CPA-Partnership--06

Becker Professional Review 2K5 Exported Questions

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2K5 Exported Questions–Regulation 4 Export Date: 7/11/2005

2K5 Exported Questions Becker Professional Review

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

1. CPA-01695 ARE R03 #6 Page 12

Thompson's basis in Starlight Partnership was $60,000 at the beginning of the year. Thompson materially participates in the partnership's business. Thompson received $20,000 in cash distributions during the year. Thompson's share of Starlight's current operations was a $65,000 ordinary loss and a $15,000 net long-term capital gain. What is the amount of Thompson's deductible loss for the period?

a. $15,000 b. $40,000 c. $55,000 d. $65,000 CPA-01695 Explanation Choice "c" is correct. A partner's deductible loss is limited to his basis plus any amounts that he is personally liable for ("at risk" provision).

Thompson's basis would be calculated as follows:

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

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

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

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

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

2. CPA-01696 ARE R03 #10 Page 18

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

The fair market value of the equipment was $3,000. Frazier's outside basis in the partnership was $1,200. Upon liquidation, Frazier received $1,500 in cash. What gain should Frazier recognize?

a. $0 b. $250 c. $300 d. $500 CPA-01696 Explanation


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Choice "c" is correct. In a complete liquidation of a partnership, the partner's basis in property received is the same as the adjusted basis of his partnership interest reduced for any monies actually received and is generally a nontaxable event. However, if a partner receives only money that exceeds his basis in the partnership, gain or loss is recognized. In this instance, Frazier's basis in his partnership interest was $1,200. He received $1,500 in cash in the liquidation. Frazier's gain is calculated as follows:

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

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

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

Choice "d" is incorrect. This choice erroneously uses Frazier's capital on the partnership's balance sheet as his basis in his partnership. CPA-01700 Type1 M/C A-D Corr Ans: B PM CQ #7 R 4-01

3. CPA-01700 ARE R99 #12 Page 12

Peters has a one-third interest in the Spano Partnership. During 1997, Peters received a $16,000 guaranteed payment, which was deductible by the partnership, for services rendered to Spano. Spano reported a 1997 operating loss of $70,000 before the guaranteed payment. What is(are) the net effect(s) of the guaranteed payment? I. The guaranteed payment increases Peters's tax basis in Spano by $16,000. II. The guaranteed payment increases Peters's ordinary income by $16,000. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01700 Explanation Choice "b" is correct. The guaranteed payment increases Peter's ordinary income by $16,000 but does not affect Peter's tax basis because guaranteed payments are not undistributed earnings (they are distributed to the partner). The answer is "II only."

Rule: Guaranteed payments are reasonable compensation paid to a partner for services rendered without regard to the partner's ratio of income. They are allowable tax deductions to the partnership and ordinary income to the partner receiving them.

Note: A guaranteed payment will not increase a partner's basis in the partnership because the payment has been distributed to the partner.

Choices "a", "c", and "d" are incorrect, per the above rule and note. CPA-01704 Type1 M/C A-D Corr Ans: C PM CQ #6 R 4-01

4. CPA-01704 ARE R97 #8 Page 7

Under which of the following circumstances is a partnership that is not an electing large partnership considered terminated for income tax purposes?


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I. Fifty-five percent of the total interest in partnership capital and profits is sold within a 12-month period.

II. The partnership's business and financial operations are discontinued. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01704 Explanation Choice "c" is correct. Such a partnership will be terminated for income tax purposes when either fifty percent or more of the total interest in capital and profits is sold within a 12-month period or the partnership's business and financial operations are discontinued. CPA-01705 Type1 M/C A-D Corr Ans: C PM CQ #2 R 4-01

5. CPA-01705 ARE R96 #1 Page 3

Jones and Curry formed Major Partnership as equal partners by contributing the assets below:

Adjusted Fair Asset basis market value Jones Cash $45,000 $45,000 Curry Land 30,000 57,000

The land was held by Curry as a capital asset, subject to a $12,000 mortgage, that was assumed by Major. What was Curry's initial basis in the partnership interest?

a. $45,000 b. $30,000 c. $24,000 d. $18,000 CPA-01705 Explanation Choice "c" is correct. Curry's initial basis in the partnership is Curry's adjusted basis in the property contributed ($30,000) less the mortgage assumed by the other partner (50% × $12,000), or $30,000 − $6,000 = $24,000.

Choice "a" is incorrect. Curry contributed land with a mortgage, not cash. Curry's basis is the adjusted basis of property contributed by Curry, less any mortgage assumed by other partners.

Choice "b" is incorrect. The mortgage on the land contributed by Curry and assumed by the other partner must also be taken into consideration.

Choice "d" is incorrect. Only the percentage of the mortgage assumed by the other partner, not the entire mortgage will reduce Curry's initial basis. CPA-01708 Type1 M/C A-D Corr Ans: A PM CQ #3 R 4-01

6. CPA-01708 ARE R96 #2 Page 3

Jones and Curry formed Major Partnership as equal partners by contributing the assets below:

Adjusted Fair Asset basis market value Jones Cash $45,000 $45,000 Curry Land 30,000 57,000

The land was held by Curry as a capital asset, subject to a $12,000 mortgage, that was assumed by Major. What was Jones' initial basis in the partnership interest?

a. $51,000


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b. $45,000 c. $39,000 d. $33,000 CPA-01708 Explanation Choice "a" is correct. Jones' initial basis is the basis of the cash contributed ($45,000) plus the percentage of the mortgage on Curry's land that was assumed (50% × $12,000), or $45,000 + $6,000 = $51,000.

Choice "b" is incorrect. The mortgage on the land contributed by Curry and assumed by Jones must also be taken into consideration.

Choice "c" is incorrect. The assumption of 50% of the mortgage on the land contributed by Curry will increase, not decrease, Jones' initial basis.

Choice "d" is incorrect. Only the percentage of the mortgage assumed by Jones, not the entire mortgage will increase Jones' initial basis. CPA-01710 Type1 M/C A-D Corr Ans: B PM CQ #8 R 4-01

7. CPA-01710 ARE R96 #3 Page 12

Basic Partnership, a cash-basis calendar year entity, began business in February 1, 2005. Basic incurred and paid the following in 2005:

Filing fees incident to the creation of the partnership $ 3,600 Accounting fees to prepare the representations in offering materials 12,000

Basic elected to amortize costs. What was the maximum amount that Basic could deduct on the 2005 partnership return?

a. $11,000 b. $3,600 c. $2,860 d. $220 CPA-01710 Explanation Choice "b" is correct. Only the filing fees incident to the creation of the partnership are eligible expenditures. Expenditures, up to $5,000, and with other total expense limitations can be immediately deducted. Remaining expenses are amortized over 180 months. CPA-01713 Type1 M/C A-D Corr Ans: B PM R 4-01

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

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

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


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

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

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

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

At partnership inception, Black acquires a 50% interest in Decorators Partnership by contributing property with an adjusted basis of $250,000. Black recognizes a gain if: I. The fair market value of the contributed property exceeds its adjusted basis. II. The property is encumbered by a mortgage with a balance of $100,000. a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01715 Explanation Choice "d" is correct. The fair market value of property (high or low) is irrelevant in determining Black's basis in Decorators. The partner's adjusted basis is used.

Since the mortgage does not exceed Black's basis, he will not recognize a gain on the contribution of the encumbered property to Decorators. CPA-01718 Type1 M/C A-D Corr Ans: A PM CQ #9 R 4-01

10. CPA-01718 ARE Nov 95 #29 Page 14

Evan, a 25% partner in Vista Partnership, received a $20,000 guaranteed payment in 1994 for deductible services rendered to the partnership. Guaranteed payments were not made to any other partner. Vista's 1994 partnership income consisted of:

Net business income before guaranteed payments $80,000 Net long-term capital gains 10,000

What amount of income should Evan report from Vista Partnership on her 1994 tax return? a. $37,500 b. $27,500 c. $22,500 d. $20,000 CPA-01718 Explanation Choice "a" is correct. Evan's income from Vista is $37,500, calculated as follows:

Partnership income before guaranteed payment to Evan $80,000 Deductible guaranteed payment to Evan (20,000) Net taxable partnership income 60,000 Evan's share of partnership income 25% Evan's amount of partnership income 15,000 Evan's 25% share of Vista's $10,000 capital gain 2,500 Evan's guaranteed payment from Vista 20,000 1994 Vista income reportable on Evan's return $37,500

Choice "b" is incorrect. Evan needs to calculate the percentage of partnership income allocable to his share of the partnership. In addition Evan needs to include the guaranteed payment.


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Choices "c" and "d" are incorrect. Evan needs to report more than the guaranteed payment and share of capital gain on his tax return. Evan needs to calculate the percentage of partnership income allocable to his share of the partnership. CPA-01721 Type1 M/C A-D Corr Ans: A PM R 4-01

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

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

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

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

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

Cash $ 5,000 Land

Adjusted basis 7,000 Fair market value 10,000

What was the amount of Hart's basis in the land?

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

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

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

Choice "d" is incorrect. The fair market value of the land is not considered in determining Hart's basis in the land.


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CPA-01737 Type1 M/C A-D Corr Ans: D PM R 4-01

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

Stone's basis in Ace Partnership was $70,000 at the time he received a nonliquidating distribution of partnership capital assets. These capital assets had an adjusted basis of $65,000 to Ace, and a fair market value of $83,000. Ace had no unrealized receivables, appreciated inventory, or properties, which had been contributed by its partners. What was Stone's recognized gain or loss on the distribution?

a. $18,000 ordinary income. b. $13,000 capital gain. c. $5,000 capital loss. d. $0. CPA-01737 Explanation Choice "d" is correct. A partner does not ordinarily recognize income on a nonliquidating partnership distribution of property other than money. The distribution of property with an adjusted basis of $65,000 to Stone from Ace will reduce Stone's basis in Ace partnership to $5,000 ($70,000 - $65,000). The fair market value of the property (high or low) is not relevant.

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

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

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

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

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

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

On February 4, 1994, Poe sold her entire interest to an unrelated party. Dean sold his 25% interest in Able to another unrelated party on December 20, 1994. No other transactions took place in 1994. For tax purposes, which of the following statements is correct with respect to Able?

a. Able terminated as of February 4, 1994. b. Able terminated as of December 20, 1994. c. Able terminated as of December 31, 1994. d. Able did not terminate. CPA-01739 Explanation Choice "b" is correct. Among other events, a partnership terminates for income tax purposes when 50% or more of its interests change hands within 12 months. That threshold was reached for Able on December 20, at which time the partnership terminated for income tax purposes.

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

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


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

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

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

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

Choices "a", "b", and "d" are incorrect, per the above rule. CPA-01743 Type1 M/C A-D Corr Ans: C PM CQ #5 R 4-01

16. CPA-01743 ARE May 95 #26 Page 6

Dean is a 25 percent partner in Target Partnership. Dean's tax basis in Target on January 1, 1994, was $20,000. At the end of 1994, Dean received a nonliquidating cash distribution of $8,000 from Target. Target's 1994 accounts recorded the following items:

Municipal bond interest income $12,000 Ordinary income 40,000

What was Dean's tax basis in Target on December 31, 1994? a. $15,000 b. $23,000 c. $25,000 d. $30,000 CPA-01743 Explanation Choice "c" is correct. Dean's basis in Target is calculated by starting with his basis at January 1, 1994 ($20,000) and adding his 25% share of partnership income items for the year. The nontaxable municipal bond income increases his basis as does the ordinary income. Target's income items include the municipal bond income ($12,000) plus the ordinary income ($40,000) for a total of $52,000, of which Dean's 25% share is $13,000. This is added to the beginning basis of $20,000, and the $8,000 cash distribution is deducted leaving a balance at December 31, 1994, of $25,000.

Choice "a" is incorrect. This answer fails to take into account Dean's distributive share of the ordinary income of Target.

Choice "b" is incorrect. This answer appears to be a distracter.

Choice "d" is incorrect. This answer fails to take into consideration the effect on Dean's basis of both the nonliquidating cash distribution and Dean's distributive share of Target's municipal bond interest income.


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CPA-01746 Type1 M/C A-D Corr Ans: A PM CQ #4 R 4-01

17. CPA-01746 ARE May 95 #27 Page 3

Strom acquired a 25 percent interest in Ace Partnership by contributing land having an adjusted basis of $16,000 and a fair market value of $50,000. The land was subject to a $24,000 mortgage, which was assumed by Ace. No other liabilities existed at the time of the contribution. What was Strom's basis in Ace? a. $0 b. $16,000 c. $26,000 d. $32,000 CPA-01746 Explanation Choice "a" is correct. Strom's basis in the land ($16,000) carries over as an element of his basis in Ace. The assumption by Ace of Strom's liabilities on the land ($24,000) is treated as a distribution of money to Strom, which reduces his basis temporarily to negative $8,000. Then through his status as a partner of Ace, Strom is treated as re-assuming 25% of the liability, or $6,000, and this increases his basis temporarily to negative $2,000. Since it is impossible to have negative basis, Strom realizes a gain (usually capital) of $2,000, the amount necessary to bring his basis up to zero.

