-
Business Entities and ConsiderationsQuestion 1
Elena restores and sells vintage bicycles on weekends. For the current year, her bicycle activity is determined not to be carried on for profit. She earned $7,200 from bicycle sales and spent $10,400 on parts, tools, and travel for the activity. She files Form 1040 and itemizes deductions on Schedule A. How must she report the $7,200 and the $10,400?
- Report the full $7,200 as income on Schedule 1, line 8j, and deduct none of the $10,400
- Report the $7,200 as income on Schedule 1, line 8j, and deduct $7,200 of the expenses on Schedule A so the activity breaks even
- Report only the $3,200 shortfall on Schedule C as a business loss and leave the $7,200 off the return because it was absorbed by expenses
- Report the $7,200 on Schedule C and deduct the $10,400 there, claiming the $3,200 net loss against her other income
Show answer
- ✓Report the full $7,200 as income on Schedule 1, line 8j, and deduct none of the $10,400Income from an activity not carried on for profit is reported as nonbusiness income on Schedule 1, line 8j, and none of the expenses of carrying on that activity are deductible, even for someone who itemizes.
- Report the $7,200 as income on Schedule 1, line 8j, and deduct $7,200 of the expenses on Schedule A so the activity breaks evenDeducting hobby expenses up to the amount of hobby income is not allowed. When the activity is not carried on for profit, the expenses are not deductible at all, not deductible up to income.
- Report only the $3,200 shortfall on Schedule C as a business loss and leave the $7,200 off the return because it was absorbed by expensesGross receipts cannot be left off the return to net them against expenses. The full $7,200 is income that must be reported, and the activity's expenses do not convert it into a Schedule C loss.
- Report the $7,200 on Schedule C and deduct the $10,400 there, claiming the $3,200 net loss against her other incomeA net loss against other income is the result for an activity carried on for profit. Once the activity is determined not to be carried on for profit, its expenses cannot produce a deductible loss.
Income from an activity not carried on for profit is reported on Schedule 1, line 8j, and none of its expenses are deductible. Elena reports the full $7,200 there and deducts none of the $10,400.
Publication 225, Farmer's Tax Guide Page 28
However, if you don’t carry on your farming activity, or other activity you engage or invest in, to make a profit, you report the income from the activity on Schedule 1 (Form 1040), line 8j. You can no longer deduct expenses of carrying on the activity, even if you itemize your deductions on Schedule A (Form 1040).
View on the source →
Taught in Hobby or Business
-
Business Entities and ConsiderationsQuestion 2
Rosa is a partner in Cedar Street Partnership, a small catering business. Which one of the following events, by itself, increases her outside basis in the partnership?
- Rosa is allocated a $4,000 distributive share of the partnership's loss.
- Rosa receives a $4,000 cash distribution from the partnership.
- Rosa's share of a partnership equipment loan shrinks by $4,000.
- Rosa's share of the partnership's bank loan grows by $4,000.
Show answer
- Rosa is allocated a $4,000 distributive share of the partnership's loss.A distributive share of partnership loss reduces outside basis. A share of income is what increases it.
- Rosa receives a $4,000 cash distribution from the partnership.A cash distribution reduces a partner's outside basis. It never increases it.
- Rosa's share of a partnership equipment loan shrinks by $4,000.A decrease in a partner's share of partnership liabilities is treated as a distribution of money, so it reduces her outside basis.
- ✓Rosa's share of the partnership's bank loan grows by $4,000.An increase in a partner's share of partnership liabilities is treated as a contribution of money, so her outside basis rises by $4,000.
An increased share of partnership liabilities counts as a contribution of money and raises outside basis. A cash distribution, a smaller share of liabilities, and a share of loss each lower it.
