Deck 9: Business Income, Deductions, and Accounting Methods

Question 1

Taxpayers must maintain written contemporaneous records of business purpose when entertaining clients in order to claim a deduction for the expenditures.

Answer 1

True

Question 2

A business generally adopts a fiscal or calendar year by using that year end on the first tax return for the business.

Answer 2

True

Question 3

Illegal bribes and kickbacks are not deductible as business expenses but fines imposed by a governmental unit are deductible as long as the fines are incurred in the ordinary course of business.

Answer 3

False

Question 4

Qualified production activity income for calculating the domestic production activities deduction is limited to taxable income for a business or modified AGI for an individual.

Question 5

Reasonable in amount means that expenditures can be exorbitant as long as the activity ismotivated by profit.

Question 6

Employees cannot deduct the cost of uniforms if the uniforms are also appropriate fornormal wear.

Question 7

The domestic production activities deduction cannot exceed 50 percent of the wages paid to employees engaged in domestic manufacturing activities during the year.

Question 8

When a taxpayer borrows money and invests the loan proceeds in municipal bonds, theinterest paid by the taxpayer on the debt will not be deductible.

Question 9

Business activities are distinguished from personal activities in that business activitiesare motivated by the pursuit of profits.

Question 10

Sole proprietorships must use the same tax year as the proprietor of the business.

Question 11

Only half the cost of a business meal is deductible even if the meal is associated with the active conduct of business.

Question 12

The phase "ordinary and necessary" has been defined to mean that an expense must beessential and indispensable to the conduct of a business.

Question 13

The test for whether an expenditure is reasonable in amount is whether the expenditurewas for an "arm's length" amount.

Question 14

A loss deduction from a casualty of a business asset is only available if the asset is completely destroyed.

Question 15

The Internal Revenue Code authorizes deductions for trade or business activities if theexpenditure is "ordinary and necessary".

Question 16

The domestic production activities deduction is a deduction for the incremental cost of manufacturing tangible assets in the United States.

Question 17

All taxpayers must account for taxable income using a calendar year.

Question 18

A fiscal tax year can end on the last day of any month other than December.

Question 19

A short tax year can end on any day of any month other than December.

Question 20

Although expenses associated with illegal activities are not deductible, politicalcontributions can be deducted as long as the donation is not made to a candidate for public office.

Question 21

Even a cash method taxpayer must consistently use accounting methods that "clearly reflect income" for tax purposes.

Question 22

Which of the following expenditures is NOT likely to be allowed as a current deduction for a landscaping and nursery business?

A) cost of fertilizer.
B) cost of uniforms for employees.
C) a cash settlement for trade name infringement.
D) cost of a greenhouse.
E) accounting fees.

Question 23

The full-inclusion method requires cash basis taxpayers to include prepayments for goods or services into realized income.

Question 24

Dick pays insurance premiums for his employees. What type of insurance premium is not deductible as compensation paid to the employee?

A) Key man life insurance with benefits payable to Dick.
B) Health insurance with benefits payable to the employee.
C) Whole life insurance with benefits payable to the employee's dependents.
D) Group term life insurance with benefits payable to the employee's dependents.
E) All of the choices are deductible by Dick.

Question 25

The all-events test for income determines the period in which income will be recognized for tax purposes.

Question 26

The IRS would most likely apply the arm's length transaction test to determine which of the following?

A) reasonableness of an expenditure.
B) whether an expenditure will be likely to produce income.
C) whether an expenditure is related to a business activity.
D) timeliness of an expenditure.
E) All of the choices are correct.

Question 27

Which of the following is a true statement?

A) An employer can only deduct half of any meals provided to employees.
B) The cost of business meals must be reasonable.
C) A taxpayer can only deduct a meal for a client if business is discussed during the meal.
D) Meals are never deductible as a business expense.
E) None of the choices are true.

Question 28

In order to deduct a portion of the cost of a business meal which of the following conditions must be met?

A) A client (not a supplier or vendor) must be present at the meal.
B) The meal must occur on the taxpayer's business premises.
C) The taxpayer or an employee must be present at the meal.
D) All of the choices are conditions for a deduction.
E) None of the choices is a condition for the deduction.

Question 29

Which of the following is an explanation for why insurance premiums on a key employee are not deductible?

