CPA Regulation (REG) : Flow-Through Income Items

Study concepts, example questions & explanations for CPA Regulation (REG)

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Example Questions

Example Question #1 : Individual Income Tax Sources Of Taxable Income

Aston and Becker are equal partners in AB Partnership. In the tax year, the ordinary income of the partnership is $20,000, and the partnership has a long-term capital gain of $12,000. Aston's basis in AB was $40,000, and he received distributions of $5,000 during the year. What is Aston's share of AB's ordinary income?

Possible Answers:

$10,000

$18,500

$15,000

$16,000

Correct answer:

$10,000

Explanation:

The question asks about Aston’s share of ordinary income. While Aston receives an equal share of the long-term capital gain, it will be taxed as a capital gain, not ordinary income. Distributions (especially non-liquidating) are generally not taxable. This leaves only Aston’s equal share of the $20,000 ordinary income, or $10,000.

Example Question #2 : Individual Income Tax Sources Of Taxable Income

Which of the following is both an item that is an allowable tax deduction to the partnership, reported separately on the individual partner’s Schedule K-1, and then included on the partner’s individual tax return?

Possible Answers:

Salaries paid to non-partner employees

Depreciation of equipment used in the business

Guaranteed payments paid to partners

Advertising expenditures

Correct answer:

Guaranteed payments paid to partners

Explanation:

Guaranteed payments are roughly equivalent to salary payments to partners for services performed. As a result, they are a deductible operating expense to the partnership, reported as income on the individual partner’s tax return, and guaranteed payments are one of the items specifically reported on the Schedule K-1. 

Example Question #3 : Individual Income Tax Sources Of Taxable Income

An individual partner received a Schedule K-1 from a partnership for year 2 reporting the following items:

Ordinary business income       $45,000

Interest income                        8,000

Net Section 1231 loss              5,000

Cash distribution                      6,000

Possible Answers:

$52,000

$54,000

$42,000

$48,000

Correct answer:

$48,000

Explanation:

The cash distribution is not a taxable event. The remaining items are all included as additions or deductions from ordinary income: ordinary business income (addition), interest income (addition), and the net Section 1231 loss (deduction). Section 1231 gains and losses are usually treated as ordinary gains and losses.

Example Question #4 : Individual Income Tax Sources Of Taxable Income

The holding period of a partnership interest acquired in exchange for a contributed capital asset begins on the date:

Possible Answers:

The partner is first credited with the proportionate share of partnership capital

The partner is admitted to the partnership

The partner’s holding period of the capital asset began

The partner transfers the asset to the partnership

Correct answer:

The partner’s holding period of the capital asset began

Explanation:

The holding period of a partnership acquired in exchange for a contributed capital asset begins on the date the partner’s holding period of the capital asset began.

Example Question #5 : Individual Income Tax Sources Of Taxable Income

On January 1, Year 2, ABC acquired a 50% interest in DEF 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 ABC’s basis in DEF at January 1, Year 2?

Possible Answers:

$4,000

$7,500

$3,500

$5,500

Correct answer:

$5,500

Explanation:

Basis $7,000 – Debt relief ($3,000 * 50%) $1,500 = $5,500 of basis.

Example Question #6 : Individual Income Tax Sources Of Taxable Income

A gain that represents a partner’s share of “hot assets” would be treated as:

Possible Answers:

Ordinary income

Capital gains

Both

Neither

Correct answer:

Ordinary income

Explanation:

An exception to the sale of capital asset sales in partnerships would be when a “hot asset” is sold. The treatment here would be as ordinary income.

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