Choice "b" is incorrect. Strom's basis in Ace is reduced because of the liability assumed by Ace.

Choice "c" is incorrect. Strom's basis in the land ($16,000) carries over as an element of Strom's basis in Ace.

Choice "d" is incorrect. Strom's basis in the land ($16,000) carries over as an element of Strom's basis in Ace. Then, Strom's basis in Ace is reduced because of the liability assumed by Ace. CPA-01749 Type1 M/C A-D Corr Ans: D PM R 4-01

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

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

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

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

The first year deduction is calculated as follows:

23,000 <5,000> immediate deduction 18,000 / 180 months = $100 per month x 3 = 300 + 5,000 = $5,300 CPA-01751 Type1 M/C A-D Corr Ans: A PM R 4-01


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

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

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

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

Choices "b", "c", and "d" are incorrect.

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

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

Curry's adjusted basis in Vantage Partnership was $5,000 at the time he received a nonliquidating distribution of land. The land had an adjusted basis of $6,000, and a fair market value of $9,000 to Vantage. What was the amount of Curry's basis in the land?

a. $9,000 b. $6,000 c. $5,000 d. $1,000 CPA-01753 Explanation Choice "c" is correct. A partner who receives a distribution of non-cash property from a partnership takes the partnership's basis as his basis, but in no case an amount greater than his basis in his partnership interest. In this case Curry would ordinarily take a $6,000 basis in the land, but since his basis in the partnership interest is only $5,000, that is the basis of the land in his hands. Curry's partnership interest now has a basis of zero.

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

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

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

a. $3,000 b. $10,000 c. $11,000 d. $13,000 CPA-01755 Explanation Choice "d" is correct.


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

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

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

On January 2, 1993, Black acquired a 50% interest in New Partnership by contributing property with an adjusted basis of $7,000 and a fair market value of $9,000, subject to a mortgage of $3,000. What was Black's basis in New at January 2, 1993?

a. $3,500 b. $4,000 c. $5,500 d. $7,500 CPA-01757 Explanation Choice "c" is correct. A contributing partner's basis is the adjusted basis of assets contributed, plus any gain recognized on the contribution, less debt relief.

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

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

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

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

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

What is Gray's tax basis in Fabco on December 31, 1993?

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

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

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

Choice "d" is incorrect. Gray's basis is increased by 50% of ordinary income or $10,000, but it is also increased by tax exempt and portfolio income. This increase is added to the beginning tax basis.


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

On January 2, 1993, Arch and Bean contribute cash equally to form the JK Partnership. Arch and Bean share profits and losses in a ratio of 75% to 25%, respectively. For 1993, the partnership's ordinary income was $40,000. A distribution of $5,000 was made to Arch during 1993. What is Arch's share of taxable income for 1993?

a. $5,000 b. $10,000 c. $20,000 d. $30,000 CPA-01762 Explanation Choice "d" is correct. Partners are taxed on their share of partnership income whether distributed or not. Arch must report 75% x $40,000, or $30,000.

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

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

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

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

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

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

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

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

At the beginning of 1993, Paul owned a 25% interest in Associates partnership. During the year, a new partner was admitted and Paul's interest was reduced to 20%. The partnership liabilities at January 1, 1993, were $150,000, but decreased to $100,000 at December 31, 1993. Paul's and the other partners' capital accounts are in proportion to their respective interests. Disregarding any income, loss or drawings for 1993, the basis of Paul's partnership interest at December 31, 1993, compared to the basis of his interest at January 1, 1993 was: a. Decreased by $37,500. b. Increased by $20,000. c. Decreased by $17,500. d. Decreased by $5,000. CPA-01768 Explanation


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

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

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

Day's adjusted basis in LMN Partnership interest is $50,000. During the year Day received a nonliquidating distribution of $25,000 cash plus land with an adjusted basis of $15,000 to LMN, and a fair market value of $20,000. How much is Day's basis in the land?

a. $10,000 b. $15,000 c. $20,000 d. $25,000 CPA-01769 Explanation Choice "b" is correct. In a nonliquidating distribution, the partner takes the partnership basis for assets distributed. This basis cannot exceed the partner's partnership interest.

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

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

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

Pert contributed land with a fair market value of $20,000 to a new partnership in exchange for a 50% partnership interest. The land had an adjusted basis to Pert of $12,000 and was subject to a $4,000 mortgage, which the partnership assumed. What is the adjusted basis of Pert's partnership interest?

a. $10,000 b. $12,000 c. $18,000 d. $20,000 CPA-01772 Explanation Choice "a" is correct. Pert's adjusted basis in the partnership is equal to the $12,000 adjusted basis of the land he contributed to the partnership less the 50% allocable percentage of the $4,000 mortgage assumed by the other partners.

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

* Other partners' percentage ownership

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

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

Choice "d" is incorrect. Use the land's $12,000 adjusted basis as the starting point, not its $20,000 fair market value, and the percentage of the liability assumed by the other partners must be subtracted.


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CPA-01773 Type1 M/C A-D Corr Ans: C PM CQ #1 R 4-01

29. CPA-01773 PII Nov 93 #49 Page 3

On June 1, 1992, Kelly received a 10% interest in Rock Co., a partnership, for services contributed to the partnership. Rock's net assets at that date had a basis of $70,000 and a fair market value of $100,000. In Kelly's 1992 income tax return, what amount must Kelly include as income from transfer of partnership interest?

a. $7,000 ordinary income. b. $7,000 capital gain. c. $10,000 ordinary income. d. $10,000 capital gain. CPA-01773 Explanation Choice "c" is correct. Kelly must include as ordinary income the fair market value of the asset received, a 10% interest in a partnership valued at $100,000, or $10,000. It is ordinary income since Kelly provided services for the partnership interest.

Choice "a" is incorrect. Use Kelly's share of the fair market value of the partnership, not its adjusted basis.

Choice "b" is incorrect. Use Kelly's share of the fair market value of the partnership, not its adjusted basis. Also, Kelly must include this value as ordinary income since Kelly provided services for the partnership interest.

Choice "d" is incorrect. The $10,000 is ordinary income because Kelly provided services for the partnership interest. CPA-01775 Type1 M/C A-D Corr Ans: B PM R 4-01

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

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

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

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

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

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

Under Section 444 of the Internal Revenue Code, certain partnerships can elect to use a tax year different from their required tax year. One of the conditions for eligibility to make a Section 444 election is that the partnership must: a. Be a limited partnership. b. Be a member of a tiered structure. c. Choose a tax year where the deferral period is not longer than three months. d. Have less than 75 partners.


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CPA-01778 Explanation Choice "c" is correct. Sec. 444 permits a partnership to elect a tax year different from the required tax year if the deferral period (i.e., the number of months between the beginning of the tax year and the end of the required tax year) is 3 months or less.

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

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

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

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

In computing the ordinary income of a partnership, a deduction is allowed for: a. Contributions to recognized charities. b. The first $100 of dividends received from qualifying domestic corporations. c. Short-term capital losses. d. Guaranteed payments to partners. CPA-01788 Explanation Choice "d" is correct. Guaranteed payments to partners are deductible in arriving at the partnership's ordinary income. Ordinary income is the "taxable income" of the partnership excluding all items required to be separately-stated. Charitable contributions, dividend income, and capital losses are all separately-stated items.

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

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

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

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

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

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

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

Choice "d" is incorrect. The partner's basis is affected; it increases by the partner's share of the increase in liabilities. CPA-01791 Type1 M/C A-D Corr Ans: A PM CQ #10 R 4-01


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34. CPA-01791 PII Nov 93 #55 Page 17

The adjusted basis of Jody's partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and property with an adjusted basis to the partnership of $40,000 and a fair market value of $35,000. What amount of taxable gain must Jody report as a result of this distribution?

a. $0 b. $5,000 c. $10,000 d. $20,000 CPA-01791 Explanation Choice "a" is correct. The $20,000 current distribution of cash is first applied to Jody's $50,000 basis, reducing it to $30,000. The current distribution of property is then applied at its $40,000 basis. Since Jody's remaining basis is $30,000, only $30,000 is applied to the property distribution, resulting in $0 taxable gain to Jody and $0 remaining basis in the partnership.

Choice "b" is incorrect. First, the cash distribution is fully applied, then the property distribution is applied at adjusted basis until the partner's basis is zero. No gain is generally recognized by the partner as a result of a current distribution unless the cash distributed is in excess of the partner's basis. In that case, the excess would be a gain to the partner (to avoid a negative basis).

Choice "c" is incorrect. The $10,000 gain is not recognized since the property distributed takes on a $30,000 basis to the partner.

Choice "d" is incorrect. First, the cash distribution is fully applied, then the property distribution is applied at adjusted basis until the partner's basis is zero. No gain is generally recognized by the partner as a result of a current distribution unless the cash distributed is in excess of the partner's basis. In that case, the excess would be a gain to the partner (to avoid a negative basis). CPA-01793 Type1 M/C A-D Corr Ans: B PM CQ #11 R 4-01

35. CPA-01793 PII Nov 93 #56 Page 17

The adjusted basis of Jody's partnership interest was $50,000 immediately before Jody received a current distribution of $20,000 cash and property with an adjusted basis to the partnership of $40,000 and a fair market value of $35,000. What is Jody's basis in the distributed property?

a. $0 b. $30,000 c. $35,000 d. $40,000 CPA-01793 Explanation Choice "b" is correct. Jody's basis in the distributed property is $30,000, Jody's remaining basis in the partnership after the cash distribution:

Jody's partnership basis $ 50,000 Cash distribution and Jody's basis in cash (20,000)

$ 30,000 Property distribution and Jody's basis in the property (30,000)* Jody's partnership basis after distributions $ 0

* If the partner's basis in the partnership ($30,000) is less than the property's basis ($40,000), the partner's basis in the property is limited to her basis in the partnership ($30,000).

Choice "a" is incorrect. $0 is Jody's basis in the partnership after the distributions, not her basis in the property.


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Choice "c" is incorrect. The partner's basis in distributed property is equal to the partnership's basis in the distributed property not the fair market value. In this instance because the partnership's basis exceeds the partner's basis in the partnership, the partner's basis is limited.

Choice "d" is incorrect. If the partner's basis in the partnership is less than the property's basis, the partner's basis in the property is limited to her basis in the partnership. Remember, the cash distributed must be subtracted from the partner's basis first. CPA-01796 Type1 M/C A-D Corr Ans: C PM CQ #12 R 4-01

36. CPA-01796 PII Nov 93 #57 Page 19

The adjusted basis of Vance's partnership interest in Lex Associates was $180,000 immediately before receiving the following distribution in complete liquidation of Lex: Fair market Basis to Lex value Cash $100,000 $100,000 Real estate 70,000 96,000

What is Vance's basis in the real estate?

a. $96,000 b. $83,000 c. $80,000 d. $70,000 CPA-01796 Explanation Choice "c" is correct. In a liquidating distribution, the $100,000 cash is applied first to the $180,000 partnership basis, reducing it to $80,000. Even though the partnership's basis in the real estate is only $70,000, Vance's basis in the real estate will be his partnership basis ($80,000) since this is the last asset distributed and it is a liquidating distribution (i.e., Vance's partnership basis must be reduced to zero). Neither Vance nor the partnership recognize any gain or loss from the distribution.

Choice "a" is incorrect. The real estate's fair market value is not used.

Choice "b" is incorrect. $83,000 is the average of the $70,000 basis and the $96,000 fair market value. The average of the two amounts is not used.

Choice "d" is incorrect. Even though the partnership's basis in the real estate is $70,000, Vance's basis in the real estate will be stepped up to $80,000, Vance's remaining basis in the partnership. Since this is a liquidating distribution, Vance's basis in the partnership must be reduced to zero. CPA-01797 Type1 M/C A-D Corr Ans: A PM R 4-01

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

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


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case, the partnership terminates September 18, 1991, the date that 2/3 interest in the partnership is sold to new partner Frank.