A) This rule was grandfathered from a time when the Internal Revenue Code disallowed all insurance premiums deductions.
B) It is impractical to trace insurance premiums to the receipt of proceeds.
C) Congress presumes that all expenses are not deductible unless specifically allowed in the Internal Revenue Code.
D) A deduction for the insurance premium would offset taxable income without the potential for the proceeds generating taxable income.
E) The federal government does not want to subsidize insurance companies.

Question 30

Which of the following is a true statement?

A) Insurance premiums are not deductible if paid for "key man" life insurance.
B) Interest expense is not deductible if the loan is used to purchase municipal bonds.
C) One half of the cost of business meals is not deductible.
D) All of the choices are true.
E) None of the choices are true.

Question 31

Which of the following expenditures is most likely to be deductible for a construction business?

A) An arm's length payment to a related party for emergency repairs of a sewage line.
B) A fine for a zoning violation.
C) An "under the table" payment to a government representative to obtain a better price for raw materials.
D) A payment to a foreign official to expedite an application for a business permit.
E) A tax underpayment penalty.

Question 32

Individual proprietors report their business income and deductions on:

A) Schedule C.
B) Form 1120S.
C) Schedule A.
D) Form 1041.
E) Form 1065.

Question 33

After a business meeting with a prospective client Holly took the client to dinner and the theatre. Holly paid $290 for the meal and $250 for the theatre tickets, amounts that were reasonable under the circumstances. What amount of these expenditures can Hollydeduct as a business expense?

A) $415
B) $270
C) $540
D) None unless Holly discussed business with the client during the meal and the entertainment.
E) None - the meals and entertainment are not deductible except during travel.

Question 34

This year Clark leased a car to drive between his office and various work sites. Clark carefully recorded that he drove the car 23,000 miles this year and paid $7,200 of operating expenses ($2,700 for gas, oil, and repairs, and $4,500 for lease payments). What amount of these expenses may Clark deduct as business expenses?

A) Clark is not entitled to any deduction if he used the car for any personal trips.
B) $7,200
C) $2,700
D) $4,500
E) Clark cannot deduct these costs because taxpayers must use the mileage method to determine any transportation deduction.

Question 35

According to the Internal Revenue Code §162, deductible trade or business expenses must be one of the following?

A) appropriate and measurable.
B) minimized.
C) personal and justifiable.
D) ordinary and necessary.
E) incurred for the production of investment income.

Question 36

Which of the following is likely to be a fully deductible business expense?

A) A speeding fine paid by a trucker who was delivering a rush order.
B) Salaries in excess of the industry average paid to attract talented employees.
C) The cost of a three-year subscription to a business publication.
D) The cost of employee uniforms that can be adapted to ordinary personal wear.
E) None of the choices are likely to be deductible.

Question 37

Which of the following business expense deductions is most likely to be unreasonable in amount?

A) Cost of entertaining a former client when there is no possibility of any future benefits from a relation with that client.
B) Compensation paid to the taxpayer's spouse in excess of salary payments to other employees.
C) Amounts paid to a subsidiary corporation for services where the amount is in excess of the cost of comparable services by competing corporations.
D) All of the choices are likely to be unreasonable in amount.
E) None of the choices are likely to be unreasonable in amount.

Question 38

The 12-month rule allows taxpayers to deduct the entire amount of certain prepaid business expenses.

Question 39

Uniform capitalization of indirect inventory costs is required for most large taxpayers.

Question 40

Paris operates a talent agency as a sole proprietorship, and this year she incurred the followingexpenses in operating her talent agency. What is the total deductible amount of these expenditures?$1,000 dinner with a film producer where no business was discussed.$500 lunch with sister Nicky where no business was discussed.$700 business dinner with a client but Paris forgot to keep any records (oops!).$900 tickets to the opera with a client following a business meeting.

A) $1,200.
B) $450.
C) $800.
D) $1,100.
E) $900.

Question 41

John is a self-employed computer consultant who lives and works in Dallas. John paid for thefollowing activities in conjunction with his business. Which is not deductible in any amount?
•Dinner with a potential client where the client's business was discussed.
• A trip to Houston to negotiate a contract.
•A seminar in Houston on new developments in the software industry.
•A trip to New York to visit a school chum who is also interested in computers.

