CPA Regulation (REG) : Taxation of Flow-Through Entities

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

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Example Questions

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Example Question #1 : Taxation Of Flow Through Entities

Anne and Bart formed AB, LLC, a limited liability company, and elected to treat it as a partnership for tax purposes. Anne contributed $10,000 cash, and Bart contributed $5,000 cash, but Bart had a special skill that the partnership needed to be successful. The partnership agreement stated that Anne and Bart would both have a 50% interest in the LLC and that all profits and losses would be divided evenly between them. The LLC paid Bart $5,000 in year 1 for Bart's services to the partnership. The $5,000 would generally be reported to Bart as which of the following?

Possible Answers:

A guaranteed payment.

Wages.

Dividends.

Salary.

Correct answer:

A guaranteed payment.

Explanation:

When a capital interest is acquired for services provided to a partnership, the interest is treated as ordinary income to the partner. Ordinary income to a partner is classified as guaranteed payments.

Example Question #2 : Taxation Of Flow Through Entities

A partner sold a 25% interest in a partnership for $400,000 cash plus assumption of the partner's share of the partnership liabilities. The following additional information relates to the partnership activities:

  • Partner's initial cash contribution: $ 100,000
  • Partnership income during the partner's ownership time period: 1,000,000
  • Partnership liabilities at date of sale: 60,000
  • Partner's cash withdrawals: 50,000

How much gain is recognized by the partner upon the sale of the partnership interest?

Possible Answers:

$650,000

$35,000

$50,000

$100,000

Correct answer:

$100,000

Explanation:

To determine the gain on the sale of the interest, the partner’s basis in the interest must first be determined:

  • Initial Contribution: $100,000
  • 25% Partnership Income over Period of Ownership: $250,000
  • 25% Share of Partnership Liabilities: $15,000
  • Partner’s Cash Withdrawals: $(50,000)
  • Total Partnership Basis: $315,000

Example Question #3 : Taxation Of Flow Through Entities

Taryn, Rose, and Summer are equal partners in TRS partnership. Taryn contributed land with an adjusted basis of $20,000 and a fair market value (FMV) of $50,000. Rose contributed equipment with an adjusted basis of $40,000 and an FMV of $50,000. Summer provided services worth $50,000. What amount of income is recognized as a result of the transfers?

Possible Answers:

$150,000

$60,000

$90,000

$50,000

Correct answer:

$50,000

Explanation:

In formation of a partnership, the only two instances in which a gain (income) is recognized is when a partner contributes services in exchange for capital interest, or when property contributed is subject to a liability in excess of the property’s adjusted basis. Here, Summer provided services and so would recognize $50,000 of income. The other two partners would recognize no gain on their contribution of property.

Example Question #4 : Taxation Of Flow Through Entities

In the absence of an election to adopt an annual accounting period, the required tax year for a partnership is:

Possible Answers:

A tax year of one or more partners with a more than 50% interest in profits and capital

A tax year of a principal partner having a 10% or greater interest

A calendar year

A tax year that results in the greatest aggregate deferral of income

Correct answer:

A tax year of one or more partners with a more than 50% interest in profits and capital

Explanation:

In the absence of election to adopt an annual accounting period, the required tax year for a partnership is the tax year of one or more partners who have more than 50% interest in aggregate of profits and capital, per the majority interest rule

Example Question #5 : Taxation Of Flow Through Entities

Andrew contributed the following assets to a partnership in exchange for a 50% interest in the partnership’s capital and profits: Cash of $50,000, Equipment with a FMV of $35,000 and Carrying amount of $25,000. Andrew’s basis in the partnership is:

Possible Answers:

$75,000

$42,500

$85,000

$37,500

Correct answer:

$85,000

Explanation:

The basis of the partner’s interest in the partnership is calculated as $50,000 + $25,000 = $75,000.

Example Question #6 : Taxation Of Flow Through Entities

A partner’s basis in a partnership will increase by his or her share of liabilities assumed by the partnership.

Possible Answers:

False

False if the partnership was formed before 2017

True if the partnership was formed before 2017

True

Correct answer:

True

Explanation:

This statement is true and has no correlation with the TCJA or any other tax reform.

Example Question #7 : Taxation Of Flow Through Entities

Strom acquired a 25% 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?

Possible Answers:

$16,000

$32,000

$26,000

$0

Correct answer:

$0

Explanation:

Since Strom contributed property subject to a liability, where the value of the liability exceeded the property, Strom begins with a negative basis of $(8,000). Strom’s partnership basis is increased by the assumption of the 25% share of the liability (=$6,000), bringing Strom’s basis up to $(2,000). Since a negative basis is not possible, Strom would have to recognize a gain to bring the partnership basis up to zero.

Example Question #1 : Taxation Of Flow Through Entities

Lemon owned 2,000 shares of Spectrol Corp. common stock that were purchased in year 1 at $10.50 per share. In year 4, Lemon received a 5% non-taxable dividend of Spectrol common stock. In year 5, the stock split 2-for-1. In the current year Lemon sold 800 shares. What is Lemon's basis in the 800 shares of stock sold?

Possible Answers:

$16,800

$4,000

$8,000

$8,400

Correct answer:

$4,000

Explanation:

The original basis in the stock was $21,000 (2,000 shares at $10.50/share). The stock dividend of 5% increased the number of shares by 100 (2,000 * 5%), bringing the total shares to 2,100, while the basis remained the same ($21,000) and consequently the per share value decreased to $10/share. The stock split doubled the number of shares from 2,100 to 4,200, but the basis remained the same and the per share value was halved (from $10/share to $5/share). As a result, the 800 shares sold had a basis of $4,000 (800 shares * $5/share).

Example Question #9 : Taxation Of Flow Through Entities

Mark and Mary formed MM, Inc. as an S corporation. Each contributed $50,000 in exchange for five shares of corporate stock. In addition, MM obtained a $60,000 loan from a local bank that was still outstanding at the end of the year. In MM's first year of operation, it reported a loss of $20,000 and did not make any distributions to the shareholders. What is Mark's basis in his MM shares at the beginning of the second year?

Possible Answers:

$70,000

$50,000

$100,000

$40,000

Correct answer:

$40,000

Explanation:

Mark began with a basis of $50,000, which was decreased by his 50% share of the operating loss of $20,000. As a result, his basis was $40,000 at the beginning of the second year. For S corporations, unlike partnerships, liabilities assumed by the corporation do not increase shareholders’ basis in the organization.

Example Question #10 : Taxation Of Flow Through Entities

Steve received a one third interest in a partnership by contributing $3,000 in cash, stock with FMV of $5,000 and a basis of $2,000, and a new computer that cost Steve $2,500. Of the following, which amount represents Steve’s basis in the partnership?

Possible Answers:

$7,500

$5,500

$10,500

$3,000

Correct answer:

$5,500

Explanation:

Steve’s basis in the partnership is calculated as $3,000 cash + $2,000 stock basis + $2,500 computer basis.

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