C) $29,480

D) None of the above

Explanation: x − $4,500 − 7.65% × x = $23,205, so solving for x, 92.35% × x = $27,705, x = $30,000.

Difficulty: 3 Hard

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

49) During the current year, Margie earned wage income of $300,000. If Margie is single, which of the following statements regarding her Medicare tax liability is true?

A) Margie will owe both the regular 1.45 percent Medicare tax and the additional .9 percent Medicare tax on her entire wage income.

B) Margie will owe the regular 1.45 percent Medicare tax on her entire wage income and the additional .9 percent Medicare tax only on her wage income in excess of $200,000.

C) Margie will owe the regular 1.45 percent Medicare tax on her entire wage income and the additional .9 percent Medicare tax only on her wage income in excess of $250,000.

D) Margie's employer is required to withhold both the regular Medicare tax but does not withhold the additional .9 percent Medicare tax.

Difficulty: 2 Medium

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

50) During 2019, Elena generated $24,500 of earnings on Schedule C. If Elena had no other earned income, how much self-employment tax will she owe on her Schedule C net profit?

A) $3,749

B) $3,259

C) $3,009

D) $3,462

Explanation: $24,500 × 92.35% × 15.3%.

Difficulty: 1 Easy

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

51) In 2019, Mike Elfred received a $165,000 salary from his employer and generated $39,000 net earnings from self-employment from his small business. Which of the following statements is true?

A) Mike does not owe any self-employment tax because his salary exceeded the 2019 base amount ($132,900) for federal employment tax.

B) Mike owes both the Medicare and Social Security tax portions of self-employment tax on his $39,000 earnings from his small business.

C) Mike owes Medicare tax but not Social Security tax on his $39,000 earnings from his small business.

D) Mike owes Social Security tax but not Medicare tax on his $39,000 earnings from his small business.

Difficulty: 2 Medium

Topic: Employment Taxes

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

52) Alan is a general partner in ADK Partnership. His partnership Schedule K-1 reports $50,000 ordinary business income, $22,000 guaranteed payment, $5,000 long-term capital gain, and $400 dividend income. Which of these items are subject to self-employment tax?

A) $50,000 ordinary income

B) $50,000 ordinary business income and $22,000 guaranteed payment

C) $50,000 ordinary business income, $22,000 guaranteed payment, and $5,000 long-term capital gain

D) All income reported on a general partner's Schedule K-1 are subject to self-employment tax

Difficulty: 1 Easy

Topic: Employment Taxes; Partnership Reporting Requirements

Learning Objective: 10-02 Compute the FICA payroll taxes and the federal SE tax.; 10-04 Explain the flow-through of partnership items to the partners.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

53) Debbie is a limited partner in ADK Partnership. Her partnership Schedule K-1 reports $19,000 ordinary business income, $2,000 long-term capital gain, and $830 dividend income. Which of these items are subject to self-employment tax?

A) None of the items are subject to SE tax because Debbie is a limited partner.

B) $19,000 ordinary business income

C) $19,000 ordinary business income and $2,000 long-term capital gain

D) All income reported on a partner's Schedule K-1 are subject to self-employment tax.

Difficulty: 1 Easy

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

54) Which of the following statements about partnerships is false?

A) A partnership is a legal entity that may enter into valid contracts.

B) Partnerships are unincorporated entities.

C) Only individuals may be partners in a partnership.

D) Partnerships are sometimes referred to as passthrough entities since they do not pay federal income tax.

Difficulty: 2 Medium

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

55) Which of the following statements concerning partnerships is false?

A) A properly-drafted partnership agreement is crucial.

B) A general partner's basis in a partnership includes his share of partnership debt.

C) Limited partnerships must have at least one general partner.

D) A partner is taxed annually on only that portion of a partnership's taxable income that is actually distributed.

Difficulty: 2 Medium

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

56) William is a member of an LLC. His Schedule K-1 reported a $1,200 share of capital loss and a $3,000 share of Section 1231 gain. William recognized a $4,500 capital gain on the sale of marketable securities and a $15,000 Section 1231 loss on the sale of business equipment. What is the net effect of these gains and losses on William's taxable income?