A) 1 only.
B) 2 only.
C) 4 only.
D) 3 only.
E) None of the choices are correct.

Question 42

When does the all-events test under the accrual method require the recognition of income from the sale of goods?

A) The earliest of the above three dates.
B) When payment is due from the buyer.
C) When the business receives payment.
D) When the title of the goods passes to the buyer.
E) None of the choices are correct.

Question 43

Which of the following is a true statement?

A) Meals are deductible for an employee who is forced to work during the lunch hour.
B) If travel has both business and personal aspects, the cost of transportation is always deductible but the deductibility of lodging depends upon whether business is conducted that day.
C) Meals, lodging, and incidental expenditures are only deductible if the taxpayer is away from home overnight while traveling.
D) When a taxpayer travels solely for business purposes, only half of the costs of travel are deductible.
E) None of the choices are true.

Question 44

Which of the following cannot be selected as a valid tax year end?

A) A tax year can end on any of these days.
B) December 31st.
C) The last Friday of the last week of June.
D) January 31st.
E) December 15th.

Question 45

(described below). What amount can Shelley deduct as an employee business expense (before considering any miscellaneous itemized deduction limitations)?

A) $2,740
B) $1,850 if Shelley's AGI is $50,000
C) $2,850
D) All of the expenses are deductible if Shelley is reimbursed under an accountable plan.
E) None of the expenses are deductible - only employers can deduct travel expenses.

Question 46

Which of the following is a true statement about travel that has both business and personal aspects?

A) The cost of lodging, and incidental expenditures is limited to those incurred during the business portion of the travel.
B) Only half of the cost of meals and transportation is deductible.
C) Meals are not deductible for this type of travel.
D) Transportation costs are always fully deductible.
E) None of the choices are correct.

Question 47

Which of the following expenses are completely deductible?

A) $2,000 spent by the employer on reimbursing an employee for entertainment.
B) $1,000 spent on compensating your brother for a personal expense.
C) $50 spent on meals while traveling on business.
D) All of the expenses are fully deductible.
E) None of the expenses can be deducted in full.

Question 48

George operates a business that generated adjusted gross income of $250,000 and taxable income of $170,000 this year (before the domestic production activities deduction).Included in income was $70,000 of qualified production activities income. George paid$60,000 of wages to employees engaged in domestic manufacturing. What domestic production activities deduction will George be eligible to claim this year?

A) $15,300.
B) $22,500.
C) $6,300.
D) $7,200.
E) $5,400.

Question 49

Ronald is a cash method taxpayer who made the following expenditures this year. Which expenditure is completely deductible in this period as a business expense?

A) $55 to collect an account receivable from a customer who has failed to pay for services rendered.
B) $4,000 for rent on his office that covers the next 24 months.
C) $2,500 for professional hockey tickets distributed to a customer to generate "goodwill" for his business.
D) $3,000 for a new watch for the mayor to keep "good relations" with city hall.
E) None of the choices are completely deductible.

Question 50

Qualified production activities income is defined as follows for purposes of the domestic production activities deduction:

A) revenue from selling or leasing property the taxpayer manufactured in the United States.
B) 6 percent of revenue from selling or leasing property the taxpayer manufactured in the United States.
C) net income from selling or leasing property the taxpayer manufactured in the United States.
D) revenue from selling or leasing property the taxpayer manufactured in the United States but the revenue was less than 50 percent of qualifying wages used in the production.
E) None of the choices are correct.

Question 51

Jim operates his business on the accrual method and this year he received $4,000 forservices that he intends to provide to his clients next year. Under what circumstances canJim defer the recognition of the $4,000 of income until next year?

A) Jim can defer the recognition of the income if he has requested that the client not pay for the services until the services are provided.
B) Jim can defer the recognition of the income if he absolutely promises not to provide the services until next year.
C) Jim must defer the recognition of the income until the income is earned.
D) Jim can elect to defer the recognition of the income if the income is not recognized for financial accounting purposes.
E) Jim can never defer the recognition of the prepayments of income.

Question 52

Beth operates a plumbing firm. In August of last year she signed a contract to provide plumbing services for a renovation. Beth began the work that August and finished the work in December of last year. However, Beth didn't bill the client until January of this year and she didn't receive the payment until March when she received payment in full. When should Beth recognize income under the accrual method of accounting?