Publication 541 — Partnerships Page 14
Increases. A partner’s basis is increased by the following items. • The partner’s additional contributions to the partnership, including an increased share of, or assumption of, partnership liabilities. • The partner’s distributive share of taxable and nontaxable partnership income. • The partner’s distributive share of the excess of the deductions for depletion over the basis of the depletable property, unless the property is oil or gas wells whose basis has been allocated to partners. Decreases. The partner’s basis is decreased (but never below zero) by the following items. • The money (including a decreased share of partnership liabilities or an assumption of the partner’s individual liabilities by the partnership) and adjusted basis of property distributed to the partner by the partnership. • The partner’s distributive share of the partnership losses (including capital losses).
View on the source →
Taught in Outside Basis
-
Business Entities and ConsiderationsQuestion 3
Beacon Inc. is in a complete liquidation. Sam owns one block of Beacon stock with an adjusted basis of $12,000, held for four years. This year Sam receives a $5,000 liquidating distribution from Beacon. This is not the final distribution, and Sam's stock is not yet redeemed or cancelled. Which statement correctly describes the tax treatment of this year's $5,000 distribution to Sam?
- Sam reports a $7,000 capital loss this year and reduces the stock basis to zero.
- Sam reports the $5,000 as ordinary dividend income this year and keeps a $12,000 stock basis.
- Sam reports a $5,000 long-term capital gain this year and keeps a $12,000 stock basis.
- No gain or loss is reported this year; the $5,000 reduces Sam's stock basis from $12,000 to $7,000.
Show answer
- Sam reports a $7,000 capital loss this year and reduces the stock basis to zero.The $7,000 is Sam's remaining basis, not a loss. A shortfall between total liquidating distributions and basis can become a loss only once the final distribution has been received and the stock is redeemed or cancelled.
- Sam reports the $5,000 as ordinary dividend income this year and keeps a $12,000 stock basis.This payment is a liquidating distribution, which is treated as a return of capital against stock basis, not as a dividend on ongoing stock. Basis is reduced rather than preserved.
- Sam reports a $5,000 long-term capital gain this year and keeps a $12,000 stock basis.Gain is reported only to the extent a liquidating distribution is more than the remaining stock basis. Here the $5,000 is fully covered by the $12,000 basis, so there is no gain and the basis drops to $7,000.
- ✓No gain or loss is reported this year; the $5,000 reduces Sam's stock basis from $12,000 to $7,000.A liquidating distribution first goes against your stock basis tax-free. Because the $5,000 is less than Sam's $12,000 basis, it just lowers the basis to $7,000, with no gain yet.
A liquidating distribution is not taxed until the shareholder has recovered the stock's basis; it first reduces basis, and only the part beyond a zero basis is capital gain. So the $5,000 lowers Sam's basis to $7,000 with no gain or loss this year.
Publication 550 — Investment Income and Expenses Page 31
Any liquidating distribution you receive is not taxable to you until you have recovered the basis of your stock. After the basis of your stock has been reduced to zero, you must report the liquidating distribution as a capital gain.
View on the source →
Taught in Liquidations and Redemptions
-
Business Entities and ConsiderationsQuestion 4
Cedar Falls Trucking Inc., a domestic corporation with three individual shareholders — Maya, Luis, and Priya — files Form 2553 to elect S corporation status. The corporation's president signs and dates the form. Maya and Luis each sign and date a shareholder consent. Priya, who owns 10% of the stock, signs nothing. The corporation otherwise meets all S corporation qualification tests. Is the Form 2553 filing complete?
- No — the election is still incomplete even if Priya signs.
- No — the election is not complete without Priya's consent.
- Yes — the election is complete with Maya's and Luis's consents.
- Yes — the president's signature alone completes the election.
Show answer
- No — the election is still incomplete even if Priya signs.Once Priya signs and dates a consent, every shareholder has consented. With the president's signature and every other test met, nothing further is missing.
- ✓No — the election is not complete without Priya's consent.Every shareholder must sign and date a consent. Priya is a shareholder, so without her signed consent the filing is missing a required piece.