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

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

Choice "d" is incorrect. The partnership terminated on the date that at least 50% of the partnership was sold. CPA-01802 Type1 M/C A-D Corr Ans: D PM CQ #13 R 4-01

38. CPA-01802 PII Nov 93 #59 Page 19

On December 31, 1992, after receipt of his share of partnership income, Clark sold his interest in a limited partnership for $30,000 cash and relief of all liabilities. On that date, the adjusted basis of Clark's partnership interest was $40,000, consisting of his capital account of $15,000 and his share of the partnership liabilities of $25,000. The partnership has no unrealized receivables or substantially appreciated inventory. What is Clark's gain or loss on the sale of his partnership interest?

a. Ordinary loss of $10,000. b. Ordinary gain of $15,000. c. Capital loss of $10,000. d. Capital gain of $15,000. CPA-01802 Explanation Choice "d" is correct. When a partner sells his partnership interest, capital gain or loss on the sale is recognized. To the extent that there are Sec. 751(a) hot assets (unrealized receivables or substantially appreciated inventory), the partner must recognize ordinary income or loss. In this case, the partnership has no Sec. 751 assets. The amount realized less the partner's basis in the partnership is the capital gain or loss. The amount realized is $55,000 ($30,000 cash received + $25,000 relief of debt). The partner's basis in the partnership is $40,000. Thus, the capital gain is $55,000 - $40,000, or $15,000.

Choice "a" is incorrect. Since there are no Sec. 751 assets, the gain or loss must be capital, not ordinary.

Choice "b" is incorrect. Since there are no Sec. 751 assets, the gain or loss must be capital, not ordinary.

Choice "c" is incorrect. The amount realized must include the $25,000 debt relief.


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

On June 30, 1993, Berk retired from his partnership. At that time, his capital account was $50,000 and his share of the partnership's liabilities was $30,000. Berk's retirement payments consisted of being relieved of his share of the partnership liabilities and receipt of cash payments of $5,000 per month for 18 months, commencing July 1, 1993. Assuming Berk makes no election with regard to the recognition of gain from the retirement payments, he should report income therefrom of: 1993 1994 a. $13,333 $26,667 b. $20,000 $20,000 c. $40,000 -- d. -- $40,000 CPA-01803 Explanation


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Choice "d" is correct. Payments made in liquidation of the interest of a retiring partner are considered a distribution by the partnership. Therefore, a retiring partner continues as a partner until his interest has been completely liquidated by partnership distributions:

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

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

40. CPA-04733 Released 2005 Page 16

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

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

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


Bailey contributed land with a fair market value of $75,000 and an adjusted basis of $25,000 to the ABC Partnership in exchange for a 30% interest. The partnership assumed Bailey's $10,000 recourse mortgage on the land. What is Bailey's basis for his partnership interest? a. $15,000 b. $18,000 c. $65,000 d. $75,000 CPA-04761 Explanation Choice "b" is correct. The partner's original basis for a partnership interest acquired by a contribution is the amount of cash plus the adjusted basis of any property contributed less the


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amount of incoming partner's liabilities assumed by the other partners. Bailey's basis is calculated as follows: Adjusted Basis of property contributed $25,000 Less: The amount of Bailey's debt assumed by the other partners: 70% of $10,000 (7,000)

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

CPA-04913 Type1 M/C A-D Corr Ans: C QZ#1 R 4-01

42. CPA-04913 Regulation Online Quiz Page 1

Ken Karas owns an 80% interest in the capital and profits of the partnership of Karas & Keel. On July 1, 2004, Karas bought surplus land from the partnership at the land's fair market value of $30,000. The partnership's basis in the land was $36,000. For the year ended December 31, 2004, the partnership's net income was $85,000, after recording the $6,000 loss on the sale of the land. Karas' distributive share of ordinary income from the partnership for 2004 was: a. $63,200 b. $68,000 c. $72,800 d. $91,000 CPA-04913 Explanation Choice "c" is correct. Losses between a controlling partner (over 50% interest in capital and profits) and his controlled partnership from the sale or exchange of property are not allowed. Thus the disallowance of the $6,000 loss would make the net income $91,000 and 80% of that is $72,800.

Choice "a" is incorrect. This results if the loss is subtracted again from the partnership's income [($85,000 - 6,000) x 80% = $63,200].

Choice "b" is incorrect. This answer did not disallow the loss but merely took 80% of the $85,000.

Choice "d" is incorrect. This answer is the total loss of the partnership. It must be multiplied by the partner's ownership interest. CPA-04915 Type1 M/C A-D Corr Ans: D QZ#2 R 4-01


Kent King's adjusted basis for his partnership interest in Troy Partnership was $32,000. In complete liquidation of his interest in Troy, King received cash of $2,000 and realty having a fair market value of $25,000. Troy's adjusted basis for this realty was $15,000. King's basis for the realty after distribution is: a. $13,000 b. $15,000 c. $25,000 d. $30,000 CPA-04915 Explanation Choice "d" is correct. In a liquidating distribution, the partner's basis in the distributed property is the same as the adjusted basis of his partnership interest reduced for any monies actually received. King's basis in his partnership interest was $32,000 less $2,000 cash received, leaving $30,000 of basis to be allocated to the realty received.

Choices "a", "b", and "c" are incorrect.


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CPA-04917 Type1 M/C A-D Corr Ans: D QZ#3 R 4-01


Ball and Baig are equal partners in the firm of Games Associates. On January 1, 2002, each partner's adjusted basis in Games was $50,000. During 2002 Games borrowed $80,000 for which Ball and Baig are personally liable. Games sustained an operating loss of $30,000 for the year ended December 31, 2002. The basis of each partner's interest in Games at December 31, 2002, was: a. $35,000 b. $50,000 c. $65,000 d. $75,000 CPA-04917 Explanation Choice "d" is correct. A partner's basis in his partnership interest is the combination of his capital account and his share of liabilities that he is personally liable for. The beginning basis of $50,000 should be decreased by each partner's share of the $30,000 operating loss, or $15,000, and increased for each partner's share of the liabilities, or $40,000, for a Dec. 31, 2002, ending basis of $75,000.

Choices "a", "b", and "c" are incorrect. CPA-04923 Type1 M/C A-D Corr Ans: C QZ#4 R 4-01


Which of the following is both an item that is an allowable tax deduction to the partnership and is reported separately on the individual partner's Schedule K-1? a. Salaries paid to non-partner employees. b. Advertising expenditures. c. Guaranteed payments paid to partners. d. Depreciation on equipment used in the business. CPA-04923 Explanation Choice "c" is correct. A partnership calculates net business income or loss and passes each partner's distributive share through on the Schedule K-1. Guaranteed payments paid to partners for services rendered or for the use of capital, without regard to partnership income or profit and loss sharing ratios, are an allowable tax deduction to the partnership and are separately reported on Schedule K-1 for inclusion on the partner's tax return.

Choice "a" is incorrect. Salaries paid to non-partner employees are deducted from revenues to arrive at net business income or loss at the partnership level. Each partner's distributive share of the net income or loss is then reported on the Schedule K-1.

Choice "b" is incorrect. Advertising expenditures incurred by the partnership are deducted from revenues to arrive at net business income or loss at the partnership level. Each partner's distributive share of the net income or loss is then reported on the Schedule K-1.

Choice "d" is incorrect. Depreciation of assets used in the business is deducted from revenues to arrive at net business income or loss at the partnership level. Each partner's distributive share of the net income or loss is then reported on the Schedule K-1. CPA-04925 Type1 M/C A-D Corr Ans: C QZ#5 R 4-01


Copper Trust, a simple trust, reported the following income and expenses during 2003:

Interest income from corporate bonds $10,000 Rental income from properties $5,000


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Trust fees allocable to income $2,000 Real estate taxes related to income

producing property $2,000

What is Copper's distributable net income (DNI) for 2003? a. $5,000 b. $10,000 c. $11,000 d. $15,000 CPA-04925 Explanation Choice "c" is correct. Distributable net income is computed as the trust's income less any expenses allocable to income. The $15,000 of income items less the $4,000 of income-related expenses produced DNI of $11,000.

Choices "a" and "b" are incorrect. Both the income from the corporate bonds and the rental income qualify as income and expenses allocable to income items are deductible in arriving at DNI.

Choice "d" is incorrect. Expenses allocable to income items are deductible in arriving at DNI. CPA-04928 Type1 M/C A-D Corr Ans: B QZ#6 R 4-01


At the beginning of the tax year, Martin Crouch contributed property to a new partnership in return for a 25% interest in capital and profits. The property contributed had a fair market value of $150,000, an adjusted basis of $100,000 and was subject to a $100,000 mortgage, which was assumed by the partnership. What was Martin's basis in the partnership as a result of the contribution? a. $0 b. $25,000 c. $100,000 d. $150,000 CPA-04928 Explanation Choice "b" is correct. Following the basis formula yields:

+ Cash + Adjusted Basis of Property - Liabilities (amount assumed by other partners) + FMV of services rendered (if applicable) + Liabilities - other partner's liabilities assumed by the incoming partner.

+ 0 + 100,000 - 75,000 + 0 + 0 $25,000 Basis

Choices "a", "c", and "d" are incorrect, per the above calculation. CPA-04929 Type1 M/C A-D Corr Ans: B QZ#7 R 4-01


Mom and Pop Partnership had the following results during the taxable year:

Income from operations: $100,000 loss Capital Gain from Sale of Land: $ 25,000


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Charitable contributions: $ 10,000

Junior, a 50% partner, had an adjusted basis of $40,000 at December 31, without regard to the current year income or loss items. In preparing his individual income tax return, Junior should report which of the following amounts? Ordinary Loss Capital Gain Charitable Contributions a. $50,000 $12,500 $5,000 b. $47,500 $12,500 $5,000 c. $40,000 $12,500 $5,000 d. $32,500 $0 $0 CPA-04929 Explanation Choice "b" is correct. The deduction of the ordinary loss is limited to Junior's basis and any at risk amounts. Junior's basis is calculated as $40,000 + $12,500 capital gain - $5,000 charitable contributions = $47,500; thus the ordinary loss deducted on his return would be limited to $47,500.

Choices "a" and "c" are incorrect. Both of these options incorrectly state the ordinary loss. Choice "a" did not take into account the limitation to basis and choice "c" did not take into account the adjustment of basis by the other income/deduction items for the year.

Choice "d" is incorrect. The loss, capital gain and charitable contributions are all stated separately - income from operations is passed through as a net number to the partners and charitable contributions and capital gain are separately stated items; not netted in that figure. CPA-04931 Type1 M/C A-D Corr Ans: A QZ#8 R 4-01


Joan is going to gift her best friend's son $15,000 during the current tax year and when she passes away, her home. Which of the following is correct with regards to these gifts during the current year assuming that the cash is given and Joan does not die during the current year? Cash Home a. Completed Gift Incomplete Gift b. Completed Gift Completed Gift c. Incomplete Gift Incomplete Gift d. Incomplete Gift Completed Gift CPA-04931 Explanation Choice "a" is correct. If Joan gives her best friend's son $15,000 during the year, it would be a completed gift, eligible for the annual gift exclusion. Any amount in excess of the exclusion amount would be a taxable gift. Given that Joan did not pass away during the current year, the gift of her home is not a completed gift, until all such actions take place, the son has no right to the home. (Advanced planning techniques could be used with trusts, etc. but the facts of the question do not make that possible.)

Choices "b", "c", and "d" are incorrect given the above explanation. CPA-04933 Type1 M/C A-D Corr Ans: C QZ#9 R 4-01


The Sarbanes-Oxley Act of 2002 mandates that a registered public accounting firm is prohibited from providing any non-audit service to an issuer contemporaneously with the audit, except: a. Bookkeeping or other services related to the accounting records or financial statements of the

audit client. b. Appraisal or valuation services, fairness opinions, or contribution-in-kind reports. c. Tax services pre-approved by the audit committee. d. Financial information systems design and implementation.


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CPA-04933 Explanation Choice "c" is correct. Most prior services that audit firms provided to publicly traded clients have been prohibited by the Sarbanes-Oxley Act of 2002, except for approved tax services.

Choices "a", "b", and "d" are incorrect per the above explanation. CPA-04936 Type1 M/C A-D Corr Ans: B QZ#10 R 4-01


The Code of Professional Conduct, Rule 101, regarding independence does not consider the following circumstances to be a lack of independence: a. The CPA firm's sole audit manager served as controller of the firm's audit client from the

January 1999 through to May 2004 when the manager began working with the CPA firm. The current audit period for this client is from April 1, 2004 through to March 31, 2005.

b. The auditor's brother-in-law's father is the controller of the client being audited. c. The audited firm is privately held and the auditor provides valuation and appraisal services

not independently approved by the client. d. A financial institution client loans the auditor money to buy a boat but does not collateralize

the loan. CPA-04936 Explanation Choice "b" is correct. Independence is impaired by a member, a member's spouse or dependents or an immediate family member who holds a key position in the audit client. A brother-in-law and family of the brother-in-law are not considered to be immediate family members or close relatives. According to the Code a close relative is defined as a parent, sibling, or nondependent child.

Choice "a" is incorrect. A CPA auditor cannot work for the client in a key position during the audit year.

Choice "c" is incorrect. The auditor may provide valuation and appraisal services that are independently approved by the client.