A) In August of last year.
B) In December of last year.
C) In January of this year.
D) In April of this year.
E) In March of this year.

Question 53

Which of the following is a true statement about the domestic production activities deduction?

A) This deduction is determined by the amount of goods manufactured in the United States for export abroad.
B) The domestic production activities deduction is not affected by the cost of labor.
C) This deduction represents a subsidy to taxpayers who manufacture or construct goods in the United States.
D) The deduction is calculated as a percentage of the cost of goods manufactured in the United States.
E) All of the choices are true.

Question 54

Which of the following types of transactions may not typically be accounted for using the cash method?

A) sales of inventory.
B) payments of debt.
C) services.
D) purchases of machinery.
E) sales of securities by an investor.

Question 55

Bill operates a proprietorship using the cash method of accounting, and this year he received54th) e following payments:
•$100 in cash from a customer for services rendered this year$100 in cash from a customer for services rendered this year.
•a promise to pay $200 from a customer for services rendered this year.
•tickets to a football game worth $250 as payment for services performed last year.
•a check for $170 for services rendered this year that Bill forgot to cash.

A) $300.
B) $520.
C) $270.
D) $350.
E) $100.

Question 56

Colbert operates a catering service on the accrual method. In November of year 1 Colbert received a payment of $9,000 for 18 months of catering services to be rendered from December 1st of year 1 through May 31st year 3. When must Colbert recognize theincome if his accounting methods are selected to minimize income recognition?

A) $500 is recognized in year 1, $6,000 in year 2, and $2,500 in year 3.
B) $2,500 is recognized in year 1 and $6,500 in year 2.
C) $9,000 is recognized in year 1.
D) $9,000 is recognized in year 3.
E) $500 is recognized in year 1 and $8,500 in year 2.

Question 57

Ed is a self-employed heart surgeon who has incurred the following reasonable expenses. Ho4w6)much can Ed deduct?$1,000 in airfare to repair investment rental property in Colorado.$500 in meals while attending a medical convention in New York.$300 for tuition for an investment seminar "How to pick stocks."$100 for tickets to a football game with hospital administrators to celebrate successful negotiation of a surgical contract earlier in the day.The correct answer is ________.

A) $1,300 "for AGI"
B) $480 "for AGI"
C) $1,300 "for AGI" and $300 "from AGI"
D) $80 "for AGI" and $1,300 "from AGI"
E) None of the choices are correct.

Question 58

Clyde operates a sole proprietorship using the cash method. This year Clyde made the follow5i5n)g expenditures:$480 to U.S. Bank for 12 months of interest accruing on a business loan from September 1st of this year through August 31st of next year.$600 for 12 months of property insurance beginning on July 1 of this year.What is the maximum amount Clyde can deduct this year?

A) $760.
B) $360.
C) $160.
D) $480.
E) $600.

Question 59

Don operates a taxi business, and this year one of his taxis was damaged in a traffic accident. The taxi was originally purchased for $32,000 and the adjusted basis was$2,000 at the time of the accident. The taxi was repaired at a cost of $2,500 andinsurance reimbursed Don $700 of this cost. What is the amount of Don's casualty loss deduction?

A) $1,800.
B) $1,300.
C) $2,000.
D) $2,500.
E) Don is not eligible for a casualty loss deduction.

Question 60

Riley operates a plumbing business and this year the 3-year old van he used in the business was destroyed in a traffic accident. The van was originally purchased for$20,000 and the adjusted basis was $5,800 at the time of the accident. Although the van was worth $6,000 at the time of accident, insurance only paid Riley $1,200 for the loss. What is the amount of Riley's casualty loss deduction?

A) $5,300.
B) $6,000.
C) $14,000.
D) $5,800.
E) $4,600.

Question 61

Werner is the president and CEO of Acme, Inc. and this year he took a prospective client to dinner.During the dinner the President and the client discussed a proposed contract for over $6 million and personal matters. After dinner the CEO took the client to a football game and no business wasdiscussed. The CEO paid $1,220 for an expensive dinner and spent $600 for tickets to the game.What is the deductible amount of these expenses?