- Yes — the election is complete with Maya's and Luis's consents.Two out of three is not enough. Every shareholder must give a signed and dated consent, so a filing missing one shareholder's consent is still incomplete.
- Yes — the president's signature alone completes the election.The officer's signature and the shareholders' consents are separate requirements. A signed form from the president does not take the place of a missing shareholder's consent.
Each shareholder must sign and date a consent. With Priya's consent missing, this filing is not complete.
Instructions for Form 2553 Page 5
Each shareholder consents by signing and dating either in column K or on a separate consent statement.
View on the source →
Taught in Electing S Status
-
Business Tax PreparationQuestion 5
Rosa is a sole proprietor selling home goods. In one year she collects $50,000 from customers. That $50,000 includes $1,200 of state sales tax imposed on Rosa as the seller, which she collected from buyers, and $1,500 of state sales tax imposed on the buyers, which Rosa collected and turns over to the state. What amount must Rosa include in business gross receipts?
- $47,300 in gross receipts.
- $48,500 in gross receipts.
- $50,000 in gross receipts.
- $48,800 in gross receipts.
Show answer
- $47,300 in gross receipts.The $1,200 collected on a tax imposed on Rosa as the seller is part of her receipts. Taking out both tax amounts removes money she received as the seller.
- ✓$48,500 in gross receipts.The $1,200 tax imposed on Rosa as the seller stays in her receipts, while the $1,500 tax imposed on the buyers and turned over to the state stays out.
- $50,000 in gross receipts.The $1,500 collected on a tax imposed on the buyers is not Rosa's income. She collects it only to pass it to the state, so it stays out of her receipts.
- $48,800 in gross receipts.This keeps the wrong amount out. It removes the $1,200 tax imposed on Rosa, which belongs in receipts, and keeps the $1,500 buyer tax, which does not.
Tax collected on an amount imposed on you as the seller is part of your gross receipts; tax you collect only because it was imposed on the buyer and you turn it over to the government is not.
Publication 334, Tax Guide for Small Business Page 31
If you collect state and local sales taxes imposed on you as the seller of goods or services from the buyer, you must include the amount collected in gross receipts. If you are required to collect state and local taxes imposed on the buyer and turn them over to state or local governments, you generally do not include these amounts in income.
View on the source →
Taught in Gross Receipts and Other Income
-
Business Tax PreparationQuestion 6
Dana holds a downtown office building for investment with an adjusted basis of $120,000 and a fair market value of $200,000. She exchanges it for another downtown office building she will hold for investment with a fair market value of $185,000, plus $15,000 cash. Both properties are U.S. real property. What amount of gain must Dana recognize on the exchange?
- $65,000
- $15,000
- $80,000
- $0
Show answer
- $65,000Recognized gain is not the realized gain minus the cash. The cash sets the amount recognized when the realized gain is larger, so subtracting the $15,000 from the $80,000 realized gain understates it.
- ✓$15,000The exchange produces an $80,000 realized gain ($185,000 building plus $15,000 cash minus the $120,000 basis), which is more than the $15,000 cash received. Gain is recognized up to the cash received, so the full $15,000 is recognized.
- $80,000Recognition is limited to the money and non-like-kind property received. Even though the realized gain is $80,000, only the $15,000 cash portion is recognized because that is the boot received.
- $0Cash received with the new building prevents full deferral. When an otherwise qualifying exchange also brings money or non-like-kind property, gain has to be recognized up to the amount of that boot.
An otherwise qualifying exchange that also brings cash or non-like-kind property requires gain to be recognized up to the boot received. Dana realized $80,000 of gain, so with $15,000 of cash boot she recognizes $15,000.
Instructions for Form 8824, Like-Kind Exchanges Page 2
Generally, if you exchange business or investment real property solely for business or investment real property of a like kind, section 1031 provides that no gain or loss is recognized. If, as part of the exchange, you also receive other (non-like-kind) property or money, gain is recognized to the extent of the other property and money received, but a loss isn't recognized.