Choice "d" is incorrect. Fully collateralized loans made within the normal course of business such as by a financial institution, do not impair independence. CPA-04942 Type1 M/C A-D Corr Ans: C R 4-01

52. CPA-04942 Regulation Online Quiz Alternative Page 0

In 2002, Chris Cox contributed property to a new partnership in return for a 50% interest in capital and profits. The property had a fair market value of $10,000, an adjusted basis of $6,000 and was subject to a $9,000 mortgage, which was assumed by the partnership. What was Chris' basis in the partnership as a result of this contribution? a. $0 b. $500 c. $1,500 d. $5,500 CPA-04942 Explanation Choice "c" is correct. A contributing partner's initial basis is calculated as follows:

+ Cash (amount contributed) + Property (adjusted net book value, or basis) - Liabilities assumed by other partners + Services (at FMV) + Liabilities assumed by incoming partner


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In this instance, Chris Cox contributed property with an adjusted basis of $6,000. The partnership assumed the liability of $9,000 of which $4,500 remained his liability (as a 50% partner). $6,000 - $4,500 = $1,500.

Choices "a", "b", and "d" are incorrect. CPA-04944 Type1 M/C A-D Corr Ans: A R 4-01


The partnership of Martin & Clark sustained a net ordinary business loss of $84,000 in 2004 (excluding any separately stated items). The partnership, as are the two partners, is on a calendar-year basis. The partners share profits and losses equally. At December 31, 2004, Clark had an adjusted basis of $36,000 before consideration of the 2004 loss. Without regard to any possible passive loss limitations, on his individual income tax return for 2004, Clark should be able to deduct a(n): a. Ordinary loss of $36,000. b. Ordinary loss of $42,000. c. Ordinary loss of $36,000 and a capital loss of $6,000. d. Capital loss of $42,000. CPA-04944 Explanation Choice "a" is correct. The partnership tax loss deduction to a partner is limited to his adjusted basis in the partnership, which is increased by any partnership liabilities, that he is personally liable for ("at risk" provision). In this instance, Clark's basis was $36,000 and his share of the business loss was $42,000. The loss he may take is limited to his basis of $36,000 and the remainder will carryover indefinitely in the future until Clark has basis sufficient to allow the deduction.

Choice "b" is incorrect. The loss taken cannot exceed the adjusted basis plus any "at risk" amounts.

Choice "c" is incorrect. A capital loss would not be recognized by a partner unless the partnership interest was disposed of through sale or unless the partnership passed through capital losses to the partner via the Schedule K-1.

Choice "d" is incorrect. Business income that flows through to a partner from the partnership is treated as ordinary income and is limited to the partner's adjusted basis in the partnership plus any "at risk" amounts. CPA-04946 Type1 M/C A-D Corr Ans: A R 4-01


If an individual donor, during 2004, makes a gift of a future interest in property with a current value of $3,000 whereby the donee is to receive possession of the gift at some future time, the annual exclusion for gift tax purposes is: a. $0 b. $3,000 c. $11,000 d. $10,000 CPA-04946 Explanation Choice "a" is correct. A future interest in property does not qualify for the annual gift tax exclusion.

Choice "b" is incorrect. The future interest does not qualify for the gift exclusion; only a present interest qualifies.

Choice "c" is incorrect. This is the annual gift tax exclusion amount for qualified gifts for 2004 (which is now indexed annually for inflation).


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Choice "d" is incorrect. This answer was the annual exclusion for years prior to 2002. However, the annual exclusion is irrelevant because the gift in the question does not qualify for an annual exclusion. CPA-04949 Type1 M/C A-D Corr Ans: B R 4-01


Copper Trust, a simple trust, reported the following income and expenses during 2003:

Interest income from corporate bonds $10,000 Rental income from properties $5,000 Trust fees allocable to income $2,000 Real estate taxes related to income

producing property $2,000

The trust distributed $5,000 to its sole beneficiary during 2003. What is Copper's income distribution deduction? a. $0 b. $5,000 c. $11,000 d. $15,000 CPA-04949 Explanation Choice "b" is correct. A trust's income distribution deduction is the lesser of the actual distribution to the beneficiary or distributable net income (DNI) less tax-exempt income. DNI is income less expenses allocable to income items, which is $11,000 ($15,000 less $4,000 in this case). The lesser of this or the $5,000 actually distributed is $5,000.

Choice "a" is incorrect. Simple trusts are entitled to an income distribution deduction calculated as the lesser of DNI less tax-exempt income or the actual distribution to the beneficiary.

Choice "c" is incorrect. This amount is the trust's DNI. The income distribution deduction is the lesser of DNI less tax-exempt income or the actual distribution to the beneficiary.

Choice "d" is incorrect. This answer is the total income of the trust; not DNI less tax-exempt income or the actual distribution to the beneficiary. CPA-04952 Type1 M/C A-D Corr Ans: C R 4-01


To arrive at an individual's taxable estate, the gross estate is reduced by: a. State death taxes paid. b. Unified credit. c. Medical expenses appropriately charged to the estate. d. The amounts bequeathed to the decedent's children. CPA-04952 Explanation Choice "c" is correct. Medical expenses appropriately charged to the estate are non-discretionary deductions from the gross estate.

Choice "a" is incorrect. State death taxes paid are a credit against the federal estate tax.

Choice "b" is incorrect. The unified credit is a credit against the estate tax.

Choice "d" is incorrect. Only charitable bequeaths and the unlimited marital deduction are subtracted to arrive at the taxable estate. CPA-04954 Type1 M/C A-D Corr Ans: C R 4-01



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Bling Retail hires Tony to prepare its tax returns. Under the Internal Revenue Code, Tony may be fined for: a. Any negligent disregard of the tax rules. b. Any willful understatement of the client's tax liability. c. Both negligent disregard of the tax rules or willful understatements of the client's tax liability. d. None of the above. CPA-04954 Explanation Choice "c" is correct. A tax preparer may be fined for either negligent disregard of the tax rules or willful understatement of a client's tax liability.

Choices "a", "b", and "d" are incorrect per the above explanation. Estate, Trust, and Gift Taxation CPA-01810 Type1 M/C A-D Corr Ans: A PM CQ #14 R 4-02

58. CPA-01810 ARE R01 #4 Page 23

For income tax purposes, the estate's initial taxable period for a decedent who died on October 24: a. May be either a calendar year, or a fiscal year beginning on the date of the decedent's death. b. Must be a fiscal year beginning on the date of the decedent's death. c. May be either a calendar year, or a fiscal year beginning on October 1 of the year of the

decedent's death. d. Must be a calendar year beginning on January 1 of the year of the decedent's death. CPA-01810 Explanation Choice "a" is correct. Rule: An estate may elect either a calendar year or a fiscal year for the estate income tax return. (Note: Trusts, with limited exceptions, must use a calendar year end.) Choices "b", "c", and "d" are incorrect, per the above rule. CPA-01812 Type1 M/C A-D Corr Ans: B PM CQ #15 R 4-02

59. CPA-01812 ARE R99 #13 Page 22

Astor, a cash-basis taxpayer, died on February 3. During the year, the estate's executor made a distribution of $12,000 from estate income to Astor's sole heir and adopted a calendar year to determine the estate's taxable income. The following additional information pertains to the estate's income and disbursements for the year:

Estate income Taxable interest $65,000 Net long-term capital gains allocable to corpus 5,000

Estate disbursements Administrative expenses attributable to taxable income 14,000 Charitable contributions from gross income to a public charity, made

under the terms of the will 9,000

For the calendar year, what was the estate's distributable net income (DNI)?

a. $39,000 b. $42,000 c. $58,000 d. $65,000 CPA-01812 Explanation


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Choice "b" is correct. The estate's distributable net income (DNI) for the calendar year is $42,000.

Rule: Absent written provisions to the contrary, capital gains and losses are classified as principal and must remain with the estate or trust (i.e., allocated to corpus) to be taxed at the estate or trust level.

Rule: All other taxable income (i.e., gross income net of deductible expenses) generated by the fiduciary assets is generally classified as distributable net income (DNI). Distributable net income is adjusted total income (line 17 on the Form 1041) with modifications for tax-exempt interest (included in DNI and allocated as tax exempt) and capital gains and losses (excluded from DNI and allocated to corpus).

Gross income:

Taxable interest $65,000 Tax exempt interest --

Deductible expenses:

Administrative expenses (14,000) Charitable contributions from gross income (9,000)

Distributable net income $42,000

Choices "a", "c", and "d" are incorrect, per the above rules. CPA-01813 Type1 M/C A-D Corr Ans: B PM CQ #16 R 4-02

60. CPA-01813 ARE R98 #6 Page 22

Gem Trust, a simple trust, reported the following items of income and expenses during 1997:

Interest income from corporate bonds $4,000 Taxable dividend income 2,000 Trustee fees allocable to income 1,500

What is Gem's 1997 distributable net income (DNI)? a. $6,000 b. $4,500 c. $2,500 d. $500 CPA-01813 Explanation Choice "b" is correct. Distributable net income is computed as the trust's income less any expenses allocated to income. The $6,000 of income items, less the $1,500 of income-related expenses, produces DNI of $4,500. This means that the first $4,500 of distributions from the trust are taxable income to the recipient(s), with any additional distributions being considered nontaxable distributions of trust corpus. If less than $4,500 is distributed, the amount actually distributed is taxable to the recipient, and any remaining undistributed portion of the $4,500 would be taxable at the trust level.

Choice "a" is incorrect. The income-related expenses must be subtracted from the trust income items in order to complete DNI.

Choice "c" is incorrect. Dividend income is part of the income in determining DNI.

Choice "d" is incorrect. Interest income is part of the income in determining DNI. CPA-01817 Type1 M/C A-D Corr Ans: C PM CQ #20 R 4-02

61. CPA-01817 ARE R97 #9 Page 28

Under the provisions of a decedent's will, the following cash disbursements were made by the estate's executor:


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I. A charitable bequest to the American Red Cross. II. Payment of the decedent's funeral expenses.

What deduction(s) is(are) allowable in determining the decedent's taxable estate?

a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01817 Explanation Choice "c" is correct. Charitable bequests to qualifying organizations, and funeral expenses of the decedant, are both allowable deductions in determining the taxable estate.

Choices "a", "b", and "d" are incorrect. Each of these answers reflect a wrong combination of items I and/or II. Be sure and answer each item independently and then choose "a", "b", "c", or "d". CPA-01822 Type1 M/C A-D Corr Ans: C PM R 4-02

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

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

Estate income $40,000 Taxable interest

Estate disbursements $34,000 Expenses attributable to taxable interest

What amount of the distribution was taxable to the beneficiary?

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

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

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

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

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

Steve and Kay Briar, U.S. citizens, were married for the entire 2004 calendar year. In 2004, Steve gave a $30,000 cash gift to his sister. The Briars made no other gifts in 2004. They each signed a timely election to treat the $30,000 gift as made one-half by each spouse. Disregarding the unified credit and estate tax consequences, what amount of the 2004 gift is taxable to the Briars?


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a. $30,000 b. $22,000 c. $8,000 d. $0 CPA-01824 Explanation Choice "c" is correct. A married couple can elect to treat taxable gifts as made half by each spouse for gift tax purposes. Every donor receives an $11,000 per person, per year, exclusion from the gift tax. Mr. and Mrs. Briar split Mr. Briar's $30,000 gift to his sister, for an effective gift of $15,000 each. Then each of them receives an $11,000 exclusion to reduce the taxable gift to $4,000. Because there are two deemed gifts, one from each spouse, the total taxable gift, ignoring the unified tax credit and the potential estate tax consequences, is $8,000.

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

Choice "b" is incorrect. Since the Briars split the gift to his sister, each of them receives an $11,000 exclusion to reduce the taxable gift.

Choice "d" is incorrect. Since the gift is greater than $22,000, some of the gift is taxable to the Briars. CPA-01828 Type1 M/C A-D Corr Ans: A PM R 4-02

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

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

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

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

For the 1994 calendar year, what was the estate's distributable net income (DNI)?

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

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

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

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

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

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

1994 Estate Income


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

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

Lyon's executor does not intend to file an extension request for the estate fiduciary income tax return. By what date must the executor file the Form 1041, U.S. Fiduciary Income Tax Return, for the estate's 1994 calendar year?

a. Wednesday, March 15, 1995. b. Monday, April 17, 1995. c. Thursday, June 15, 1995. d. Friday, September 15, 1995. CPA-01882 Explanation Choice "b" is correct.

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

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

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

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

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

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

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

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

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

Bell, a cash basis calendar year taxpayer, died on June 1, 1993. In 1993, prior to her death, Bell incurred $2,000 in medical expenses. The executor of the estate paid the medical expenses, which were a claim against the estate, on July 1, 1993. If the executor files the appropriate waiver, the medical expenses are deductible on: a. The estate tax return.


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b. Bell's final income tax return. c. The estate income tax return. d. The executor's income tax return. CPA-01887 Explanation Choice "b" is correct. If the proper waiver is filed, medical expenses paid for the decedent by her executor within one year of her death can be deducted on the decedent's final income tax return.