Question 62

Ajax Computer Company is an accrual method calendar year taxpayer. Ajax has never advertised in the national media prior to this year. In November of this year, however, Ajax paid $1 million for television advertising time during a "super" sporting event scheduled to take place in early February of next year. In addition, in November of this year the company paid $500,000 for advertising time during a professional golftournament which will occur once in April of next year. What amount of these payments, if any, can Ajax deduct this year?

A) $1.5 million.
B) $500,000.
C) $1 million.
D) $1.5 million only if the professional golf tournament is played before April 15.
E) No deduction can be claimed this year.

Question 63

Judy is a self-employed musician who performs for a variety of events. This year Judy was fined$250 by the city for violating the city's noise ordinance with a relatively loud performance. As a consequence, Judy contributed $1,000 to a campaign committee formed to recall the city's mayor. Judy normally hires three part-time employees to help her schedule events and transport equipment. Judy paid a total of $33,000 to her employees through June of this year. In June Judy fired herpart-time employees and hired her husband to replace them. However, Judy paid him $55,000 rather than $33,000. Judy is on the cash method and calendar year, and she wants to know what amount of these expenditures is deductible as business expenses.

Question 64

Jones operates an upscale restaurant and he pays experienced cooks $35,000 per year.This year he hired his son as an apprentice cook. Jones agreed to pay his son $40,000 per year. Which of the following is a true statement about this transaction?

A) Jones will be allowed to deduct $35,000 as compensation and another $5,000 can be deducted as an employee gift.
B) Jones can only deduct $20,000 because an apprentice cook is only worth half as much as an experienced cook.
C) Jones will be allowed to accrue $40,000 only if he pays his son in cash.
D) Jones will be allowed to deduct $40,000 only if his son eventually develops into an expert cook.
E) None of the choices are true.

Question 65

Which of the following is a true statement about accounting for business activities?

A) The cash method can only be adopted by individual taxpayers.
B) The accrual method can only be adopted by corporate taxpayers.
C) An overall accounting method is initially adopted on the first return filed for the business.
D) An overall accounting method can only be adopted with the permission of the Commissioner.
E) None of the choices are true.

Question 66

Crystal operates a business that provides typing and delivery services. This year Crystal spent$2,500 to purchase special shirts that identify her employees and provide some notoriety for her business. The shirts are especially colorful and include logos on the front pocket and back. Besides salary payments, Crystal also compensates her employees by offering to pay whole life insurance premiums for any that want to provide insurance coverage for their beneficiaries. This year Crystal paid $5,000 in life insurance premiums. What amount of these payments can Crystal deduct? Crystal is on the cash method and calendar year.

Question 67

Which of the following is a true statement about a request for a change in accounting method?

A) Some requests are automatically granted.
B) Form 3115 is required to be filed with a request for change in accounting method.
C) Many requests require payment of a fee and a good business purpose for the change.
D) Most requests require the permission of the Commissioner.
E) All of the choices are true.

Question 68

Smith operates a roof repair business. This year Smith's business generated cash receipts of $32,000 andSmith made the following expenditures associated with his business: The education expense was for a two-week, nighttime course in business management. Smith believes the expenditure should qualify as an ordinary and necessary business expense. What net incomeshould Smith report from his business? Smith is on the cash method and calendar year.

Question 69

Kip started a wholesale store this year selling bulk peanut butter. In January of this year Kip purchased an initial five tubs of peanut butter for a total cost of $5,000. In July Kip purchased three tubs for a total cost of $6,000. Finally, in November Kip bought two tubs for a total cost of $1,000. Kip sold six tubs by year end. What is Kip's ending inventory under the FIFO cost-flow method?

A) $5,000.
B) $12,000.
C) $1,000.
D) $6,000.
E) $2,500.

Question 70

Bryon operates a consulting business and he usually works alone. However, during the summer Bryon will sometimes hire undergraduate students to collect data for his projects. This past summer Bryon hired Fred, the son of a prominent businessman, for a part-time summer job. The summer job usually pays about $17,000, but Bryon paid Fred $27,000 to gain favor with Fred's father. Whatamount of Fred's summer wages can Bryon deduct for tax purposes? Bryon is on the cash method and calendar year.

Question 71

Manley operates a law practice on the accrual method and calendar year. At the beginning of the year Manley's firm had an allowance for doubtful accounts with abalance of $15,000. At the end of the year, Manley recorded bad debt expense of $23,000 and the balance of doubtful accounts had increased to $18,000. What is Manley's deduction for bad debt expense this year?