View on the source →
Taught in Like-Kind Exchanges and Converted Property
-
Business Tax PreparationQuestion 7
Nadia, a self-employed consultant, gives two business gifts to the same client, Rosa, during the same tax year: a $32 desk clock in March and a $28 leather notebook in November. Neither item is a widely distributed imprinted item costing $4 or less, a sign or display rack for Rosa's business premises, or any other exception item. What is Nadia's total deductible amount for the gifts to Rosa for the year?
- $25
- $35
- $60
- $0
Show answer
- ✓$25Gifts to one person during the same tax year are deductible only up to $25 in total. The $32 clock plus the $28 leather notebook cost $60, so only $25 of that total is deductible.
- $35The $35 excess over the cap is not deductible. The limit allows a deduction of up to $25, not the amount by which the gifts exceed $25.
- $60The full $60 cost is not deductible. Gifts to the same person during one tax year are subject to a $25 total cap, so the amount above $25 is lost.
- $0The gifts are not fully nondeductible. Business gifts are deductible within the annual per-person limit, so $25 of the $60 remains deductible.
Business gifts to each person are deductible up to $25 per tax year. Nadia gave $60 to one person in one year, so her deduction is capped at $25.
Publication 463, Travel, Gift, and Car Expenses Page 16
$25 limit. You can deduct no more than $25 for business gifts you give directly or indirectly to each person during your tax year.
View on the source →
Taught in Travel, Meals, Gifts, and Vehicles
-
Business Tax PreparationQuestion 8
Maya operates a sole proprietorship that builds and sells wooden tables. The production, purchase, and sale of merchandise is an income-producing factor for the business, so an inventory is necessary to account for her income. She does not qualify for any small-business exception to the inventory rule. Which of the following describes a permitted accounting method for her business?
- She may use the cash method for her furniture purchases and sales as long as she uses an accrual method for other income and expenses.
- She must use an accrual method for her furniture purchases and sales, but she may use the cash method for other income and expenses.
- She may use the cash method for her furniture purchases and sales as well as for all other income and expenses.
- She must use an accrual method for her furniture purchases and sales and also for every other item of income and expense.
Show answer
- She may use the cash method for her furniture purchases and sales as long as she uses an accrual method for other income and expenses.This reverses the requirement. The accrual requirement applies to the purchases and sales where inventory matters, not to the other items, so this combination is not permitted.
- ✓She must use an accrual method for her furniture purchases and sales, but she may use the cash method for other income and expenses.When an inventory is necessary, the purchases-and-sales portion must be on an accrual method while the remaining items may stay on the cash method. That combination clearly reflects income and stays within the hybrid restriction.
- She may use the cash method for her furniture purchases and sales as well as for all other income and expenses.When an inventory is necessary to account for income, purchases and sales must be on an accrual method. Using the cash method for purchases and sales does not satisfy that requirement.
- She must use an accrual method for her furniture purchases and sales and also for every other item of income and expense.The accrual requirement for an inventory business covers purchases and sales. Other items of income and expense may still be reported on the cash method, so accrual-for-everything is stricter than the rule requires.
When an inventory is necessary, purchases and sales must be on an accrual method, while other income and expense items may remain on the cash method.
Publication 538, Accounting Periods and Methods Page 8
If an inventory is necessary to account for your income, you must use an accrual method for purchases and sales. However, see Exception for Small Business Taxpayers, later. Generally, you can use the cash method for all other items of income and expenses.
View on the source →
Taught in Accounting Methods and Changes
-
Business Tax PreparationQuestion 9
Dana's plant nursery pays Priya, a web designer, a flat $4,500 to rebuild its website over three months. Dana sets the launch date and asks Priya to attend a weekly planning meeting. Priya works from her own studio, on her own hours and with her own methods, using a $9,000 workstation she also uses for her two other clients during the project. She pays her own costs and gets no benefits from the nursery. How should Priya be classified, and what tax treatment follows?