A) $3,300 net capital gain; $12,000 deductible net Section 1231 loss

B) $4,500 net capital gain; $12,000 deductible net Section 1231 loss

C) $4,500 net capital gain; $15,000 deductible net Section 1231 loss

D) $3,300 net capital gain; -0- deductible net Section 1231 loss

Difficulty: 2 Medium

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

57) Alice is a partner in Axel Partnership. Her share of the partnership's current ordinary business income was $100,000. She received a $60,000 cash distribution from the partnership on December 1. Alice qualifies for the QBI deduction, without regard to the wage or taxable income limitations. Assuming that Alice's marginal tax rate is 37%, calculate her after-tax cash flow from the partnership this year.

A) $70,400

B) $30,400

C) $45,200

D) $29,600

Explanation: $60,000 cash received − $29,600 tax [($100,000 - $20,000 QBI deduction) × 37%].

Difficulty: 2 Medium

Topic: Partnership Reporting Requirements; Partnerships

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.; 10-05 Differentiate between a distributive share of partnership income and cash flow.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

58) Hay, Straw and Clover formed the HSC Partnership, agreeing to share profits and losses equally. Clover will manage the business for which he will receive a guaranteed payment of $30,000 per year. Cash receipts and disbursements for the year were as follows

What is Clover's share of the partnership's ordinary income and guaranteed payment?

A) Ordinary income, $30,000; Guaranteed payment, $10,000.

B) Ordinary income, $20,000; Guaranteed payment, $10,000.

C) Ordinary income, $30,000; Guaranteed payment, $30,000.

D) Ordinary income, $20,000; Guaranteed payment, $30,000.

Explanation: Ordinary income is $60,000 ($90,000 − $30,000). Clover is allocated 1/3 of the ordinary income and all of the guaranteed payment.

Difficulty: 3 Hard

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.; 10-05 Differentiate between a distributive share of partnership income and cash flow.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

59) Waters Corporation is an S corporation with two equal shareholders, Mia Jones and David Kerns. This year, Waters recorded the following items of income and expense:

Waters distributed $25,000 to each of its shareholders during the year. Calculate the S corporation's ordinary (non-separately stated) income and indicate which items must be separately stated.

A) Ordinary income, $126,000; long-term capital gain is separately stated.

B) Ordinary income, $120,000; interest income and long-term capital gain are separately stated.

C) Ordinary income, $136,000; nothing is separately stated.

D) Ordinary income, $195,000; interest income, long-term capital gain, and salary costs are separately stated.

Explanation: Ordinary income = $500,000 − $250,000 − $75,000 − $55,000.

Difficulty: 3 Hard

Topic: Tax Consequences to Shareholders

Learning Objective: 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

60) Waters Corporation is an S corporation with two equal shareholders, Mia Jones and David Kerns. This year, Waters recorded the following items of income and expense:

Waters distributed $25,000 to each of its shareholders during the year. If Mia has no other sources of income, what is her gross income for the year?

A) $63,000

B) $60,000

C) $68.000

D) $97,500

Explanation: 50% × ($120,000 ordinary income + $6,000 interest income + $10,000 capital gain).

Difficulty: 3 Hard

Topic: Tax Consequences to Shareholders

Learning Objective: 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

61) Martha Pim is a general partner in PLF Partnership. This year, Martha received a $48,000 guaranteed payment from PLF, and her distributive share of PLF's ordinary business income was $93,200. Which of the following is accurate?

A) Martha must pay income tax on $141,200 and self-employment tax on $48,000.

B) Martha must pay income tax on $141,200 and self-employment tax on $93,200.

C) Martha must pay both income tax and self-employment tax on $141,200.

D) Martha must pay income tax on $48,000 and self-employment tax on $93,200.

Difficulty: 2 Medium

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

62) Waters Corporation is an S corporation with two equal shareholders, Mia Jones and David Kerns. This year, Waters recorded the following items of income and expense:

Waters distributed $25,000 to each of its shareholders during the year. If Mia's adjusted tax basis in her partnership interest was $50,000 at the beginning of the year, compute her adjusted tax basis in her partnership interest at the end of the year.

A) $93,000

B) $118,000

C) $50,000

D) $85,000

Explanation: $50,000 + $60,000 + $3,000 + $5,000 − $25,000.

Difficulty: 3 Hard

Topic: Adjusting the Basis of a Partnership Interest; Tax Consequences to Shareholders

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.; 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

63) Which of the following items would be separately stated instead of included in ordinary income when reported by a partnership?