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

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

Choice "d" is incorrect. The executor cannot deduct the decedent's medical expenses on his own income tax return. Although the executor paid them, he did so in a representative capacity on the decedent's behalf. CPA-01889 Type1 M/C A-D Corr Ans: C PM CQ #17 R 4-02

68. CPA-01889 ARE Nov 94 #58 Page 27

If the executor of a decedent's estate elects the alternate valuation date and none of the property included in the gross estate has been sold or distributed, the estate assets must be valued as of how many months after the decedent's death?

a. 12 b. 9 c. 6 d. 3 CPA-01889 Explanation Choice "c" is correct.

Rule: The alternate valuation date is the earlier of the date of distribution or six months after the date of death.

Choices "a", "b", and "d" are incorrect, per the above rule. CPA-01891 Type1 M/C A-D Corr Ans: C PM CQ #21 R 4-02

69. CPA-01891 ARE May 94 #33 (Adapted) Page 28

In 2004, Sayers, who is single, gave an outright gift of $50,000 to a friend, Johnson, who needed the money to pay medical expenses. In filing the 2004 gift tax return, Sayers was entitled to a maximum exclusion of: a. $0 b. $10,000 c. $11,000 d. $20,000 CPA-01891 Explanation Choice "c" is correct. Medical expenses paid directly to the health care provider qualify for an unlimited deduction, even if paid for unrelated persons. In this problem the payment was made to the friend, not to the health care provider directly. The $11,000 annual exclusion per donee applies to all gifts other than future interests.

Choice "a" is incorrect. The $11,000 annual exclusion per donee applies to all gifts other than future interests.

Choice "b" is incorrect. The annual exclusion of $10,000 is incorrect (old law).


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Choice "d" is incorrect. Medical expenses paid directly to the health care provider qualify for an unlimited deduction, even if paid for unrelated persons. In this problem the payment was made to the friend, not to the health care provider directly. CPA-01893 Type1 M/C A-D Corr Ans: D PM R 4-02

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

What amount of a decedent's taxable estate is effectively tax-free in 2004 if the maximum unified estate and gift tax credit is taken?

a. $11,000 b. $345,800 c. $1,000,000 d. $1,500,000 CPA-01893 Explanation Choice "d" is correct. The maximum amount that can be transferred tax-free is $1,500,000 in 2004.

Choice "a" is incorrect. $11,000 is the annual gift tax exclusion per donee for gifts of a present interest.

Choice "b" is incorrect. The $345,800 is the unified estate and gift tax credit amount (or the amount of the tax avoided) for a tax-free transfer of $1,000,000.

Choice "c" is incorrect. This is the 2003 amount (old limit).

CPA-01896 Type1 M/C A-D Corr Ans: A PM R 4-02

71. CPA-01896 PII Nov 93 #40 Page 28

Which of the following is(are) deductible from a decedent's gross estate? I. Expenses of administering and settling the estate. II. State inheritance or estate tax.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01896 Explanation Choice "a" is correct. Expenses of administering and settling the estate are deductible from the gross estate. State inheritance or estate taxes are a credit against the tentative federal estate tax, not a deduction.

Choice "b" is incorrect. State inheritance or estate taxes are a credit against the tentative federal estate taxes, not a deduction.

Choice "c" is incorrect. State inheritance or estate taxes are a credit against the tentative federal estate taxes, not a deduction.

Choice "d" is incorrect. Expenses of administering and settling the estate are deductible from the gross estate. CPA-01900 Type1 M/C A-D Corr Ans: A PM CQ #18 R 4-02

72. CPA-01900 PII Nov 91 #27 Page 26

Within how many months after the date of a decedent's death is the federal estate tax return (Form 706) due if no extension of time for filing is granted?

a. 9


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b. 6 c. 42 d. 32 CPA-01900 Explanation Choice "a" is correct.

Rule: The federal estate tax return is due 9 months after the date of the decedent's death. To remember this: It takes 9 months to be born and it takes 9 months to file the death tax return.

Choices "b", "c", and "d" are incorrect, per the above rule. CPA-01903 Type1 M/C A-D Corr Ans: D PM CQ #19 R 4-02

73. CPA-01903 ARE May 94 #32 Page 27

On February 1, 1993, Hall learned that he was bequeathed 500 shares of common stock under his father's will. Hall's father had paid $2,500 for the stock in 1990. Fair market value of the stock on February 1, 1993, the date of his father's death, was $4,000 and had increased to $5,500 six months later. The executor of the estate elected the alternate valuation date for estate tax purposes. Hall sold the stock for $4,500 on June 1, 1993, the date that the executor distributed the stock to him. How much income should Hall include in his 1993 individual income tax return for the inheritance of the 500 shares of stock which he received from his father's estate?

a. $5,500 b. $4,000 c. $2,500 d. $0 CPA-01903 Explanation Choice "d" is correct. There is no income tax on the value of inherited property. The gain on the sale is the difference between the sales price of $4,500 and Hall's basis. Hall's basis is the alternate valuation elected by the executor. This is the value 6 months after date of death or date distributed if before 6 months. The property was distributed 4 months after death and the value that day ($4,500) is used for the basis. $4,500 − $4,500 = 0.

Choice "a" is incorrect. There is no income tax on the value of inherited property.

Choice "b" is incorrect. This is the basis of the stock if the alternate date had not been used. Heirs are not taxed on inheritances. The income or loss results when inherited property is sold.

Choice "c" is incorrect. There is no income tax on the value of inherited property. The gain on the sale is the difference between the sales price of $4,500 and Hall's basis. Hall's basis is the alternate valuation elected by the executor. CPA-04732 Type1 M/C A-D Corr Ans: B PM R 4-02


Don and Linda Grant, U.S. citizens, were married for the entire 2003 calendar year. In 2003, Don gave a $60,000 cash gift to his sister. The Grants made no other gifts in 2003. They each signed a timely election to treat the $60,000 gift as one made by each spouse. Disregarding the unified credit and estate tax consequences, what amount of the 2003 gift is taxable to the Grants for gift tax purposes? a. $0 b. $38,000 c. $49,000 d. $60,000 CPA-04732 Explanation


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Choice "b" is correct. A donor (person giving a gift) may exclude the first $11,000 of gifts made to each donee. A gift by either spouse may be treated as made one-half by each; this gift splitting creates a $22,000 exclusion per donee. Therefore, $60,000 - $22,000 = $38,000 is the amount of taxable gift made by the Grants.

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

Choice "c" is incorrect. The Grants elected to split the gift, therefore, a $22,000 exclusion, not a $11,000 exclusion, applies.

Choice "d" is incorrect. This gift is subject to the annual exclusion which is $22,000 when gift splitting is elected by a married couple.

Tax Return Preparer Issues CPA-02063 Type1 M/C A-D Corr Ans: B PM R 4-03

75. CPA-02063 ARE R02 #5 Page 32

A taxpayer filed his income tax return after the due date but neglected to file an extension form. The return indicated a tax liability of $50,000 and taxes withheld of $45,000. On what amount would the penalties for late filing and late payment be computed?

a. $0 b. $5,000 c. $45,000 d. $50,000 CPA-02063 Explanation Choice "b" is correct. The penalty for failure to file a tax return by the due date is 5% per month or fraction of month (up to a maximum of 25%) on the amount of tax shown as DUE on the return. The penalty for failure to pay by the due date (1/2% per month) is also based on the amount DUE on the return.

CPA-02069 Type1 M/C A-D Corr Ans: B PM CQ #22 R 4-03

76. CPA-02069 ARE R01 #5 Page 33

Which of the following acts constitute(s) grounds for a tax preparer penalty? I. Without the taxpayer's consent, the tax preparer disclosed taxpayer income tax return

information under an order from a state court. II. At the taxpayer's suggestion, the tax preparer deducted the expenses of the taxpayer's

personal domestic help as a business expense on the taxpayer's individual tax return.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-02069 Explanation Choice "b" is correct. Tax preparer penalties may be assessed for improper use or disclosure of information. Acceptable circumstances for disclosure include:

1. Computer processing 2. Peer review 3. Administrative order (court order)

A tax preparer penalty may be assessed for fraud and accuracy related acts. Intentional disregard of the regulations would be deducting of personal help as a business expense.


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77. CPA-02080 ARE R99 #15 Page 33

Vee Corp. retained Water, CPA, to prepare its 20X4 income tax return. During the engagement, Water discovered that Vee had failed to file its 20X0 income tax return. What is Water's professional responsibility regarding Vee's unfiled 20X0 income tax return?

a. Prepare Vee's 20X0 income tax return and submit it to the IRS. b. Advise Vee that the 20X0 income tax return has not been filed and recommend that Vee

ignore filing its 20X0 return since the statute of limitations has passed. c. Advise the IRS that Vee's 20X0 income tax return has not been filed. d. Consider withdrawing from preparation of Vee's 20X4 income tax return until the error is

corrected. CPA-02080 Explanation Choice "d" is correct. The CPA should consider withdrawing from the preparation of Vee's 20X4 income tax return until the error (i.e., the non-filing of the 20X0 tax return) has been corrected.

Rule: Upon discovery of an error in a previously-filed return or the client's failure to file a required return, the CPA should promptly notify the client (either orally or in writing) of the error, noncompliance, or omission and advise the client of the appropriate measures to be taken (e.g., advise the client to file the tax return). If the client does not rectify the error, the CPA should consider withdrawing from the engagement.

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

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

Choice "c" is incorrect, as a CPA has no responsibility to advise the IRS of any client wrongdoing. CPA-02088 Type1 M/C A-D Corr Ans: B PM CQ #23 R 4-03

78. CPA-02088 ARE R97 #11 Page 32

Morgan, a sole practitioner CPA, prepares individual and corporate income tax returns. What documentation is Morgan required to retain concerning each return prepared? a. An unrelated party compliance statement. b. Taxpayer's name and identification number or a copy of the tax return. c. Workpapers associated with the preparation of each tax return. d. A power of attorney. CPA-02088 Explanation Choice "b" is correct. For each tax return prepared, a tax preparer must retain either the taxpayer's name and identification number, or a copy of the return.

Choice "a" is incorrect. This is not an item that a tax preparer is required to retain.

Choice "c" is incorrect. A taxpayer is not required to retain workpapers used in preparing a tax return, although doing so is often a sound business practice. Among other reasons, the workpapers could be beneficial in the event of an audit, or in the preparation of the following year's tax return for the client.

Choice "d" is incorrect. This is not an item that a tax preparer is required to retain.


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

An accuracy-related penalty applies to the portion of tax underpayment attributable to:


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I. Negligence or a disregard of the tax rules or regulations. II. Any substantial understatement of income tax.

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


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

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

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

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

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


81. CPA-02187 May 94 #19 Page 33

A tax return preparer may disclose or use tax return information without the taxpayer's consent to: a. Facilitate a supplier's or lender's credit evaluation of the taxpayer. b. Accommodate the request of a financial institution that needs to determine the amount of

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

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


82. CPA-02189 May 94 #20 Page 32

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


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I. Knowing or reckless disclosure or use of tax information obtained in preparing a return. II. A willful attempt to understate any client's tax liability on a return or claim for refund.

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


83. CPA-02191 Nov 95 #26 Page 32

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

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

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


84. CPA-02193 R98 #20 Page 33

To avoid tax return preparer penalties for a return's understated tax liability due to an intentional disregard of the regulations, which of the following actions must a tax preparer take?

a. Audit the taxpayer's corresponding business operations. b. Review the accuracy of the taxpayer's books and records. c. Make reasonable inquiries if the taxpayer's information is incomplete. d. Examine the taxpayer's supporting documents. CPA-02193 Explanation Choice "c" is correct. A tax preparer must make reasonable inquiries if the taxpayer's information is incomplete.

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

Choices "a", "b", and "d" are incorrect, per the above rule.


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CPA-04753 Type1 M/C A-D Corr Ans: B PM R 4-03


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

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

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

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

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

86. CPA-04650 Reg C05 #1 Page 35

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


87. CPA-04651 Reg C05 #2 Page 35

Under the provisions of the Sarbanes-Oxley Act of 2002, which of the following is/are correct regarding the Audit Committee of a Public Company? I. Each member of the Audit Committee must be a member of the Board of Directors of the

issuer. II. The Audit Committee is directly responsible for the compensation of the work of any

registered public accounting firm employed by that issuer. a. I only. b. II only. c. Neither I nor II. d. Both I and II.


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CPA-04651 Explanation Only choice "d" is correct. Each member of the audit committee of an issuer is required to be a member of the issuer’s board of directors. Equally, the audit committee does have responsibility for overseeing the appointment, compensation and work done by the audit firm.