- Independent contractor. Dana withholds nothing, and Priya pays her own income tax and self-employment tax.
- Employee. Dana withholds nothing, and Priya pays self-employment tax on the $4,500.
- Employee. Dana withholds income tax and Priya's share of social security and Medicare taxes and gives her a Form W-2.
- Independent contractor, but Dana withholds income tax and Priya's share of social security and Medicare taxes and gives her a Form W-2.
Show answer
- ✓Independent contractor. Dana withholds nothing, and Priya pays her own income tax and self-employment tax.Taken together the facts describe a business of her own: equipment she uses for several clients, costs she bears, a flat fee she can gain or lose on, and control over how the work is done. A deadline and a weekly meeting do not outweigh that. No tax is withheld from a contractor's pay; she pays her own income and self-employment tax.
- Employee. Dana withholds nothing, and Priya pays self-employment tax on the $4,500.Self-employment tax is paid by people in business for themselves. An employee's social security and Medicare taxes are withheld from wages by the employer instead.
- Employee. Dana withholds income tax and Priya's share of social security and Medicare taxes and gives her a Form W-2.The deadline and the weekly meeting are real signs of control, but no single fact decides. Her own equipment, her other clients, the costs she bears, the flat fee, and her control over how she works point to a contractor, so there is no wage withholding and no Form W-2.
- Independent contractor, but Dana withholds income tax and Priya's share of social security and Medicare taxes and gives her a Form W-2.Withholding and a Form W-2 go with an employee's wages. A business does not withhold tax from an independent contractor's pay.
Weigh all the facts together. Priya's own equipment, other clients, borne costs, flat fee, and control over her methods outweigh Dana's deadline and meeting, so she is an independent contractor: nothing is withheld, and she pays her own income and self-employment tax.
Publication 1779, Independent Contractor or Employee Page 2
These relevant facts fall into three main categories: behavioral control; financial control; and relationship of the parties. In each case, it is very important to consider all the facts – no single fact provides the answer.
View on the source →
Taught in Worker Classification
-
Specialized Returns and TaxpayersQuestion 10
The Harper Complex Trust has $12,000 of accounting income for the year and $9,000 of distributable net income (DNI) for the year. During the year the trustee paid $12,000 to beneficiary Maya, and no other amounts were paid, credited, or required to be distributed. What are the correct tax results for the trust's income distribution deduction and Maya's gross income inclusion from this distribution?
- The trust deducts $12,000 and Maya includes $12,000.
- The trust deducts $9,000 and Maya includes $12,000.
- The trust deducts $9,000 and Maya includes $9,000.
- The trust deducts $12,000 and Maya includes $9,000.
Show answer
- The trust deducts $12,000 and Maya includes $12,000.The $12,000 paid out does not control the tax result when DNI is smaller. DNI caps both the deduction and the inclusion at $9,000, so the remaining $3,000 is taxed to the trust.
- The trust deducts $9,000 and Maya includes $12,000.The cap applies on both sides. Maya does not include more than DNI, so her inclusion is $9,000, not the full $12,000 she received.
- ✓The trust deducts $9,000 and Maya includes $9,000.Both the trust's deduction and the beneficiary's inclusion are capped at DNI. Here DNI is $9,000, so the extra $3,000 distributed stays taxable to the trust and is not income to Maya.
- The trust deducts $12,000 and Maya includes $9,000.The cap applies on both sides. The trust cannot deduct more than DNI, so its deduction is $9,000, not the full $12,000 it paid.
The income distribution deduction is limited to DNI, and a beneficiary includes a distribution only up to DNI. When a distribution exceeds DNI, the excess remains taxable to the trust.
Instructions for Form 1041, U.S. Income Tax Return for Estates and Trusts Page 4
Distributable net income (DNI). The income distribution deduction allowable to estates and trusts for amounts paid, credited, or required to be distributed to beneficiaries is limited to DNI. This amount, which is figured on Schedule B, line 7, is also used to determine how much of an amount paid, credited, or required to be distributed to a beneficiary will be includible in their gross income.
