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Accounting Methods and Records - See Special Enrollment Exam

  1. Which of the following is correct regarding the LIFO inventory method for a taxpayer's 2025 tax year?
    Answer: A taxpayer that elects LIFO for tax purposes must also use LIFO in reports to shareholders, partners or other proprietors, beneficiaries, and for credit purposes, under the LIFO conformity requirement. IRC §472(c) imposes the LIFO conformity requirement: a taxpayer using LIFO for tax must use no inventory method other than LIFO in reports to shareholders, partners or other proprietors, beneficiaries, and for credit purposes. Choice D is correct. Choice A is false because LIFO inventories are valued at cost; the lower-of-cost-or-market method is not available with LIFO. Choice B is false because the LIFO election generally must be made with the timely filed return (including extensions) for the year of election, on Form 970, not on an amended return filed years later. Choice C is false because the conformity requirement also applies to reports made for credit purposes.
  2. Which of the following correctly describes the taxpayer's method of accounting for 2025?
    Answer: The taxpayer's method is permissible: as a qualifying small taxpayer, she may treat inventory as non-incidental materials and supplies, deducting the costs consistently, without capitalizing them under section 263A. Governing authority: IRC §471(c) and §263A. A qualifying small taxpayer — one that meets the §448 gross receipts test (no more than $31 million of average annual gross receipts for the three preceding tax years), has no applicable financial statement, and uses the cash method — may treat inventory as non-incidental materials and supplies, deducting the cost in the year the goods are provided to customers or the year they are paid for, whichever is later, provided the treatment is consistent with the taxpayer's books and records. Such a taxpayer is not subject to §263A with respect to inventory. The taxpayer's $6 million average receipts and absence of an applicable financial statement qualify her, and because she holds no material year-end merchandise, goods are sold in the year she pays for them, so deducting costs when paid is permissible. Choice A is correct. Choice B states the general inventory rule but ignores the §471(c) small-taxpayer exception. Choice C wrongly asserts that the cash method is unavailable to a retailer; qualifying small retailers may use the cash method under §471(c). Choice D misapplies §263A, which does not require capitalization for this qualifying small taxpayer.
  3. Which of the following is correct regarding a taxpayer's obligation to obtain IRS consent when changing a method of accounting?
    Answer: A taxpayer that adopts an accounting method for the first time on its initial return is not changing a method of accounting and does not need IRS consent if the method clearly reflects income. IRC §446(e) and Treas. Reg. §1.446-1(e)(2)(ii)(b) require IRS consent for a change in method of accounting; adopting a method on the first return is not a change, and correction of mathematical or posting errors is not a change. Thus Choice A is correct. Choice B is false because the §448(c) gross receipts test determines whether a taxpayer is required to use accrual, but it does not excuse a voluntary change from one method to another from the consent requirement. Choice C is false because a mathematical or posting error is not a change in method of accounting and does not require Form 3115. Choice D is false because §446(e) applies to a change from one permissible method to another; consent is still required, usually by filing Form 3115.
  4. What amount from these three checks must be included in gross income on the plumber's 2025 return?
    Answer: $7,200 Governing authority: IRC §451(a) and Treas. Reg. §1.451-2(a) (constructive receipt). A cash-basis taxpayer includes income when it is actually or constructively received — when the taxpayer has unrestricted control over the amount — and a check is income when it is delivered or made available, not when it is deposited or cashed. The $7,200 check received on December 28 is 2025 income even though the plumber deposited it in January; the delay was the plumber's choice. The $3,800 check dated January 2, 2026, is not 2025 income: a post-dated check cannot be negotiated before its date, so receiving it on December 31 is subject to a substantial restriction. The $5,400 check mailed on December 30 was not received until January 5, 2026, so it was not actually or constructively received in 2025; a check is income when received, not when mailed. Choice A is correct. Choice B adds the $3,800 post-dated check, ignoring the substantial restriction on negotiating it. Choice C adds the $5,400 mailed check, applying a mailbox rule to the receipt of income, which the cash method does not recognize. Choice D includes all three checks, disregarding both the post-dating restriction and the January delivery of the mailed check.