A) Municipal bond interest income

B) Capital loss

C) Dividend income

D) All of the above items would be separately stated

Difficulty: 1 Easy

Topic: Partnership Reporting Requirements

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

64) Max is a 10% limited partner in LMN partnership. His adjusted basis in his partnership interest was $50,000 at the beginning of the current year. During the year, the partnership earned $100,000 of ordinary income, incurred a $5,000 capital loss, and paid $1,000 of nondeductible expenses. Max received a distribution of $2,000 from the partnership. Calculate Max's ending adjusted basis in his partnership interest.

A) $142,000

B) $57,400

C) $57,500

D) $59,200

Explanation: $57,400 = $50,000 initial basis + 10% × $100,000 share of ordinary income − 10% × $5,000 share of capital loss − 10% × $1,000 share of nondeductible expenses − $2,000 distribution.

Difficulty: 2 Medium

Topic: Partnership Reporting Requirements; Adjusting the Basis of a Partnership Interest

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.; 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

65) George and Martha formed a partnership by each contributing $5,000 cash. The partnership then borrowed another $60,000 to finance its operations. If George and Martha are both general partners, compute each partner's initial basis in his/her partnership interest.

A) $5,000

B) $65,000

C) $35,000

D) $0

Explanation: $5,000 cash contribution plus 50 percent share of partnership debt.

Difficulty: 2 Medium

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

66) Which of the following statements about S corporations is true?

A) An S corporation has unlimited liability.

B) An S corporation is a flow-through entity for federal income tax purposes.

C) S corporations can only have 75 shareholders.

D) S corporations can have several classes of stock.

Difficulty: 1 Easy

Topic: Eligible Corporations; Tax Consequences to Shareholders

Learning Objective: 10-08 Determine if a corporation is eligible to be an S corporation.; 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

67) Bernard and Leon formed a partnership on January 1 with cash contributions of $600,000 and $200,000, respectively. The partners agree to share profits and losses in the ratio of their initial capital contributions. The partnership immediately borrowed $800,000. What is Bernard's tax basis in his partnership interest?

A) $1,200,000

B) $600,000

C) $800,000

D) $1,400,000

Explanation: $600,000 + ($800,000 × 75%).

Difficulty: 1 Easy

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

68) Cramer Corporation and Mr. Chips formed a general partnership. Cramer contributed $500,000 cash, and Mr. Chips contributed a building with a $500,000 FMV and $300,000 tax basis. The partnership immediately borrowed $700,000 of recourse debt. What is Cramer's tax basis in its partnership interest?

A) $500,000

B) $1,200,000

C) $850,000

D) $650,000

Difficulty: 1 Easy

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

69) Cramer Corporation and Mr. Chips formed a general partnership. Cramer contributed $500,000 cash, and Mr. Chips contributed a building with a $500,000 FMV and $300,000 tax basis. The partnership immediately borrowed $700,000 of recourse debt. What is Mr. Chips' tax basis in its partnership interest?

A) $500,000

B) $1,200,000

C) $850,000

D) $650,000

Difficulty: 1 Easy

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

70) Cramer Corporation and Mr. Chips formed a partnership in which Cramer is the general partner and Mr. Chips is a limited partner. Cramer contributed $500,000 cash, and Mr. Chips contributed a building with a $500,000 FMV and $300,000 tax basis. The partnership immediately borrowed $700,000 of recourse debt. What is Cramer's tax basis in its partnership interest?

A) $500,000

B) $1,200,000

C) $850,000

D) $650,000

Difficulty: 2 Medium

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

71) Cramer Corporation and Mr. Chips formed a partnership in which Cramer is the general partner and Mr. Chips is a limited partner. Cramer contributed $500,000 cash, and Mr. Chips contributed a building with a $500,000 FMV and $300,000 tax basis. The partnership immediately borrowed $700,000 of recourse debt. What is Mr. Chips' tax basis in its partnership interest?

A) $500,000

B) $850,000

C) $650,000

D) $300,000

Difficulty: 2 Medium

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

72) Jackie contributed $60,000 in cash to a partnership for a 50% interest. This year, the partnership earned $200,000 ordinary business income, made a $20,000 contribution to the United Way, and distributed $25,000 cash to Jackie. Her tax basis in the partnership at year end is:

A) $110,000

B) $85,000

C) $125,000

D) $215,000

Explanation: $60,000 + ($200,000 × 0.50) − ($20,000 × 0.5) − $25,000.