View on the source →
Taught in Distributable Net Income
-
Specialized Returns and TaxpayersQuestion 11
Bright Futures is a tax-exempt charitable organization whose exempt purpose is youth mentoring. It operates a commercial parking lot open to the general public every Saturday, year-round, in the same manner as nearby for-profit lots. Running the lot has nothing to do with mentoring except that all of its profits pay for the mentoring programs. Is operating the parking lot an unrelated trade or business?
- No, it is not a trade or business at all.
- No, it is substantially related to the organization's exempt purpose.
- Yes, it is an unrelated trade or business.
- No, it is not regularly carried on.
Show answer
- No, it is not a trade or business at all.Running a parking lot for the public to earn a profit is a trade or business, whoever operates it. Being tax-exempt does not change the activity's character.
- No, it is substantially related to the organization's exempt purpose.Spending every dollar of profit on mentoring does not make running a parking lot related to mentoring. What counts is whether the activity itself contributes importantly to the exempt purpose, not where its money goes.
- ✓Yes, it is an unrelated trade or business.The lot is a profit-seeking commercial activity run with the frequency of an ordinary for-profit lot, and it helps the mentoring mission only by supplying money. Supplying money is not enough to count as contributing importantly to the exempt purpose.
- No, it is not regularly carried on.Opening every Saturday, year-round, the way nearby for-profit lots operate is regular conduct. Regular does not mean daily.
An activity that is a regularly conducted profit-seeking business and helps the exempt purpose only by producing funds is unrelated, even when every profit dollar supports that purpose.
Publication 598, Tax on Unrelated Business Income Page 4
Use by the organization, of the profits derived from this activity, does not, alone, make the activity substantially related to the performance by the organization of its exempt purpose or function.
View on the source →
Taught in Exempt Filing and Unrelated Business Income
-
Specialized Returns and TaxpayersQuestion 12
Denise files as single and actively participated in her rental real estate activity this year. She has a $20,000 passive loss from that rental activity, modified adjusted gross income of $130,000, and no other passive income. How much of the rental loss can she deduct this year under the special $25,000 rental real estate allowance, and what happens to the rest?
- Deduct $5,000 this year and carry forward $15,000
- Deduct $0 this year and carry forward $20,000
- Deduct $10,000 this year and carry forward $10,000
- Deduct $20,000 this year and carry forward $0
Show answer
- Deduct $5,000 this year and carry forward $15,000The reduction is only 50% of MAGI over $100,000, not the full excess, so the remaining allowance is $10,000, not $5,000.
- Deduct $0 this year and carry forward $20,000The allowance is not fully eliminated until MAGI reaches $150,000 for a single filer, so a MAGI of $130,000 still leaves part of the allowance available.
- ✓Deduct $10,000 this year and carry forward $10,000The $25,000 allowance is reduced by half of the $30,000 excess of MAGI over $100,000, leaving a $10,000 allowance, so $10,000 of the $20,000 loss is allowed and the other $10,000 is suspended.
- Deduct $20,000 this year and carry forward $0The full loss is not allowed when MAGI is above $100,000; the allowance shrinks as MAGI rises, so part of the loss must be carried forward.
For a single filer the $25,000 allowance is reduced by 50% of MAGI over $100,000, so at $130,000 MAGI the allowance is $10,000 and the unused $10,000 of loss is carried forward.
Publication 925, Passive Activity and At-Risk Rules Page 6
Phaseout rule. The maximum special allowance of $25,000 ($12,500 for married individuals filing separate returns and living apart at all times during the year) is reduced by 50% of the amount of your modified adjusted gross income that is more than $100,000 ($50,000 if you’re married filing separately). If your modified adjusted gross income is $150,000 or more ($75,000 or more if you’re married filing separately), you generally can’t use the special allowance.
View on the source →
Taught in Passive Loss Limits