  5. A cash-basis, calendar-year sole proprietor made the following payments in 2025: - $9,600 paid on July 1, 2025, for a 24-month business insurance policy covering July 1, 2025, through June 30, 2027. - $4,800 paid on October 1, 2025, for a 12-month business insurance policy covering October 1, 2025, through September 30, 2026. - $3,600 paid on December 15, 2025, for business rent for January 2026. - $5,400 paid on December 20, 2025, for consulting services to be performed in February 2026. What amount of these payments is deductible on the proprietor's 2025 return?
    Answer: $16,200 Authority: Treas. Reg. § 1.263(a)-4(f) (the 12-month rule). A taxpayer is not required to capitalize an amount paid to create a right or benefit that does not extend beyond the earlier of 12 months after the first date the benefit is realized or the end of the tax year following the year of payment; a payment that fails that test must be capitalized and amortized over the benefit period. The 24-month policy fails the 12-month rule because the benefit extends to June 30, 2027, beyond both July 1, 2026 (12 months after coverage began) and December 31, 2026; it is capitalized and amortized over 24 months, giving 6/24 × $9,600 = $2,400 for 2025. The 12-month policy qualifies: the benefit ends September 30, 2026, within 12 months after coverage began and before December 31, 2026, so the full $4,800 is deductible in 2025. The January 2026 rent and the February 2026 consulting services are benefits realized and exhausted in 2026, well before December 31, 2026, so the $3,600 and $5,400 are deductible when paid in 2025. Total: $2,400 + $4,800 + $3,600 + $5,400 = $16,200. Choice C is correct. Choice A ($3,600) ignores the 12-month rule, amortizing both insurance policies over their coverage periods (6/24 × $9,600 = $2,400 plus 3/12 × $4,800 = $1,200) and capitalizing the rent and consulting services with no 2025 deduction. Choice B ($13,800) applies the 12-month rule to the short-term items but capitalizes the 24-month policy without amortizing the six months of 2025 coverage. Choice D ($23,400) deducts all four payments in full, ignoring the capitalization requirement for the 24-month policy.
  6. Which of the following is correct regarding the installment method under IRC §453 for a sale in 2025?
    Answer: A taxpayer who sells depreciable personal property at a gain and uses the installment method must recognize the depreciation recapture income in the year of sale; only the gain in excess of that recapture may be reported as payments are received. IRC §453(i) requires depreciation recapture to be recognized in the year of sale; only gain in excess of recapture may be reported under the installment method. Choice C is correct. Choice A is false because §453(b)(2) denies installment reporting for dealer dispositions, including real property held for sale to customers; the amount of the sales price does not make the property eligible. Choice B is false because §453(k)(2) bars installment reporting for stock or other property regularly traded on an established securities market. Choice D is false because the installment method is not limited to cash-method taxpayers; an accrual-method taxpayer may use it for a non-dealer disposition.
  7. What is the correct advice about retaining these records?
    Answer: She must keep them until the limitations period for the 2025 return expires, generally three years after filing, because the records substantiate the van's adjusted basis and the gain on the sale. Governing authority: IRC §6001, Treas. Reg. §1.6001-1(a), and IRS Pub. 583. Taxpayers must keep books and records sufficient to establish the items on their returns, and records supporting the basis of an asset must be kept until the period of limitations expires for the year in which the asset is sold or otherwise disposed of. The van was fully depreciated by 2018, but the 2012 purchase invoice and the depreciation schedule are needed to compute the adjusted basis and the gain on the March 2025 sale, so they must be retained at least until the period of limitations for the 2025 return expires — generally three years after the return is filed. Choice D is correct. Choice A overlooks the 2025 sale; the expiration of the limitations periods for the years the depreciation was claimed does not end the records' usefulness because the basis carries into the year of sale. Choice B substitutes the four-year employment tax record retention rule, which applies to employment tax records, not to income tax records supporting asset basis. Choice C invents a seven-year rule for business dispositions; the seven-year retention guideline relates to claims for worthless securities and bad debts.
