Question 1

On December 12, 2020, Hook Company, a calendar year, cash basis business, mailed a $5,600 bill to Mrs. Gilder for professional services rendered during the month of November. Mrs. Gilder dropped off her $5,600 check at Hook's office on December 28, but the company secretary did not deposit the check in Hook's bank account until January 3. Which of the following statements is true?

Accepted Answer

CA) The constructive receipt doctrine states that income is recognized when it is actually or constructively received. In this case, Hook Company had access to the funds when the check was received on December 28, 2020, thus it should recognize the income in 2020.C) As a cash basis taxpayer, income is recognized when cash is actually received. Although the check was received in 2020, it was not deposited until 2021. However, the correct interpretation under the constructive receipt doctrine would typically require recognizing the income when the check was received, not when it was deposited. This choice might be considered correct in a strict cash basis context without considering constructive receipt, but it contradicts the more accurate application of tax principles.

Question 2

Welch Inc. has used a fiscal year ending September 30 as its taxable year since its incorporation in 1988. The shareholders have decided to shut down Welch's business and dissolve the corporation on March 31. Which of the following statements is false?

Accepted Answer

Since Welch's taxable year ends on September 30, its final tax return will cover the period from October 1 to March 31, which is less than 12 months and therefore considered a short-period return. However, option B correctly states this fact. Option C is false because it suggests that Welch's final tax return will only cover the period from January 1 to March 31, which is incorrect. Option D is not chosen because one of the statements is false.

Question 3

Village Inc. has average gross receipts of $100 million annually. This year, Village incurred $25 million of net business interest and has adjusted taxable income of $42 million. Village's current deduction for business interest is:

Accepted Answer

The Tax Cuts and Jobs Act (TCJA) introduced new business interest expense limitation rules, which limit the current deduction for business interest to 30% of the taxpayer's adjusted taxable income (ATI) plus the taxpayer's business interest income for the year. However, for taxable years beginning in 2019 and 2020, the CARES Act increased the limitation from 30% to 50% of ATI. In this case, Village Inc.'s limitation is calculated as: 
$42m (ATI) x 50% = $21m
Therefore, Village can currently deduct up to $21 million of its net business interest expense. However, Village's net business interest expense is $25 million, so the deduction is limited to $12.6 million (the full $21 million limitation minus the excess interest expense of $3.9 million). Therefore, the correct answer is C.

Question 4

Toro Inc. has average gross receipts of $30 million annually. In 2019, Toro incurred $7 million of net business interest and has adjusted taxable income of $12 million. Toro's current deduction for business interest is:

Accepted Answer

Under the Tax Cuts and Jobs Act (TCJA), businesses are generally allowed to deduct interest expenses up to 50% of their adjusted taxable income (ATI). For Toro Inc., with an ATI of $12 million, 50% of this amount is $6 million. Therefore, Toro can deduct up to $6 million of its $7 million net business interest expense.

Question 5

Toro Inc. has average gross receipts of $30 million annually. This year, Toro incurred $5 million of net business interest and has adjusted taxable income of $12 million. Toro's current deduction for business interest is:

Accepted Answer

Toro's deduction for business interest is limited to 30% of its adjusted taxable income ($12 million) which is equal to $3.6 million. Therefore, the deduction for Toro’s business interest expense is $3.6 million.

Question 6

Which of the following statements about tax policy objectives regarding business expenses is false?

Accepted Answer

The statement that the business interest expense limitation increases the disparity between the tax treatment of debt and equity financing is true. Therefore, the statement is false.

Question 7

Which of the following statements about the cash method of accounting is false?

Accepted Answer

Under the cash method, annual taxable income does not necessarily equal annual net cash inflow because not all cash inflows are taxable income, and not all cash outflows are deductible expenses.

Question 8

Tonto Inc. has used a calendar year as its taxable year since its incorporation in 1990. Tonto has an excellent business reason for changing to a fiscal year ending May 31. Which of the following statements is true?

Accepted Answer

When a corporation changes its taxable year, it must file a short-period return for the period from the end of the old taxable year to the beginning of the new taxable year. In this case, Tonto must file a short-period return for January 1 to May 31.

Question 9

Stack Inc. owns a $1 million insurance policy on the life of Mary Stack, the corporate CEO. The corporation is the policy beneficiary. Stack's annual premium on the policy is $3,160. Which of the following statements is true?

Accepted Answer

Premiums paid on a life insurance policy where the payer is also the beneficiary are not deductible as a business expense. However, the proceeds from such a policy are generally received tax-free by the beneficiary.