Difficulty: 3 Hard

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

73) Mutt and Jeff are general partners in M&J Partnership and share profits and losses equally. Partnership operations for the current tax year were:

Mutt's tax basis in his partnership interest at the beginning of the current year was $12,000. What is his basis at the beginning of next year?

A) $25,000

B) $37,000

C) $13,000

D) $27,000

Explanation: $12,000 beginning basis + 50% × ($100,000 + $10,000 − $60,000) = $37,000.

Difficulty: 2 Medium

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

74) At the beginning of year 1, Paulina purchased a 25% general partner interest in Gamma Partnership for $25,000. Paulina's partnership Schedule K-1 for year 1 reported that her share of Gamma's debt at year-end was $10,000 and her share of ordinary loss was $5,000. On January 1, year 2, Paulina sold her interest to another partner for $22,000 cash (including relief of liabilities). Compute Paulina's gain or loss on the sale of her partnership interest.

A) $3,000 loss

B) $8,000 loss

C) $2,000 gain

D) $0 gain or loss

Explanation: Her basis prior to the sale is $30,000 = $25,000 + $10,000 − $5,000. Her amount realized on the sale is $32,000 = $22,000 cash + $10,000 relief of liabilities.

Difficulty: 3 Hard

Topic: Partnership Reporting Requirements; Adjusting the Basis of a Partnership Interest

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.; 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

75) Gavin owns a 50% interest in London Partnership. His tax basis in his partnership interest at the beginning of the year was $20,000. His partnership Schedule K-1 showed the following:

Calculate Gavin's tax basis in his partnership interest at the end of the year?

A) $85,000

B) $95,000

C) $75,000

D) $65,000

Explanation: $20,000 + $60,000 + $5,000 increase in share of debt.

Difficulty: 2 Medium

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

76) Which of the following statements regarding a partner's tax basis in a partnership interest is true?

A) Partnership tax basis is increased annually by cash distributions from the partnership.

B) Partnership tax basis is reduced by the partner's share of nondeductible partnership expenses.

C) Partnership tax basis is reduced by the partner's share of nontaxable partnership income.

D) Partnership tax basis becomes negative if allocable losses exceed basis.

Difficulty: 2 Medium

Topic: Adjusting the Basis of a Partnership Interest; Basis Limitation on Partnership Losses

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.; 10-07 Apply the basis limitation on the deduction of partnership losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

77) Perry is a partner in a calendar year partnership. His Schedule K-1 for the current tax year showed the following:

Perry's tax basis in his partnership interest at the beginning of the year was $15,400. How much of the ordinary loss may he deduct on his Form 1040? Assume the excess business loss limitation does not apply.

A) $11,700

B) $14,000

C) $10,200

D) $13,300

Explanation: $15,400 − $5,800 + $2,100 + $1,600 = 13,300 basis for loss limitation.

Difficulty: 2 Medium

Topic: Basis Limitation on Partnership Losses

Learning Objective: 10-07 Apply the basis limitation on the deduction of partnership losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

78) Alex is a partner in a calendar year partnership. His partnership Schedule K-1 for the current tax year showed the following:

Alex has a $7,000 loss carryforward from the partnership last year, which he could not deduct because of the basis limitation. What is his tax basis in his partnership interest at the end of the current tax year?

A) $41,000

B) $32,500

C) $39,500

D) $34,000

Explanation: Carryforward loss ($7,000) + $41,000 − $1,500 = $32,500.

Difficulty: 3 Hard

Topic: Basis Limitation on Partnership Losses

Learning Objective: 10-07 Apply the basis limitation on the deduction of partnership losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

79) Orange, Inc. is a calendar year partnership with the following current year information:

On January 1, John James bought 50% general interest in Orange, Inc. for $30,000. How much of the operating loss may John deduct on his Form 1040? Assume the excess business loss limitation does not apply.

A) $60,000

B) $30,000

C) $40,000

D) $50,000

Explanation: For a general partner, tax basis includes a pro rata share of all debt. Therefore, John gets basis for his cash and 50% of the debt.

