CPA Regulation (REG) : Special Issues in Taxation of Organizations

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

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Example Questions

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Example Question #5 : Book/Tax Differences

A C Corp had a beginning credit balance in its warranty reserve account of $120,000. During the year, it accrued estimated warranty expense of $16,000. At the end of the year, the Corp’s warranty reserve had a $90,000 credit balance. What amount of warranty expense should the C Corp deduct?

Possible Answers:

$16,000

$46,000

$30,000

$14,000

Correct answer:

$46,000

Explanation:

Companies may only deduct the actual amount of cost incurred in meeting their warranty obligations. The actual cost incurred by the Corp in meeting its warranty obligation is calculated as $120,000 + $16,000 - $90,000 = $46,000.

Example Question #6 : Book/Tax Differences

Of the following items, which would result in a permanent book to tax difference as compared to a temporary?

Possible Answers:

Municipal bonds

Organizational cost deductions

LIFO accounting

Depreciation

Correct answer:

Municipal bonds

Explanation:

Muni bonds are local government bonds which are tax-deductible for federal purposes. This income will never be taxed at the federal level, thus creating a permanent difference.

Example Question #1 : Tax Exempt Organizations

With regard to unrelated business income of an exempt organization, which one of the following statements is correct?

Possible Answers:

An exempt organization is not taxed on unrelated business income of less than $1,000.

An exempt organization that earns any unrelated business income in excess of $100,000 during a particular year will lose its exempt status for that particular year.

The tax on unrelated business income can be imposed even if the unrelated business activity is intermittent and is carried on once per year.

An unrelated trade or business activity that results in a loss is excluded from the definition of unrelated business.

Correct answer:

An exempt organization is not taxed on unrelated business income of less than $1,000.

Explanation:

Unrelated business income (UBI) is tax exempt up to $1,000 (only UBI in excess of $1,000 is taxed). Any activity that would create UBI that results in a loss may be carried over like the NOL of any other organization. UBI does not have a specific limit above which tax exempt status is lost. Additionally, UBI relates to an ongoing business enterprise, and does not apply to one-time or intermittent activity.

Example Question #2 : Tax Exempt Organizations

The private foundation status of an exempt organization will terminate if it:

Possible Answers:

Is governed by a charter that limits the exempt purposes.

Does not distribute all of its net assets to one or more public charities.

Is a foreign corporation.

Becomes a public charity.

Correct answer:

Becomes a public charity.

Explanation:

Termination of tax-exempt status for a private foundation may occur voluntarily or involuntarily. Involuntary termination occurs when a foundation becomes a public charity; an organization cannot be both. Involuntary termination may also occur if the IRS makes a determination to terminate tax exempt status of an organization due to repeated or willful violations of private foundation provisions.

Example Question #3 : Tax Exempt Organizations

Which of the following activities regularly conducted by a tax-exempt organization will result in unrelated business income?

I.  Selling articles made by disabled persons as part of their rehabilitation, when the organization is involved exclusively in their rehabilitation.
II. Operating a grocery store almost fully staffed by emotionally disabled persons as part of a therapeutic program.

Possible Answers:

II only

Both I and II

Neither I nor II

I only

Correct answer:

Neither I nor II

Explanation:

Unrelated business income (UBI) is an unrelated business that meets three criteria: 1) it is a trade or business; 2) it regularly carried on; and 3) is not substantially related to furthering the tax-exempt purpose of the organization. In both of the options given, the information indicates that these activities relate to a tax-exempt organization’s purpose (rehabilitation of disabled persons or therapy for emotionally disabled persons). 

Example Question #4 : Tax Exempt Organizations

Of the following types of business, which may not qualify for a 501c3 exemption from federal income taxes?

Possible Answers:

A partnership

A fund

A foundation

Corporation

Correct answer:

A partnership

Explanation:

Partnerships are not included in the tax exempt section of IRC Section 501c3 which provides for corporations, funds, and foundations to be organizations eligible for exemption from federal income taxes.

Example Question #5 : Tax Exempt Organizations

ABC Trust is an exempt organization that operates under a corporate charter granted by the state in which its principal office is located. ABC’s tax on unrelated business taxable income is:

Possible Answers:

Credited against the tax on recognized gains

Abated

Computed at rates applicable to trusts

Computed at corporate income tax rates

Correct answer:

Computed at corporate income tax rates

Explanation:

ABC’s tax on unrelated business taxable income is computed at corporate income tax rates. Unless the organization is taxable as a trust, its UBTI is subject to regular corporate taxes.

Example Question #6 : Tax Exempt Organizations

Which of the following is the correct designation for an exempt organization?

Possible Answers:

501(c)(3)

100(b)(4)

Both

Neither

Correct answer:

501(c)(3)

Explanation:

Under US Federal regulations, tax-exempt organizations are qualified under 501(c)(3).

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