Question 10

JKL Inc. and Matthew Inc. enter into a business transaction. The two corporations are related parties for tax purposes. Which of the following statements is true?

Accepted Answer

When two corporations are related parties for tax purposes, the IRS has the right to reallocate income from the transaction to prevent distortion. This is done to ensure that the transaction is being conducted at arm's length and that the income is properly allocated between the two entities. The other options presented in the question are not necessarily true for related party transactions.

Question 11

Lawes Company, a cash basis business, mailed a $24,500 invoice to MWQ Partnership for professional services rendered. MWQ offered to pay the invoice by transferring 250 shares of ConAgri common stock to Lawes. The shares are selling on the NYSE at $98 per share. If Lawes accepts the shares in payment, it recognizes:

Accepted Answer

Since Lawes Company is a cash basis business, it recognizes income when it is received, regardless of the form in which it is received. Accepting 250 shares of ConAgri common stock valued at $98 per share results in receiving $24,500 (250 shares * $98 per share), which is equivalent to the invoice amount. Therefore, Lawes recognizes $24,500 as taxable income upon receipt of the shares.

Question 12

Which of the following statements about methods of accounting is false?

Accepted Answer

Taxpayers can use different methods of accounting for tax purposes and financial statement purposes as long as the methods clearly reflect the taxpayer's income.

Question 13

Jethro Company, an accrual basis taxpayer, had a $10,000 overdue account payable to a major supplier. The supplier agreed to settle the account for $9,000 cash from Jethro. Which of the following statements is true?

Accepted Answer

When a debt is settled for less than the amount owed, the difference is considered cancellation of debt income, which is taxable.

Question 14

Why does the federal tax law disallow a business deduction for political contributions?

Accepted Answer

Allowing a business deduction for political contributions would be considered a subsidy for partisan political activities, which is inconsistent with the principles of taxation. The government does not want to encourage companies to donate to political parties, so it chooses to disallow the deduction.

Question 15

Village Inc. has average gross receipts of $100 million annually. In 2019, Village incurred $25 million of net business interest and has adjusted taxable income of $42 million. Village's current deduction for business interest is:

Accepted Answer

Under the Tax Cuts and Jobs Act (TCJA), businesses with average gross receipts of more than $25 million are subject to limitations on business interest expense deductions. In this case, Village Inc. exceeds the threshold and will have its deduction for business interest limited.

To calculate the limitation, we need to determine the business interest expense limit. This is calculated as 30% of adjusted taxable income (42 million) plus business interest income (which is not provided in the question). Thus, the business interest expense limit is $12.6 million (30% x $42 million).

Next, we need to determine Village's actual business interest expense. This is provided in the question as $25 million.

Finally, we compare the actual business interest expense ($25 million) to the business interest expense limit ($12.6 million). Since the actual business interest expense exceeds the limit, the deduction for business interest is limited to the business interest expense limit of $12.6 million. Therefore, the correct answer is C.

Question 16

Which of the following business expenses always results in a difference between taxable income and book income?

Accepted Answer

Client entertainment expenses often result in differences between taxable income and book income because the IRS limits the deductibility of these expenses for tax purposes, whereas for financial accounting purposes, the full expense is typically recorded.

Question 17

Pim Inc. operates a business with a natural annual operating cycle ending August 31. Which of the following can Pim adopt as its taxable year?

Accepted Answer

Pim Inc. can adopt a calendar year or any fiscal year as its taxable year because businesses are generally allowed to choose their taxable year as long as it reflects their natural business cycle. Since Pim's natural business cycle ends on August 31, it can choose a fiscal year that aligns with this cycle or opt for the standard calendar year.

Question 18

Which of the following methods of accounting is never permissible for computing taxable income?

Accepted Answer

All of the methods listed, including the cash receipts and disbursements method, the accrual method, and the hybrid method, are permissible for computing taxable income under various circumstances and for different types of taxpayers.

Question 19

Why does the federal tax law disallow a business deduction for a fine or penalty paid to any government?

Accepted Answer

A deduction for the payment of a fine or penalty would effectively mean the public is subsidizing the penalized behavior, which is against public policy principles aiming to deter such behavior.

Question 20

Pozzi Company, a cash basis business, received $16,930 cash as payment on a loan Pozzi made to a business associate two years ago. The payment consisted of a $15,000 principal payment and $1,930 interest. On receipt of the cash, Pozzi recognizes:

Accepted Answer

The $15,000 principal payment is not taxable income since it just repays the loan. However, the $1,930 interest is taxable income for Pozzi Company.

Quiz 6: Taxable Income From Business Operations