Difficulty: 3 Hard

Topic: Basis Limitation on Partnership Losses

Learning Objective: 10-07 Apply the basis limitation on the deduction of partnership losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

80) Which of the following statements regarding the basis limitation on deduction of partnership losses is false?

A) If a partner's share of partnership losses exceeds the partner's tax basis in the partnership interest, the excess is not deductible in the current year.

B) Partnership losses that are not deductible due to the basis limitation can be carried forward indefinitely.

C) Partners can increase tax basis in their partnership interest only by making additional capital contributions.

D) If a partnership becomes profitable in the future, the partner's share of such future income will create basis against which loss carryforwards can be deducted.

Difficulty: 2 Medium

Topic: Basis Limitation on Partnership Losses

Learning Objective: 10-07 Apply the basis limitation on the deduction of partnership losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

81) Funky Chicken is a calendar year general partnership with the following current year information:

On January 1 June Cross bought 60% of Funky Chicken for $45,000. How much of the operating loss may Cross deduct currently? Assume the excess business loss limitation does not apply.

A) $57,000

B) $80,000

C) $65,000

D) $75,000

Explanation: For a general partner, tax basis includes a pro rata share of all debt. Therefore, June gets basis for her cash and 60% of the debt.

Difficulty: 3 Hard

Topic: Basis Limitation on Partnership Losses

Learning Objective: 10-07 Apply the basis limitation on the deduction of partnership losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

82) Which of the following statements regarding limited liability companies is false?

A) Every member of an LLC has limited liability for the LLC's debts.

B) An LLC with only one member is generally treated as a corporation for income tax purposes.

C) An LLC with more than one member is generally treated as a partnership for income tax purposes.

D) State laws do not limit the number of members or the type of entity that can be a member in an LLC.

Difficulty: 2 Medium

Topic: Limited Liability Companies

Learning Objective: 10-03 Explain how limited liability companies (LLCs) are treated for Federal tax purposes.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

83) Which of the following statements regarding limited liability companies is true?

A) Just like an S corporation, an LLC member's share of ordinary income is not subject to self-employment taxes.

B) Just like an S corporation, an LLC is restricted to 100 members.

C) Because LLCs are a relatively new organizational form, many tax questions concerning their operation have yet to be resolved.

D) Just like a limited partnership, only LLC members who are not actively involved in the entity's business activities have limited liability for the LLC's debts.

Difficulty: 2 Medium

Topic: Limited Liability Companies

Learning Objective: 10-03 Explain how limited liability companies (LLCs) are treated for Federal tax purposes.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

84) Which of the following statements regarding S corporations is true?

A) An S corporation may have no more than 50 shareholders.

B) Any individual, estate, corporation, or trust may be an S corporation shareholder.

C) An S corporation may have only one class of stock.

D) An S corporation shareholder's allocable share of ordinary income is subject to self-employment tax.

Difficulty: 2 Medium

Topic: Eligible Corporations; Tax Consequences to Shareholders

Learning Objective: 10-08 Determine if a corporation is eligible to be an S corporation.; 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

85) XYZ, Inc. wishes to make an election to become an S corporation for federal tax purposes. Which of the following statements regarding the election is false?

A) All of the corporation's shareholders must consent to make an S election.

B) If a shareholder in an S corporation sells his shares of stock to a nonresident alien, the election will terminate.

C) If an S corporation loses its election, the shareholders cannot make a new election for five years without IRS consent.

D) All of the shareholders must consent to voluntarily terminating an S election.

Difficulty: 2 Medium

Topic: Eligible Corporations

Learning Objective: 10-08 Determine if a corporation is eligible to be an S corporation.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

86) Grant and Amy have formed a new business to be operated through an S corporation. They each own 50% of the corporation's outstanding common stock. During the first year of operations, the business incurred an operating loss of $100,000. In allocating this loss to the shareholders:

A) Grant and Amy must each be allocated $50,000 of the operating loss.

B) If the corporate charter permits, the S corporation can make a special allocation of 100% of the operating loss to Grant.

C) Because the shareholders have limited liability for the S corporation's debts, they are not permitted any deduction for the operating loss.

D) The corporation should also consider ownership of any outstanding preferred stock in making the loss allocation.