88. CPA-04652 Reg C05 #3 Page 34

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

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

89. CPA-01476 Lw R03 #1 Page 45

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

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

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

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

90. CPA-01477 Lw R03 #2 Page 41

Under the ethical standards of the profession, which of the following situations involving nondependent members of an auditor's family is most likely to impair the auditor's independence? a. A parent's immaterial investment in a client. b. A first cousin's loan from a client. c. A spouse's employment with a client. d. A sibling's loan to a director of a client. CPA-01477 Explanation


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Choice "c" is correct. Under Rule 101 of the Code of Professional Conduct, a member of a firm who is subject to independence in fact and appearance extends to the member's spouse, dependent children, and dependent relatives. A spouse working for a client is considered part of the class of "members" subject to independence.

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

91. CPA-01478 Lw R03 #3 Page 40

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

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

92. CPA-01480 Lw R03 #4 Page 42

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

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

workpapers and issuing the audit report. CPA-01480 Explanation Choice "b" is correct. Under Rule 101 of the Code of Professional Conduct regarding independence, a member's independence is impaired with respect to a client who is more than one year overdue in the payment of professional fees. An attestation engagement, such as an audit requires independence in fact and appearance. Fees from prior work must be paid in full before the issuance of a report on the following year's work.

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

Choice "d" is incorrect. Burrow would not accept an engagement of this type and in any instance; the fees related to the prior year work would not be paid by the issuance of the current year report.


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CPA-01481 Type1 M/C A-D Corr Ans: D PM CQ #24 R 4-05

93. CPA-01481 Lw R02 #1 Page 41

Kar, CPA, is a staff auditor participating in the audit engagement of Fort, Inc. Which of the following circumstances impairs Kar's independence? a. During the period of the professional engagement, Fort gives Kar tickets to a football game

worth $75. b. Kar owns stock in a corporation that Fort's 401(k) plan also invests in. c. Kar's friend, an employee of another local accounting firm, prepares Fort's tax returns. d. Kar's sibling is an internal auditor employed part-time by Fort. CPA-01481 Explanation Choice "d" is correct. Independence of a member is impaired if the CPA's spouse, parent, child, sibling, etc. are employed by the client in a position that is audit sensitive (i.e., internal auditor, cashier, accounting supervisor, etc.).

Choice "a" is incorrect because the tickets will probably be considered a token gift, and receipt of a token gift does not impair independence.

Choice "b" is incorrect because such an indirect ownership interest will not be deemed to affect independence.

Choice "c" is incorrect because a friend's relationship to the audit client does not affect independence. CPA-01483 Type1 M/C A-D Corr Ans: B PM R 4-05

94. CPA-01483 Lw R02 #2 Page 40

On June 1, 2000, a CPA obtained a $100,000 personal loan from a financial institution client for whom the CPA provided compilation services. The loan was fully secured and considered material to the CPA's net worth. The CPA paid the loan in full on December 31, 2000. On April 3, 2001, the client asked the CPA to audit the client's financial statements for the year ended December 31, 2001. Is the CPA considered independent with respect to the audit of the client's December 31, 2001, financial statements? a. Yes, because the loan was fully secured. b. Yes, because the CPA was not required to be independent at the time the loan was granted. c. No, because the CPA had a loan with the client during the period of a professional

engagement. d. No, because the CPA had a loan with the client during the period covered by the financial

statements. CPA-01483 Explanation Choice "b" is correct. A member's independence is impaired if a member has a loan with a client and that loan is preferential in relationship to "other borrowers." Since this loan was fully secured and there was no indication of a "preference," it appears to be in the ordinary course of business. Furthermore, the CPA was no longer a debtor of the financial institution at the time of the audit engagement. A CPA must be independent in fact and appearance when providing auditing and attestation services, not compilation services.

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

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

Choice "d" is incorrect. The fact that the CPA had a loan with the client during the period covered in the client's financial statements itself does not impair independence.


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95. CPA-01484 Lw R96 #1 Page 48

Which of the following services may a CPA perform in carrying out a consulting service engagement for a client? I. Review of the client-prepared business plan. II. Preparation of information for obtaining financing.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01484 Explanation Choice "c" is correct. Under the AICPA Statements on Standards for Consulting Services, a CPA is allowed to perform "consultations," which includes reviewing and commenting on a client-prepared business plan. The standards also allow CPAs to perform "transaction" services, an example of which is the preparation of information for obtaining financing. CPA-01486 Type1 M/C A-D Corr Ans: C PM R 4-05

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

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

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

Choice "b" is incorrect. This is not considered incompatible with a CPA's practice.

Choice "d" is incorrect. A CPA may accept engagements obtained through the efforts of third parties. CPA-01487 Type1 M/C A-D Corr Ans: D PM R 4-05

97. CPA-01487 Lw Nov 95 #2 Page 45

According to the ethical standards of the profession, which of the following acts is generally prohibited? a. Issuing a modified report explaining a failure to follow a governmental regulatory agency's

standards when conducting an attest service for a client. b. Revealing confidential client information during a quality review of a professional practice by

a team from the state CPA society. c. Accepting a contingent fee for representing a client in an examination of the client's federal

tax return by an IRS agent. d. Retaining client records after an engagement is terminated prior to completion and the client

has demanded their return. CPA-01487 Explanation Choice "d" is correct. The Code of Professional Conduct provides that a CPA may not commit a discreditable act. Retaining a client's records after a demand for their return has been ruled to be a discreditable act.


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Choice "a" is incorrect. Issuing a modified report explaining a failure to follow a governmental regulatory agency's standards when conducting an attest service for a client is not generally prohibited.

Choice "b" is incorrect. A CPA may reveal confidential client information to a state CPA society quality review team.

Choice "c" is incorrect. Contingent fees are prohibited when preparing a tax return, but not when representing a client in an examination by the IRS. CPA-01488 Type1 M/C A-D Corr Ans: B PM R 4-05

98. CPA-01488 Lw Nov 95 #3 Page 43

According to the standards of the profession, which of the following activities may be required in exercising due care? Consulting with Obtaining specialty experts accreditation a. Yes Yes b. Yes No c. No Yes d. No No CPA-01488 Explanation Choice "b" is correct. Exercise of due care dictates consultation or referral when a professional engagement exceeds the CPA's personal competence. There is no requirement of obtaining specialty accreditation. CPA-01497 Type1 M/C A-D Corr Ans: A PM CQ #25 R 4-05

99. CPA-01497 Lw Nov 95 #4 Page 40

According to the standards of the profession, which of the following activities would most likely not impair a CPA's independence? a. Providing extensive advisory services for a client. b. Contracting with a client to supervise the client's office personnel. c. Signing a client's checks in emergency situations. d. Accepting a luxurious gift from a client. CPA-01497 Explanation Choice "a" is correct. The CPA's role here is merely as an advisor.

Choice "b" is incorrect. Supervising personnel is a management function and would impair independence.

Choice "c" is incorrect. Signing a client's check, even in emergency situations is a management function and would impair independence.

Choice "d" is incorrect. Accepting more than a token gift from a client impairs independence. CPA-01498 Type1 M/C A-D Corr Ans: C PM R 4-05

100. CPA-01498 Lw Nov 95 #5 Page 50

Under the Statements on Standards for Consulting Services, which of the following statements best reflects a CPA's responsibility when undertaking a consulting services engagement? The CPA must: a. Not seek to modify any agreement made with the client. b. Not perform any attest services for the client. c. Inform the client of significant reservations concerning the benefits of the engagement.


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d. Obtain a written understanding with the client concerning the time for completion of the engagement.

CPA-01498 Explanation Choice "c" is correct. A CPA providing consulting services must communicate with the client and inform the client of any significant reservations that the CPA has concerning the benefits of the engagement.

Choice "a" is incorrect. A CPA must seek to modify the terms of the engagement if circumstances require a significant change.

Choice "b" is incorrect. A CPA need not be independent to perform consulting services. Performance of consulting services for attest clients does not in and of itself impair independence relative to the attest engagement.

Choice "d" is incorrect. The engagement terms can be oral, even though a written understanding is preferable. CPA-01499 Type1 M/C A-D Corr Ans: C PM R 4-05

101. CPA-01499 Lw May 95 #1 Page 41

According to the standards of the profession, which of the following circumstances will prevent a CPA performing audit engagements from being independent? a. Obtaining a collateralized automobile loan from a financial institution client. b. Litigation with a client relating to billing for consulting services for which the amount is

immaterial. c. Employment of the CPA's spouse as a client's internal auditor. d. Acting as an honorary trustee for a not-for-profit organization client. CPA-01499 Explanation Choice "c" is correct. Independence of a member is impaired if the CPA's spouse is employed by the client in a position which is audit-sensitive. Examples of positions, which are audit-sensitive, include cashier, internal auditor, accounting supervisor, purchasing agent, or inventory warehouse supervisor.

Choice "a" is incorrect. The following types of loans do not impair independence:

1) automobile loans, 2) loans of the surrender value under terms of an insurance policy, 3) borrowings fully collateralized by cash deposits at the same financial institution, and 4) credit cards and cash advances on checking accounts with an aggregate balance not paid

currently of $5,000 or less.

Choice "b" is incorrect. Litigation not related to the engagement for an immaterial amount does not impair independence.

Choice "d" is incorrect. Acting as an honorary trustee for a not-for-profit company does not impair independence. CPA-01500 Type1 M/C A-D Corr Ans: D PM R 4-05

102. CPA-01500 Lw May 95 #3 Page 50

According to the standards of the profession, which of the following events would require a CPA performing a consulting services engagement for a nonaudit client to withdraw from the engagement? I. The CPA has a conflict of interest that is disclosed to the client and the client consents to the

CPA continuing the engagement. II. The CPA fails to obtain a written understanding from the client concerning the scope of the

engagement.


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a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01500 Explanation Choice "d" is correct. A CPA should disclose possible conflicts of interest but is not required to withdraw from the engagement if the conflicts are properly disclosed. The CPA should have an understanding with the client regarding the nature of the services, but the understanding can be oral. CPA-01501 Type1 M/C A-D Corr Ans: A PM R 4-05

103. CPA-01501 Lw Nov 94 #1 Page 45

The profession's ethical standards most likely would be considered to have been violated when a CPA represents that specific consulting services will be performed for a stated fee and it is apparent at the time of the representation that the: a. Actual fee would be substantially higher. b. Actual fee would be substantially lower than the fees charged by other CPAs for comparable

services. c. CPA would not be independent. d. Fee was a competitive bid. CPA-01501 Explanation Choice "a" is correct. Advertising or other forms of solicitation that are false, misleading, or deceptive are not in the public interest and are prohibited. Intentionally understating a fee estimate is a deceptive act.

Choice "b" is incorrect. Advertising or other forms of solicitation that are false, misleading, or deceptive are not in the public interest and are prohibited. Overestimating a fee is not a false, misleading, or deceptive act.

Choice "c" is incorrect. A CPA need not be independent to perform consulting services.

Choice "d" is incorrect. Advertising or other forms of solicitation that are false, misleading, or deceptive are not in the public interest and are prohibited. There is nothing false, misleading, or deceptive in giving a competitive bid. CPA-01502 Type1 M/C A-D Corr Ans: C PM R 4-05

104. CPA-01502 Lw Nov 94 #2 Page 43

According to the profession's ethical standards, which of the following events may justify a departure from a Statement of Financial Accounting Standards? Evolution of a new form New of business legislation transaction a. No Yes b. Yes No c. Yes Yes d. No No CPA-01502 Explanation Choice "c" is correct. Rule 203 provides that while SFAS should be followed, unusual circumstances, such as new legislation or the evolution of a new form of business transaction can justify a departure.


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105. CPA-01503 Lw Nov 94 #3 Page 43

To exercise due professional care an auditor should: a. Critically review the judgment exercised by those assisting in the audit. b. Examine all available corroborating evidence supporting management's assertions. c. Design the audit to detect all instances of illegal acts. d. Attain the proper balance of professional experience and formal education. CPA-01503 Explanation Choice "a" is correct. Due care in performing an audit requires a member to plan and supervise adequately any professional activity for which he or she is responsible. This includes critical review at every level of supervision the work done and the judgment exercised by those assisting in the examination.

Choice "b" is incorrect. An auditor need not examine all available corroborating evidence. Only sufficient competent evidence to provide the auditor with a reasonable basis for forming an opinion is required.

Choice "c" is incorrect. Because of the characteristics of illegal acts, an audit made in accordance with generally accepted auditing standards provides no assurance that illegal acts will be detected or that any contingent liabilities that may result will be disclosed.