  8. For a cash-method taxpayer, which of the following is correct regarding the timing of income for 2025?
    Answer: Under the cash method, income is constructively received when credited to the taxpayer's account or set apart without substantial limitation or restriction, even if not reduced to possession by year end. Treas. Reg. §1.451-2(a) provides that income is constructively received when it is credited to a taxpayer's account or set apart without substantial limitations or restrictions, and the taxpayer need not have actual possession. Choice C is correct. Choice A is false because a negotiable check received on December 31 is income when received, not when deposited. Choice B is false because actual reduction to possession is not a prerequisite to constructive receipt. Choice D is false because an unconditional credit on December 31 is constructive receipt even if the employer does not pay the bonus until the next year.
  9. An accrual-basis, calendar-year C corporation had the following expenses for 2025: - $60,000 consulting fees for services performed and invoiced in December 2025, paid to an unrelated consultant on February 1, 2026. - A $30,000 bonus to its president, who owns 60% of the corporation's stock and reports on the cash method, authorized by the board on December 15, 2025, for services performed in 2025, and paid on April 2, 2026. - A $22,000 charitable contribution pledged to a university on December 1, 2025, and paid on April 10, 2026. The board of directors did not authorize the contribution during 2025. - $10,000 for December 2025 utilities, billed on December 30, 2025, and paid on January 5, 2026. What amount of these expenses is deductible on the corporation's 2025 return?
    Answer: $70,000 IRC § 461(h) (economic performance); IRC § 267(a)(2) (related-party timing); IRC § 170(a)(2) (accrual-basis charitable contributions). Under the accrual method, an expense is deductible when the all-events test is met and economic performance has occurred. The $60,000 consulting fee is deductible in 2025: the unrelated consultant performed the services in December 2025, so economic performance occurred then, and payment in February 2026 does not change the year of deduction. The $10,000 of utilities is deductible in 2025 because economic performance occurs as the utility service is provided, in December 2025. The $30,000 bonus is not deductible in 2025: the president owns more than 50% of the stock, so he is a related person under § 267(b)(2), and because he uses the cash method, § 267(a)(2) defers the corporation's deduction until he includes the bonus in income in 2026. The $22,000 contribution is not deductible in 2025: under § 170(a)(2), an accrual-basis corporation may deduct a contribution in the year before payment only if the board authorizes it during that year and it is paid by the 15th day of the 4th month after year-end (April 15, 2026, for a 2025 authorization). The April 10 payment was timely, but the board did not authorize the contribution in 2025, so it is deductible in 2026, when paid. Together, the $60,000 fee and the $10,000 of utilities total $70,000, which is Choice B. Choice A ($60,000) omits the utilities, treating them as deductible when paid in January 2026, although economic performance occurred in December 2025. Choice C ($92,000) adds the contribution, applying the § 170(a)(2) election although the board did not authorize the contribution during 2025. Choice D ($100,000) adds the bonus, ignoring the § 267(a)(2) deferral for an amount owed to a cash-method shareholder who owns more than 50% of the stock.
  10. Which of the following is correct for 2025 regarding the use of the cash receipts and disbursements method of accounting?
    Answer: A qualified personal service corporation that is a C corporation may use the cash method even if its average annual gross receipts for the three preceding tax years exceed $31 million. IRC §448(b)(2) permits a qualified personal service corporation to use the cash receipts and disbursements method without regard to the §448(c) gross receipts test. Choice B states that rule. Choice A misstates the scope of the gross receipts exception: the §448(b)(3) exception does not apply to tax shelters, which are prohibited from using the cash method by §448(a)(3). Choice C is false because a partnership with a C corporation partner whose average gross receipts exceed $31 million fails the gross receipts exception in §448(b)(3) and is therefore required to use the accrual method; not being a tax shelter does not cure that failure. Choice D is false because §448 applies to C corporations and partnerships with C corporation partners, not to S corporations; an S corporation is not required to use the accrual method for all items solely because its gross receipts exceed the §448(c) threshold.