Difficulty: 1 Easy

Topic: Eligible Corporations

Learning Objective: 10-08 Determine if a corporation is eligible to be an S corporation.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

87) Loretta is the sole shareholder of Country Collectibles, a calendar year S corporation. Although Loretta spends at least 40 hours per week supervising Country Collectible's employees, she has never drawn a salary from the business. Country Collectibles has been in existence for five years and has earned a profit every year. Loretta withdraws $100,000 cash from the S corporation each year. Which of the following statements accurately describes the tax consequences of these withdrawals?

A) The withdrawals are nontaxable, with no risk that they could be recharacterized as taxable salary or dividend payments.

B) The withdrawals are considered taxable dividends to Loretta.

C) There is significant risk that the IRS could recharacterize the payments to Loretta as salary. Such treatment would increase taxable income for both Loretta and the S corporation.

D) There is significant risk that the IRS could recharacterize the payments to Loretta as salary. Such treatment would not change taxable income for Loretta and reduce taxable income of the S corporation.

Explanation: Loretta would report salary income and an equal reduction in ordinary income from the S corporation, with a zero net effect on her taxable income.

Difficulty: 2 Medium

Topic: Tax Consequences to Shareholders

Learning Objective: 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

88) Loretta is the sole shareholder of Country Collectibles, a calendar year S corporation. Although Loretta spends at least 40 hours per week supervising Country Collectible's employees, she has never drawn a salary from the business. Country Collectibles has been in existence for five years and has earned a profit every year. Loretta withdraws $100,000 cash from the S corporation each year. As a result of an audit, the IRS asserts that $75,000 of the cash withdrawal should be considered a salary payment to Loretta. What are the payroll tax consequences of this recharacterization?

A) No payroll taxes will be owed as a result of the audit.

B) Loretta and Country Collectibles will each be liable for unpaid payroll taxes as a result of the audit.

C) Only Loretta will be liable for unpaid payroll taxes as a result of the audit.

D) Only Country Collectibles will be liable for unpaid payroll taxes as a result of the audit.

Difficulty: 2 Medium

Topic: Tax Consequences to Shareholders

Learning Objective: 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

89) Cactus Company is a calendar year S corporation with the following current year information:

On January 1, John James bought 50% of Cactus Company stock for $30,000. How much of the operating loss may John deduct on his Form 1040? Assume the excess business loss limitation does not apply.

A) $60,000

B) $30,000

C) $40,000

D) $50,000

Explanation: S corporation debt is included in tax basis only if loaned directly by the shareholder. So John's basis equals the cash invested.

Difficulty: 3 Hard

Topic: Basis Limitation of S Corporation Losses

Learning Objective: 10-10 Apply the basis limitation on the deduction of S corporation losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

90) Funky Chicken is a calendar year S corporation with the following current year information:

On January 1 June Cross bought 60% of Funky Chicken for $45,000. She then loaned the company $20,000. How much of the operating loss may Cross deduct on her Form 1040? Assume the excess business loss limitation does not apply.

A) $57,000

B) $80,000

C) $65,000

D) $75,000

Explanation: S corporation debt is included in basis only if loaned directly by the shareholder. So June gets the full $20,000 she loaned as basis, but none of the bank loan.

Difficulty: 3 Hard

Topic: Basis Limitation of S Corporation Losses

Learning Objective: 10-10 Apply the basis limitation on the deduction of S corporation losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

91) On January 1, Leon purchased a 10% stock interest in an S corporation for $30,000. He also loaned the S corporation $5,000 in exchange for a written promissory note. The S corporation generated a $330,000 operating loss for the year. Leon deducted his 10% share of the loss, reducing his tax basis in his stock to zero, and his tax basis in the note to $2,000. The following year, the S corporation repaid the note before Leon restored his basis in the note. What are the consequences of the loan repayment to Leon?

A) $3,000 capital gain

B) $3,000 ordinary income

C) $2,000 capital gain

D) $2,000 ordinary income

Difficulty: 2 Medium

Topic: Basis Limitation of S Corporation Losses

Learning Objective: 10-10 Apply the basis limitation on the deduction of S corporation losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

92) In applying the basis limitation on the deduction of S corporation losses, which of the following statements is true?

A) The basis of a shareholder's interest in an S corporation, for purposes of limiting deductibility of losses, is computed in the same manner as a partner's basis in a partnership interest.