Choice "d" is incorrect. The attainment of the proper balance between professional experience and formal education is related to the training and proficiency requirement rather than to the requirement of due care. CPA-01504 Type1 M/C A-D Corr Ans: D PM R 4-05

106. CPA-01504 Lw Nov 94 #4 Page 41

Must a CPA in public practice be independent in fact and appearance when providing the following services? Compilation Compilation of personal Preparation of a financial of a financial statements tax return forecast a. Yes No No b. No Yes No c. No No Yes d. No No No CPA-01504 Explanation Choice "d" is correct. Independence is required for attestation engagements (i.e., audits and reviews). Compilations and tax return preparation are not attestation engagements. CPA-01505 Type1 M/C A-D Corr Ans: D PM CQ #26 R 4-05

107. CPA-01505 Lw Nov 94 #5 Page 41

According to the profession's standards, which of the following is not required of a CPA performing a consulting engagement? a. Complying with Statements on Standards for Consulting Services. b. Obtaining an understanding of the nature, scope, and limitations of the engagement. c. Supervising staff who are assigned to the engagement. d. Maintaining independence from the client. CPA-01505 Explanation Choice "d" is correct. The standards for performing consulting services do not require a CPA to be independent.


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Choice "a" is incorrect. The Statements on Standards for Consulting Services apply to all engagements to provide consulting services.

Choice "b" is incorrect. A CPA performing a consulting engagement is required to establish with the client a written or oral understanding about the responsibilities of the parties and the nature, scope, and limitations of services to be performed, and modify the understanding if circumstances require a significant change during the engagement.

Choice "c" is incorrect. When performing a consulting engagement, the CPA is required to adequately plan and supervise the performance of professional services. CPA-01506 Type1 M/C A-D Corr Ans: A PM R 4-05

108. CPA-01506 Lw Nov 94 #6 Page 48

According to the profession's standards, which of the following would be considered consulting services? Advisory Implementation Product services services services a. Yes Yes Yes b. Yes Yes No c. Yes No Yes d. No Yes Yes CPA-01506 Explanation Choice "a" is correct. Consulting services may include one or more of the following: consultations, advisory services, implementation services, transaction services, staff and other support services, and product services. CPA-01507 Type1 M/C A-D Corr Ans: C PM R 4-05

109. CPA-01507 Lw May 94 #1 Page 45

Which of the following actions by a CPA most likely violates the profession's ethical standards? a. Arranging with a financial institution to collect notes issued by a client in payment of fees due. b. Compiling the financial statements of a client that employed the CPA's spouse as a

bookkeeper. c. Retaining client records after the client has demanded their return. d. Purchasing a segment of an insurance company's business that performs actuarial services

for employee benefit plans. CPA-01507 Explanation Choice "c" is correct. Rule 501 provides that a member may not commit a discreditable act, and retaining a client's records after a demand has been made for their return has been ruled to be a discreditable act.

Choice "a" is incorrect. CPAs are entitled to be paid for their services, and arranging to collect notes issued by a client in payment of services is a method of collecting fees and is not a contingency payment. It does not violate any ethical rule.

Choice "b" is incorrect. While Rule 101 generally requires that a CPA be independent, and there is a lack of independence where a close relative works for the client, it has been ruled that a member may issue a compilation report for a client with respect to which the member is not independent as long as the member discloses the lack of independence. For a compilation, an accountant is not required to be independent.

Choice "d" is incorrect. It has been ruled that actuarial services are compatible with the functions of a CPA as long as the service adheres to the Code and bylaws. CPA-01508 Type1 M/C A-D Corr Ans: A PM R 4-05


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110. CPA-01508 Lw May 94 #2 Page 39

Which of the following statements best explains why the CPA profession has found it essential to promulgate ethical standards and to establish means for ensuring their observance? a. A distinguishing mark of a profession is its acceptance of responsibility to the public. b. A requirement for a profession is to establish ethical standards that stress primary

responsibility to clients and colleagues. c. Ethical standards that emphasize excellence in performance over material rewards establish

a reputation for competence and character. d. Vigorous enforcement of an established code of ethics is the best way to prevent

unscrupulous acts. CPA-01508 Explanation Choice "a" is correct. A distinguishing mark of a profession is its acceptance of responsibility to the public. CPA-01509 Type1 M/C A-D Corr Ans: A PM R 4-05

111. CPA-01509 Lw May 94 #3 Page 40

Which of the following reports may be issued only by an accountant who is independent of a client? a. Standard report on an examination of a financial forecast. b. Report on consulting services. c. Compilation report on historical financial statements. d. Compilation report on a financial projection. CPA-01509 Explanation Choice "a" is correct. The accountant must be independent to issue a standard report on examination of a financial forecast.

Choice "b" is incorrect. A member need not be independent to issue a report on consulting services.

Choice "c" is incorrect. It has been ruled that a member can issue a historic compilation report even though the accountant lacks independence, but the lack of independence must be disclosed.

Choice "d" is incorrect. An accountant can issue compilations even though the accountant is not independent, but the lack of independence must be disclosed. CPA-01510 Type1 M/C A-D Corr Ans: B PM R 4-05

112. CPA-01510 Lw May 94 #4 Page 41

According to the profession's ethical standards, an auditor would be considered independent in which of the following instances? a. The auditor is the officially appointed stock transfer agent of a client. b. The auditor's checking account that is fully insured by a federal agency, is held at a client

financial institution. c. The client owes the auditor fees for more than two years prior to the issuance of the audit

report. d. The client is the only tenant in a commercial building owned by the auditor. CPA-01510 Explanation Choice "b" is correct. Because the deposit account is fully insured, independence is not considered to be impaired.


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Choice "a" is incorrect. It has been held that an auditor who is appointed the stock transfer agent of a corporation is not considered to be independent because the functions of a stock transfer agent are similar to that of a manager of the client.

Choice "c" is incorrect. If fees are owed for more than one year, the auditor is considered to be a creditor of the client, and independence is impaired.

Choice "d" is incorrect. If the client is the auditor's only tenant, the auditor definitely has a financial interest in the clients well being and that impairs independence. CPA-01511 Type1 M/C A-D Corr Ans: D PM R 4-05

113. CPA-01511 Lw May 94 #5 Page 48

Which of the following services may a CPA perform in carrying out a consulting service for a client? I. Analysis of the client's accounting system. II. Review of the client's prepared business plan. III. Preparation of information for obtaining financing.

a. I and II only. b. I and III only. c. II and III only. d. I, II, and III. CPA-01511 Explanation Choice "d" is correct. In a management consulting services engagement, the CPA may do all three of the listed choices. CPA-01512 Type1 M/C A-D Corr Ans: D PM R 4-05

114. CPA-01512 Lw May 94 #6 Page 49

Nile, CPA, on completing an audit, was asked by the client to provide technical assistance in implementing a new EDP system. The set of pronouncements designed to guide Nile in this engagement is the Statement(s) on: a. Quality Control Standards. b. Auditing Standards. c. Standards for Accountants' EDP Services. d. Standards for Consulting Services. CPA-01512 Explanation Choice "d" is correct. The Standards for Consulting Services state that they govern implementation services.

Choice "a" is incorrect. The quality control standards require CPA firms to establish a system within the firm designed to ensure compliance with professional standards.

Choice "b" is incorrect. The auditing standards guide the performance of audits.

Choice "c" is incorrect. There are no Standards for Accountants EDP Services. CPA-01513 Type1 M/C A-D Corr Ans: D PM R 4-05

115. CPA-01513 Au Nov 93 #1 Page 41

According to the profession's ethical standards, a CPA would be considered independent in which of the following instances? a. A client leases part of an office building from the CPA, resulting in a material indirect financial

interest to the CPA.


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b. The CPA has a material direct financial interest in a client, but transfers the interest into a blind trust.

c. The CPA owns an office building and the mortgage on the building is guaranteed by a client. d. The CPA belongs to a country club client in which membership requires the acquisition of a

pro rata share of equity. CPA-01513 Explanation Choice "d" is correct. Membership in a social club in which membership requirements involve acquisition of a pro rata share of equity does not impair independence because such equity is not considered to be a direct financial interest. The member however should not serve in any management capacity.

Choice "a" is incorrect. Leasing property to a client results in an indirect financial interest that impairs a CPA's independence.

Choice "b" is incorrect. Any direct or material indirect financial interest impairs a CPA's independence with respect to a client, whether or not the financial interest is placed in a blind trust.

Choice "c" is incorrect. A CPA's independence is considered impaired if the CPA has any loan to or from the client. A loan includes a guarantee of a loan. CPA-01514 Type1 M/C A-D Corr Ans: C PM R 4-05

116. CPA-01514 Au Nov 93 #14 Page 43

Which of the following statements applies to consultation services engagements? a. A practitioner should obtain an understanding of the internal control structure to assess

control risk. b. A practitioner is not permitted to compile a financial forecast. c. A practitioner should obtain sufficient relevant data to complete the engagement. d. A practitioner is to maintain an appearance of independence. CPA-01514 Explanation Choice "c" is correct. One of the Standards for Consulting Services is to obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to professional services performed.

Choice "a" is incorrect. Assessment of control risk is necessary for an audit engagement, but not for a consulting engagement.

Choice "b" is incorrect. Compiling a financial forecast would be considered a transaction service, which is a consulting service.

Choice "d" is incorrect. The consultant must serve the client interest, while maintaining integrity and objectivity. Independence, on the other hand, refers to relationships that may appear to impair a CPA's objectivity in rendering attestation services. CPA-01515 Type1 M/C A-D Corr Ans: A PM R 4-05

117. CPA-01515 Au May 93 #1 Page 42

A violation of the profession's ethical standards most likely would have occurred when a CPA: a. Issued an unqualified opinion on the 1992 financial statements when fees for the 1991 audit

were unpaid. b. Recommended a controller's position description with candidate specifications to an audit

client. c. Purchased a CPA firm's practice of monthly write-ups for a percentage of fees to be received

over a three-year period. d. Made arrangements with a financial institution to collect notes issued by a client in payment

of fees due for the current year's audit.


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CPA-01515 Explanation Choice "a" is correct. Independence of the member's firm may be impaired if more than one year's fees due from a client remain unpaid. Such amounts take on some of the characteristics of a loan, and it may appear that the practitioner is providing working capital for the client.

Choice "b" is incorrect. CPAs often make recommendations for a controller's position description as a management advisory service.

Choice "c" is incorrect. Purchasing a CPA firm's practice based on a percentage of fees is a legitimate method of pricing the business. It should not be confused with a contingent fee.

Choice "d" is incorrect. Making arrangements with a financial institution to collect notes issued by a client and payment of fees due is a business arrangement. It is not a conflict of interest be-cause there is no direct financial interest in the company. CPA-01516 Type1 M/C A-D Corr Ans: A PM R 4-05

118. CPA-01516 Au May 93 #5 Page 47

A pervasive characteristic of a CPA's role in a Management Consulting Services engagement is that of being a(an): a. Objective advisor. b. Independent practitioner. c. Computer specialist. d. Confidential reviewer. CPA-01516 Explanation Choice "a" is correct. A pervasive characteristic of the practitioner's role in a management consulting services engagement is that of being an objective adviser.

Choice "b" is incorrect. A CPA does not have to be an independent practitioner to perform management consulting service engagements.

Choice "c" is incorrect. Computer specialization is not a pervasive characteristic of management consulting services. Management consulting services encompass other areas such as management efficiency, factory automation, etc.

Choice "d" is incorrect. The focus of a management consulting services engagement is on making recommendations to the client, not on reviewing confidential information. CPA-04784 Type1 M/C A-D Corr Ans: B PM R 4-05

119. CPA-04784 Releaed 2005 Page 45

According to the ethical standards of the profession, which of the following acts generally is prohibited? a. Accepting a contingent fee for representing a client in connection with obtaining a private

letter ruling from the Internal Revenue Service. b. Retaining client records after the client has demanded their return. c. Revealing client tax returns to a prospective purchaser of the CPA's practice. d. Issuing a modified report explaining the CPA's failure to follow a governmental regulatory

agency's standards when conducting an attest service for a client. CPA-04784 Explanation Choice "b" is correct. Under Rule 501 of the Code of Conduct members may not commit any act that discredits the profession. Failure to return records to a client after the client makes demand is a specifically listed as an act that would discredit the profession.

Choice "a" is incorrect because a contingent fee is permitted when representing a client in a request for a ruling by IRS. The determination of the result would be determined by the IRS, not the accountant.


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Choice "c" is incorrect. Although an accountant may not reveal confidential client information to others without the client's permission, the rule does not prohibit a review of the accountant's practice in connection with a sale of the accountant's practice. The accountant is required to take appropriate precautions in such cases. A written confidentiality agreement would be an example of such a precaution.

Choice "d" is incorrect. Unusual circumstances may justify a departure from generally accepted accounting principals if compliance would cause the report to be misleading (e.g., new legislation or new forms of business transactions). The departure must be described and explained. CPA-04785 Type1 M/C A-D Corr Ans: C PM R 4-05


An auditor's independence is considered impaired if the auditor has: a. An immaterial, indirect financial interest in a client. b. An automobile loan from a client bank, collateralized by the automobile. c. A joint, closely-held business investment with the client that is material to the auditor's net

worth. d. A mortgage loan, executed with a financial institution client on March 1,1990, that is material

to the auditor's net worth. CPA-04785 Explanation Choice "c" is correct. Under Rule 101 of the Code of Conduct, independence is impaired with an audit client if the auditor has a direct financial interest regardless of materiality or a material indirect financial interest in the client. A joint, closely-held business investment with the client that was material would be clear violation.