  11. On which return may the corporation deduct the bonus?
    Answer: On its 2025 return, because the corporation became liable for a definite bonus amount in 2025, the services were performed in 2025, and the engineer's 20% stock interest does not make her a related party. Governing authority: IRC §461(h), §404(b), §267(a)(2) and (b)(2); Treas. Reg. §1.461-4(d)(2)(i); Treas. Reg. §1.404(b)-1T. An accrual-method employer may deduct a bonus in the year in which the all-events test is met and economic performance has occurred. The employer became liable for a definite bonus amount on December 15, 2025, and economic performance for compensation occurs as the services are performed, so the deduction is properly taken in 2025. Payment on January 10, 2026, also falls within the 2½-month period following year-end, so the bonus is not treated as deferred compensation under Treas. Reg. §1.404(b)-1T. Section 267(a)(2) does not defer the deduction because the engineer is not a related party: an individual is related to a corporation under §267(b)(2) only if the individual owns more than 50% of the stock, and she owns 20%. Choice A is correct. Choice B applies a cash-method timing rule to an accrual-basis corporation; payment is not the event that fixes the deduction. Choice C applies the §267 matching rule to a 20% owner, ignoring the more-than-50% ownership requirement. Choice D imposes a payment-by-due-date condition that the law does not require; the applicable timing rule for the payment is the 2½-month period for non-deferred compensation.
  12. How must the corporation treat these costs on its 2025 return?
    Answer: The invoice price, freight and warehouse rent must be capitalized into inventory, but the in-store unloading and shelving wages are currently deductible. IRC § 263A and Treas. Reg. § 1.263A-3(c). The corporation's average annual gross receipts of $38 million exceed the 2025 $31 million small-business threshold, so it is subject to § 263A as a reseller. It capitalizes the invoice price, the inbound freight, and the rent for the off-site warehouse, which is a storage cost of an off-site storage facility. Handling costs are generally capitalized, but handling costs incurred at a retail sales facility for goods sold to retail customers at that facility, such as unloading, unpacking and shelving, are not required to be capitalized. The in-store wages are therefore currently deductible. Choice C is correct. Choice A treats inventory costs as period costs. Choice B omits freight-in and off-site storage costs, which a § 263A reseller must capitalize. Choice D applies the general handling-cost rule and ignores the retail-sales-facility exception.
  13. How should the corporation correct its treatment of the long-term contracts?
    Answer: File Form 3115 to change to the percentage-of-completion method and take the resulting section 481(a) adjustment into account over the applicable adjustment period, without amending prior returns. Governing authority: IRC §446(e), §460, and §481(a); Treas. Reg. §1.446-1(e)(2)(ii). A long-term construction contract generally must be accounted for under the percentage-of-completion method, and a 30-month office-building contract is not a small construction contract because that exception requires expected completion within two years. The change from the cash method to the required method is a change in accounting method—a change from an improper method to a proper method is still a change in method—so the corporation must obtain IRS consent (normally by filing Form 3115) and account for the cumulative difference as a section 481(a) adjustment; it does not amend its prior returns. Choice C is correct. Choice A treats the longstanding practice as a return-preparation error correctable by amended returns; a multi-year treatment of a material item is a method of accounting, not an error. Choice B omits the consent requirement; attaching a disclosure statement is not a method of obtaining consent. Choice D misunderstands Form 8275, which is a disclosure used to avoid certain penalties and does not make an impermissible method permissible.
  14. Which business is prohibited from using the cash method for its 2025 return?
    Answer: The C corporation with $34 million of average annual gross receipts, because its three-year average exceeds the $31 million gross receipts threshold for 2025. Governing authority: IRC §448(a), (b), and (c). The cash method is prohibited for a C corporation, for a partnership with a C corporation partner, and for a tax shelter, unless the taxpayer meets the gross receipts test: average annual gross receipts for the three prior tax years may not exceed the inflation-adjusted threshold, which is $31 million for 2025. The C corporation with a $34 million average fails the test and must use the accrual method for 2025. Choice B is correct. Choice A states a rule that does not exist — a C corporation may use the cash method when it satisfies the gross receipts test (and the facts exclude the qualified personal service corporation exception). Choice C misapplies the threshold to a partnership that has no corporate partners; §448 does not restrict such a partnership's overall method (and the facts say it is not a tax shelter). Choice D repeats that error for the partnership.

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