B) A shareholder is permitted to deduct losses against basis in any debt obligation from the S corporation to the shareholder.

C) If a shareholder's tax basis in a debt obligation is reduced, any gain resulting from the repayment of that obligation is considered ordinary income.

D) All of the above statements are false.

Difficulty: 2 Medium

Topic: Tax Consequences to Shareholders; Basis Limitation of S Corporation Losses

Learning Objective: 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.; 10-10 Apply the basis limitation on the deduction of S corporation losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

93) On January 1 of this year, Conrad Nelson contributed $15,000 cash in exchange for 50 shares of stock in Sterling Inc., an S corporation. Sterling employs Conrad as its director of marketing. Conrad's current year salary was $70,000 and his pro rata share of Sterling's ordinary business income was $16,800. During the year, Conrad received a $9,000 cash distribution with respect to his Sterling stock. Compute Conrad's basis in his Sterling stock at year end.

A) $15,000

B) $22,800

C) $31,800

D) $92,800

Difficulty: 2 Medium

Topic: Tax Consequences to Shareholders

Learning Objective: 10-09 Identify similarities and differences in the tax treatment of S corporations versus partnerships.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

94) On January 1, 2019, Laura Wang contributed $30,000 cash in exchange for 30 shares of stock in Suki Inc., an S corporation. On May 12, Laura loaned $8,500 to Suki in exchange for a 5-year interest-bearing note. Laura's pro rata share of Suki's 2019 ordinary business loss was $34,100, and she received no cash distributions during the year. Assume the excess business loss limitation does not apply. Which of the following statements is accurate?

A) Laura can deduct $30,000 of the loss in 2019. On January 1, 2020, the basis in her Suki stock is zero, and the basis in her Suki note is $8,500.

B) Laura can deduct $34,100 of the loss in 2019. On January 1, 2020, the basis in her Suki stock is $4,400, and the basis in her Suki note is zero.

C) Laura can deduct $34,100 of the loss in 2019. On January 1, 2020, the basis in her Suki stock is zero, and the basis in her Suki note is $4,400.

D) None of the above is accurate.

Difficulty: 2 Medium

Topic: Basis Limitation of S Corporation Losses

Learning Objective: 10-10 Apply the basis limitation on the deduction of S corporation losses.

Accessibility: Keyboard Navigation

Type: Static

Gradable: automatic

95) In 2019, William Wallace's sole proprietorship, Western Wear Apparel, generated $162,426 Schedule C net profit ($150,000 net earnings from self-employment). In addition, William recognized a $25,000 Section 1231 gain on a sale of land formerly used by the business as a parking lot. The business checking account earned $250 interest income. William qualifies for the QBI deduction without regard to the wage or taxable income limitations.

a. Which of these income items are subject to self-employment tax?

b. Compute William's 2019 self-employment tax, assuming he has no other earned income.

c. Compute the total increase in William's 2019 taxable income attributable to his business.

a. Only the $150,000 net earnings from self-employment is subject to SE tax.

b. Since this profit exceeds the 2019 Social Security wage base of $132,900, his self-employment tax is $20,830 = $16,480 ($132,900 × 12.4%) + $4,350 ($150,000 × 2.9%). The deductible portion of self-employment tax is $10,415 = ($20,830 × 50%).

c. William's taxable income from his business activities is $144,776 = $162,426 Schedule C net profit + $25,000 Section 1231 gain + $250 interest income – $10,415 deductible self-employment tax - $32,485 QBI deduction ($162,426 x 20%).

Difficulty: 3 Hard

Topic: Sole Proprietorships; Employment Taxes

Learning Objective: 10-01 Compute net profit or loss from a sole proprietorship.; 10-02 Compute the FICA payroll taxes and the federal SE tax.

Accessibility: Keyboard Navigation

Type: Static

Gradable: manual

96) Adam and Barbara formed a partnership to construct an apartment building. Adam contributed $500,000 cash and Barbara contributed land ($500,000 FMV and $250,000 basis) in exchange for a 50 percent interest in AB Partnership. Immediately after its formation, the partnership borrowed $600,000 from a local bank to begin construction. Compute each partner's initial basis in their partnership interest, assuming that:

a. Adam and Barbara are both general partners.

b. Adam is a limited partner and Barbara is a general partner.

a. If both are general partners, Adam's initial basis is $800,000 = $500,000 cash contributed + 50% × $600,000 debt; Barbara's initial basis is $550,000 = $250,000 basis of land contributed + 50% × $600,000 debt.

b. If Adam is a limited partner and Barbara is a general partner, Adam's initial basis is $500,000 = cash contributed; Barbara's initial basis is $850,000 = $250,000 basis of land contributed + 100% × $600,000 debt.