Choice "a" is incorrect because an immaterial indirect financial interest is permissible.

Choice "b" is incorrect because fully collateralized auto loans with financial institution clients are permissible.

Choice "d" is incorrect. Although such a loan made today would impair independence, there is an exception made for such loans executed prior to February 5, 2001. CPA-04791 Type1 M/C A-D Corr Ans: B PM R 4-05


Under the ethical standards of the profession, which of the following positions would be considered a position of significant influence in an audit client? a. A marketing position related to the client's primary products. b. A policy-making position in the client's finance division. c. A staff position in the client's research and development division. d. A senior position in the client's human resources division. CPA-04791 Explanation Choice "b" is correct. Rule 101 of the Code of Conduct requires auditors to be independent of their clients. Independence is not impaired by an immediate family member's employment with a client provided that (s)he is not in a key position. Having a policy making position in the client's finance division would clearly be a key position.

Choices "a", "c", and "d" are incorrect. Having a marketing position, a position in research and development or a position in human resources would not be directly related to financial activities. CPA-04792 Type1 M/C A-D Corr Ans: B PM R 4-05



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A CPA who is not in public practice is obligated to follow which of the following rules of conduct? a. Independence. b. Integrity and objectivity. c. Contingent fees. d. Commissions. CPA-04792 Explanation Choice "b" is correct. A CPA must maintain objectivity and integrity in the performance of any professional service.

Choice "a" is incorrect. Independence is only required for audits and other attestation services. A CPA who is not in public practice would not perform audits or attestation services.

Choice "c" is incorrect. A CPA who is not in public practice would not charge contingent fees to his employer.

Choice "d" is incorrect. Commissions are prohibited if the CPA is performing an audit or review, an examination of prospective financial information or a compilation when the member does not disclose independence. These are not applicable to a CPA who is not in public practice. Responsibilities in Tax Practice (required homework reading) CPA-01518 Type1 M/C A-D Corr Ans: D PM R 4-06

123. CPA-01518 Lw May 95 #4 Page 53

Kopel was engaged to prepare Raff's 1994 federal income tax return. During the tax preparation interview, Raft told Kopel that he paid $3,000 in property taxes in 1994. Actually, Raff's property taxes amounted to only $600. Based on Raff's word, Kopel deducted the $3,000 on Raff's return, resulting in an understatement of Raff's tax liability. Kopel had no reason to believe that the information was incorrect. Kopel did not request underlying documentation and was reasonably satisfied by Raff's representation that Raft had adequate records to support the deduction. Which of the following statements is correct? a. To avoid the preparer penalty for willful understatement of tax liability, Kopel was obligated to

examine the underlying documentation for the deduction. b. To avoid the preparer penalty for willful understatement of tax liability, Kopel would be

required to obtain Raff's representation in writing. c. Kopel is not subject to the preparer penalty for willful understatement of tax liability because

the deduction that was claimed was more than 25% of the actual amount that should have been deducted.

d. Kopel is not subject to the preparer penalty for willful understatement of tax liability because Kopel was justified in relying on Raff's representation.

CPA-01518 Explanation Choice "d" is correct. In preparing or signing a return, a CPA may in good faith rely without verification upon information furnished by the client or by third parties. TX 132.02

Choice "a" is incorrect. A tax preparer need not examine all underlying documents to assure that the client is properly representing expenses.

Choice "b" is incorrect. A tax preparer need not obtain a client's representation regarding deductions in writing.

Choice "c" is incorrect. A tax preparer's liability for misrepresentations does not depend on the percentage difference between actual expenses and claimed expenses, but rather on whether the preparer willfully misrepresented the deduction. CPA-01519 Type1 M/C A-D Corr Ans: C PM R 4-06

124. CPA-01519 Lw May 94 #8 Page 56


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Which of the following acts by a CPA will not result in a CPA incurring an IRS penalty? a. Failing, without reasonable cause, to provide the client with a copy of an income tax return. b. Failing, without reasonable cause, to sign a client's tax return as preparer. c. Understating a client's tax liability as a result of an error in calculation. d. Negotiating a client's tax refund check when the CPA prepared the tax return. CPA-01519 Explanation Choice "c" is correct. The IRS does not impose a penalty on a CPA for making an error in calculating a tax return.

Choice "a" is incorrect. A CPA must give his or her client a copy of the client's tax return or face imposition of a penalty.

Choice "b" is incorrect. A CPA must sign tax returns that the CPA prepares. Willful violation of this rule can result in imposition of a penalty.

Choice "d" is incorrect. A CPA is prohibited from negotiating a client's refund check. CPA-01522 Type1 M/C A-D Corr Ans: A PM R 4-06

125. CPA-01522 Lw Nov 93 #9 Page 56

Clark, a professional tax return preparer, prepared and signed a client's 1992 federal income tax return that resulted in a $600 refund. Which one of the following statements is correct with regard to an Internal Revenue Code penalty Clark may be subject to for endorsing and cashing the client's refund check? a. Clark will be subject to the penalty if Clark endorses and cashes the check. b. Clark may endorse and cash the check, without penalty, if Clark is enrolled to practice before

the Internal Revenue Service. c. Clark may not endorse and cash the check, without penalty, because the check is for more

than $500. d. Clark may endorse and cash the check, without penalty, if the amount does not exceed

Clark's fee for preparation of the return. CPA-01522 Explanation Choice "a" is correct. A tax preparer may not endorse and cash a client's tax refund check. CPA-01524 Type1 M/C A-D Corr Ans: C PM R 4-06

126. CPA-01524 Lw May 93 #7 Page 51

A CPA will be liable to a tax client for damages resulting from all of the following actions, except: a. Failing to timely file a client's return. b. Failing to advise a client of certain tax elections. c. Refusing to sign a client's request for a filing extension. d. Neglecting to evaluate the option of preparing joint or separate returns that would have

resulted in a substantial tax savings for a married client. CPA-01524 Explanation Choice "c" is correct. A CPA is not required to sign a client's request for an extension, and indeed would be prohibited from doing so if the extension was sought on fraudulent grounds.

Choice "a" is incorrect. Failure to timely file a client's tax return could constitute negligence (a departure from the duty of ordinary care owed to a client) for which the CPA could be held liable.

Choice "b" is incorrect. Failure to advise a client of tax elections could constitute negligence (a departure from the duty of ordinary care owed to a client) for which the CPA could be held liable.

Choice "d" is incorrect. Failure to determine whether a client should file jointly or separately likely constitutes negligence (a departure from the ordinary standard of care owed to a client) for which a CPA could be held liable.


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127. CPA-01525 Lw May 93 #8 Page 53

Starr, CPA, prepared and signed Cox's 1992 federal income tax return. Cox informed Starr that Cox had paid doctors' bills of $20,000 although Cox actually had paid only $7,000 in doctors' bills during 1992. Based on Cox's representations, Starr computed the medical expense deduction that resulted in an understatement of tax liability. Starr had no reason to doubt the accuracy of Cox's figures and Starr did not ask Cox to submit documentation of the expenses claimed. Cox orally assured Starr that sufficient evidence of the expenses existed. In connection with the preparation of Cox's 1992 return, Starr is: a. Liable to Cox for interest on the underpayment of tax. b. Liable to the IRS for negligently preparing the return. c. Not liable to the IRS for any penalty or interest. d. Not liable to the IRS for any penalty, but is liable to the IRS for interest on the underpayment

of tax. CPA-01525 Explanation Choice "c" is correct. A CPA is entitled to rely on the client's representations that adequate documentation exists to support the expenses that the client claims. As long as the CPA asks the client whether the client has documentation, the CPA will not be liable for either a penalty or interest because of the client's misrepresentation. CPA-04764 Type1 M/C A-D Corr Ans: C PM R 4-06


A member would be in violation of the Standards for Tax Services if the member recommends a return position under which of the following circumstances? a. It does not meet the realistic possibility standard but is not frivolous and is disclosed on the

return. b. It might result in penalties and the member advises the taxpayer and discusses avoiding such

penalties through disclosing the position. c. It does not meet the realistic possibility standard but the member feels the return has a

minimal likelihood for examination by the IRS. d. It meets the realistic possibility standard based on the well-reasoned opinion of the taxpayer's

attorney. CPA-04764 Explanation Choice "c" is correct. In general, a tax preparer should only recommend a tax return position if the tax preparer has a good faith belief that the position has a realistic possibility of being sustained administratively or judicially on its merits if challenged. However, if a tax return position does not meet the "realistic possibility standard", the taxpayer may still take the position and the tax preparer may still prepare and sign the return provided the position is adequately disclosed on the tax return and the position is not frivolous. The tax preparer should advise the client that it might be possible to avoid certain penalties if the tax return position is disclosed on the return. However, a tax preparer may not advise a client to take a position due to the fact that they are unlikely to be audited (playing the audit lottery). Therefore, the return position in "c" cannot be taken since the tax preparer is relying upon the unlikelihood of being audited.

Choice "a" is incorrect. In general, a tax preparer should only recommend a tax return position if the tax preparer has a good faith belief that the position has a realistic possibility of being sustained administratively or judicially on its merits if challenged. However, if a tax return position does not meet the "realistic possibility standard", the taxpayer may still take the position and the tax preparer may still prepare and sign the return provided the position is adequately disclosed on the tax return and the position is not frivolous. The tax preparer should advise the client that it might be possible to avoid certain penalties if the tax return position is disclosed on the return. The return position taken in choice "a" falls within this guidance.


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Choice "b" is incorrect. In general, a tax preparer should only recommend a tax return position if the tax preparer has a good faith belief that the position has a realistic possibility of being sustained administratively or judicially on its merits if challenged. However, if a tax return position does not meet the "realistic possibility standard", the taxpayer may still take the position and the tax preparer may still prepare and sign the return provided the position is adequately disclosed on the tax return and the position is not frivolous. The tax preparer should advise the client that it might be possible to avoid certain penalties if the tax return position is disclosed on the return. The return position taken in choice "b" falls within this guidance.

Choice "d" is incorrect. In general, a tax preparer should only recommend a tax return position if the tax preparer has a good faith belief that the position has a realistic possibility of being sustained administratively or judicially on its merits if challenged. The return position taken in "d" falls within this guidance.

Licensing and Disciplinary Systems Within the Profession (required homework reading) CPA-01517 Type1 M/C A-D Corr Ans: D PM R 4-07

129. CPA-01517 Lw R96 #2 Page 57

Which of the following bodies ordinarily would have the authority to suspend or revoke a CPA's license to practice public accounting? a. The SEC. b. The AICPA. c. A state CPA society. d. A state board of accountancy. CPA-01517 Explanation Choice "d" is correct. A state board of accountancy may suspend a CPA's license since such licenses are granted by the state.

Choice "a" is incorrect. While the SEC may prohibit CPAs from working with securities and may seek civil and criminal sanctions against CPAs for securities violations, the SEC has no power to suspend state professional licenses.

Choice "b" is incorrect. A state CPA society and the AICPA are private organizations with no state licensing power.

Choice "c" is incorrect. A state CPA society and the AICPA are private organizations with no state licensing power. Statement on Responsibilities in Personal Financial Planning (required homework reading) CPA-01528 Type1 M/C A-D Corr Ans: A PM R 4-08

130. CPA-01528 Reg C03 #2 Page 60

Personal financial planning engagements include which of the following? I. Implementation engagements to assist clients to take action on planning decisions. II. Engagements limited to compiling personal financial statements.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. CPA-01528 Explanation Choice "a" is correct. PFP engagements may include assisting a client to take action on planning decisions. These are called implementation engagements. PFP engagements do not include engagements limited to compiling personal financial statements.


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131. CPA-01531 Reg R99 #1 Page 60

Which of the following services is a CPA generally required to perform when conducting a personal financial planning engagement? a. Assisting the client to identify tasks that are essential in order to act on planning decisions. b. Assisting the client to take actions on planning decisions. c. Monitoring progress in achieving goals. d. Updating recommendations and revising planning decisions. CPA-01531 Explanation Choice "a" is correct. PFP engagements involve all of the following: defining the engagement objectives, planning specific procedures appropriate to the engagement, developing recommendations and communicating them to clients, and identifying the tasks for taking action on planning decisions.

Choices "b", "c", and "d" are incorrect. A CPA is not responsible for assisting the client in acting on planning decisions (implementation engagements), monitoring the client's progress in achieving goals (monitoring engagements) or updating recommendations (updating engagements) unless these added services were specifically agreed to.

Documents

CPA-Partnership--06