A) $5,000.
B) $20,000.
C) $26,000.
D) $23,000.
E) $3,000.

Question 72

Todd operates a business using the cash basis of accounting. At the end of last year, Todd was granted permission to switch his sales on account to the accrual method. Last year Todd made $420,000 of sales on account and $64,000 was uncollected at the end of the year. What is Todd's §481 adjustment for this year?

A) increase expenses by $64,000.
B) increase expenses by $420,000.
C) increase income by $16,000.
D) increase income by $420,000.
E) Todd has no §481 adjustment this year.

Question 73

Which of the following types of expenditures is not subject to capitalization under theUNICAP rules?

A) Cost of raw materials.
B) Selling expenditures.
C) Cost of manufacturing labor.
D) Compensation of managers who supervise production.
E) All of the choices are subject to capitalization under the UNICAP rules.

Question 74

Joe is a self-employed electrician who operates his business on the accrual method. This year Joe purchased a shop for his business, and for the first time at year end he received a bill for $4,500 of property taxes on his shop. Joe didn't pay the taxes until after year end but prior to filing his tax return. Which of the following is a true statement?

A) The taxes are a payment liability.
B) Unless Joe makes an election, the taxes are not deductible this year.
C) If he elects to treat the taxes as a recurring item, Joe can accrue and deduct $4,500 of taxes on the shop this year.
D) The taxes would not be deductible if Joe's business was on the cash method.
E) All of the choices are true.

Question 75

Which of the following is a true statement about impermissible accounting methods?

A) An impermissible method may never be used by a taxpayer.
B) Cash method accounting is an impermissible method for partnerships and Subchapter S electing corporations.
C) An impermissible method is adopted by using the method to report results for two consecutive years.
D) There is no accounting method that is impermissible.
E) None of the choices are true.

Question 76

Big Homes Corporation is an accrual method calendar year taxpayer that manufactures and sells modular homes. This year for the first time Big Homes was forced to offer a rebate on the purchase of new homes. At year end, Big Homes had paid $12,000 inrebates and was liable for an additional $7,500 in rebates to buyers. What amount of the rebates, if any, can Big Homes deduct this year?

A) $12,000 because rebates are payment liabilities.
B) $19,500 if this amount is not material, Big Homes expects to continue the practice of offering rebates in future years, and Big Homes expects to pay the accrued rebates before filing their tax return for this year.
C) $12,000 because the $7,500 liability is not fixed and determinable.
D) $19,500 because Big Homes is an accrual method taxpayer.
E) Big Homes is not entitled to a deduction because rebates are against public policy.

Question 77

Which of the following is NOT considered a related party for the purpose of limitation on accruals to related parties?

A) Brother when the taxpayer is an individual.
B) A partner when the taxpayer is a partnership.
C) A minority shareholder when the taxpayer is a corporation.
D) Spouse when the taxpayer is an individual.
E) All of the parties in all the choices are related parties.

Question 78

Mike started a calendar year business on September 1st of this year by paying 12 months rent on his shop at $1,000 per month. What is the maximum amount of rent that Mike can deduct this year under each type of accounting method?

A) $4,000 under the cash method and $4,000 under the accrual method.
B) $4,000 under the cash method and $12,000 under the accrual method.
C) $12,000 under the cash method and $4,000 under the accrual method.
D) $4,000 under the cash method and zero under the accrual method.
E) $12,000 under the cash method and $12,000 under the accrual method.

Question 79

Brad operates a storage business on the accrual method. On July 1 Brad paid $48,000 for rent on his storage warehouse and $18,000 for insurance on the contents of thewarehouse. The rent and insurance covers the next 12 months. What is Brad's deduction for the rent and insurance?

A) $48,000 for the rent and $9,000 for the insurance.
B) $24,000 for the rent and $18,000 for the insurance.
C) $24,000 for the rent and $9,000 for the insurance.
D) $48,000 for the rent and $18,000 for the insurance.
E) None of the choices are true.

Question 80

Which of the following is a payment liability?

A) Real estate taxes.
B) Tort claims.
C) Insurance premiums.
D) Refunds.
E) All of the choices are correct.