Difficulty: 1 Easy

Topic: Adjusting the Basis of a Partnership Interest

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: manual

97) Bevo Partnership had the following financial activity for the year:

Compute Bevo's ordinary business income for the year and indicate which items must be separately stated.

Difficulty: 2 Medium

Topic: Partnership Reporting Requirements; Partnerships

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.; 10-05 Differentiate between a distributive share of partnership income and cash flow.

Accessibility: Keyboard Navigation

Type: Static

Gradable: manual

98) Ted is a 20 percent general partner in Bevo.

Bevo Partnership had the following financial activity for the year:

a. Compute Ted's share of partnership ordinary income and separately stated items.

b. If Ted's adjusted basis in his Bevo interest was $30,000 at the beginning of the year, compute his adjusted basis at the end of the year. Assume that Bevo's debt did not change during the year.

c. How would your basis computation change if Bevo's debt at the end of the year as $50,000 less than its debt at the beginning of the year?

a. Ted's share of: partnership ordinary income, $56,000; Section 1231 gain, $1,000; nondeductible expenses, $2,000; distributions, $15,000.

b. Ted's basis at the end of the year (with no change in debt): $70,000 = $30,000 + $56,000 + $1,000 − $2,000 − $15,000.

c. If debt declines, Ted's basis drops to $60,000 = $70,000 − 20% × $50,000 debt decrease.

Difficulty: 2 Medium

Topic: Partnership Reporting Requirements; Partnerships; Adjusting the Basis of a Partnership Interest

Learning Objective: 10-04 Explain the flow-through of partnership items to the partners.; 10-05 Differentiate between a distributive share of partnership income and cash flow.; 10-06 Adjust the tax basis in a partnership interest.

Accessibility: Keyboard Navigation

Type: Static

Gradable: manual

99) At the beginning of 2019, Quentin purchased a 25 percent general partner interest in Maxim Partnership for $30,000. Quentin's 2019 Schedule K-1 reported that his share of Maxim's debt at year-end was $20,000 and his share of ordinary loss was $42,000. On January 1, 2020, Quentin sold his interest to another partner for $5,000 cash.

a. How much of his share of Maxim's loss can Quentin deduct on his 2019 return? Assume that the excess business loss limitation does not apply.

b. Compute Quentin's recognized gain on sale of his Maxim interest.

a. Quentin can deduct the full amount of the loss. His ending basis in his partnership interest is $8,000 = $30,000 + $20,000 − $42,000.

b. Quentin's gain on sale of his interest is $17,000 = ($5,000 + $20,000 debt relief) amount realized − $8,000 basis.

Difficulty: 3 Hard

Topic: Adjusting the Basis of a Partnership Interest; Basis Limitation on Partnership Losses

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.; 10-07 Apply the basis limitation on the deduction of partnership losses.

Accessibility: Keyboard Navigation

Type: Static

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100) Jose is married filing a joint return. In 2019, he earned $160,000 of profit from his sole proprietorship, which operates a service business. The business paid no W-2 wages in 2019 and owns no tangible business property.

a. Compute Jose's allowable QBI deduction if his joint return reflects taxable income of $300,000 before the deduction.

b. Compute Jose's allowable QBI deduction if his joint return reflects taxable income of $340,000 before the deduction.

a. QBI deduction is $32,000 ($160,000 x 20%). Because his taxable income is below the 2019 threshold of $321,400, he is exempt from the wage limitation and the exclusion of services businesses.

b. His taxable income exceeds the 2019 $321,400 threshold by $18,600. His QBI deduction is reduced by 18.6%, to $26,048 ($32,000 – 18.6% x $32,000).

Difficulty: 3 Hard

Topic: Adjusting the Basis of a Partnership Interest; Basis Limitation on Partnership Losses

Learning Objective: 10-06 Adjust the tax basis in a partnership interest.; 10-07 Apply the basis limitation on the deduction of partnership losses.

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