CPA Exam — Taxation and Regulation (REG) — All Questions

Axel Corp.'s book net income is $500,000. It includes: federal income tax expense of $105,000; tax-exempt municipal bond interest of $10,000; a $5,000 fine paid to a state agency for a safety violation; $8,000 of business meals, all expensed; and book depreciation that is $30,000 less than tax depreciation. What is Axel's taxable income on Schedule M-1?

• a.$604,000
• b.$570,000
• c.$584,000
• d.$574,000✓

Add back federal income tax ($105,000, nondeductible under IRC 275), the fine ($5,000, IRC 162(f)) and the nondeductible half of meals ($4,000, IRC 274(n)); subtract the tax-exempt interest ($10,000, IRC 103) and the extra tax depreciation ($30,000). $500,000 + $105,000 + $5,000 + $4,000 - $10,000 - $30,000 = $574,000. $570,000 forgets the meals, $584,000 forgets the municipal interest, and $604,000 forgets the depreciation.

In 2025 Dune Corp., a C corporation, has a $30,000 net capital loss and ordinary income of $200,000. How may Dune use the capital loss?

• a.Carry it back 3 years, then forward 5, against capital gains only✓
• b.Carry it forward indefinitely and deduct it against any income
• c.Deduct $3,000 against ordinary income and carry the rest forward
• d.Deduct all $30,000 against this year's ordinary business income

IRC 1211(a) allows a corporation's capital losses only to the extent of capital gains. Under IRC 1212(a)(1), a corporation's net capital loss is carried back to each of the 3 preceding years and then forward to each of the 5 following years, treated as a short-term capital loss in those years. The $3,000 allowance against ordinary income and the indefinite carryforward are rules for individuals (IRC 1211(b), 1212(b)).

Elm Corp. has a $300,000 net operating loss carryforward from 2022. In 2025 its taxable income before the NOL deduction is $250,000. What is Elm's 2025 NOL deduction?

• a.$300,000, creating a $50,000 new NOL
• b.$200,000, with $100,000 carried forward✓
• c.$250,000, with $50,000 carried forward
• d.$187,500, with $112,500 carried forward

For taxable years beginning after 2020, IRC 172(a)(2) limits the deduction for NOLs arising after 2017 to 80 percent of taxable income computed without the NOL deduction: 80 percent x $250,000 = $200,000. The remaining $100,000 carries forward indefinitely (IRC 172(b)(1)(A)). A carryforward cannot be used beyond the 80 percent limit or to create a new loss.

Fir Corp. had taxable income of $1.5 million in 2023. Its 2024 tax was $200,000, and its 2025 tax is $260,000. For its second through fourth 2025 estimated tax installments, what required annual payment must Fir use to avoid a penalty?

• a.$220,000, 110% of the prior year's tax
• b.$260,000, 100% of current-year tax✓
• c.$234,000, 90% of the current-year tax
• d.$200,000, 100% of the prior year's tax

IRC 6655(d)(1)(B) normally allows the lesser of 100 percent of current-year tax or 100 percent of prior-year tax. A large corporation, one with taxable income of $1 million or more in any of the three preceding years (6655(g)(2)), cannot use the prior-year amount except for its first installment (6655(d)(2)). Fir qualifies because of 2023, so installments 2-4 must be based on the $260,000 current-year tax. The 90 and 110 percent figures are individual rules under IRC 6654.

Gale Corp. spends $10,000 on business meals with clients, where business is discussed, and $6,000 on tickets for clients to professional sporting events. How much of the $16,000 may Gale deduct?

• a.$5,000✓
• b.$16,000
• c.$8,000
• d.$10,000

IRC 274(a)(1) disallows any deduction for activities of a type generally considered entertainment, amusement or recreation, so the sporting event tickets are not deductible at all. Business meals are limited to 50 percent by IRC 274(n)(1), giving $5,000. $8,000 applies 50 percent to both items.

Hale Corp., a calendar-year corporation, begins business on October 1, 2025. It paid $52,000 of legal and state incorporation fees to organize and $8,000 of commissions to sell its stock. It elects to deduct and amortize organizational expenditures. What is its 2025 deduction?

• a.$5,783
• b.$1,000
• c.$3,000
• d.$3,817✓

Stock issuance costs are not organizational expenditures (Treas. Reg. 1.248-1(b)(3)(i)), so only $52,000 counts. IRC 248(a) allows $5,000 reduced by the $2,000 excess over $50,000, or $3,000, plus the remaining $49,000 over 180 months beginning in October: $49,000 / 180 x 3 = $817. Total $3,817. $3,000 omits the amortization, $5,783 ignores the $50,000 phase-down of the $5,000, and $1,000 wrongly treats the stock commissions as organizational costs ($60,000 eliminates the immediate deduction, leaving $60,000 / 180 x 3).

Jade Co. sells tangible goods to customers in State X. Its only in-state activity has been solicitation of orders by traveling sales reps, with orders approved and shipped from outside State X. Which new activity would cost Jade the protection of Public Law 86-272 from State X's net income tax?

• a.Its reps begin soliciting orders that are sent out for approval
• b.Its employees begin repairing customers' machines in State X✓
• c.Its reps begin soliciting orders from State X buyers by phone
• d.It begins shipping approved orders from a warehouse in State Y

15 U.S.C. 381(a) bars a state from imposing a net income tax when the only in-state activities are solicitation of orders for sales of tangible personal property that are sent outside the state for approval and filled by shipment from outside the state. Performing repair services in the state goes beyond solicitation, so the protection is lost. Soliciting by phone, shipping from another state, and sending orders out for approval all stay within the statute.

Kiln Corp., commercially domiciled in State A, has $1,000,000 of apportionable business income and $50,000 of nonbusiness dividends. State A uses the UDITPA equally weighted three-factor formula, and Kiln's State A factors are property 40%, payroll 30% and sales 20%. How much income is taxable in State A?

• a.$200,000
• b.$300,000
• c.$315,000
• d.$350,000✓

Business income is apportioned by the average of the property, payroll and sales factors: (40% + 30% + 20%) / 3 = 30%, and 30% x $1,000,000 = $300,000. Under UDITPA, nonbusiness interest and dividends are allocated to the state of commercial domicile, so all $50,000 goes to State A, for $350,000. $315,000 wrongly apportions the dividends, and $200,000 uses the sales factor alone.

A corporation wants to be an S corporation. Which of these shareholders would make it ineligible?

• a.An individual who is a resident alien
• b.A charity exempt under section 501(c)(3)
• c.The estate of a deceased shareholder
• d.A partnership that owns 5% of its stock✓

IRC 1361(b)(1)(B) allows only individuals, estates, certain trusts and organizations described in 1361(c)(6) (which includes 501(c)(3) charities) as shareholders, so a partnership shareholder disqualifies the corporation. Only nonresident aliens are barred (1361(b)(1)(C)); a resident alien is an eligible individual shareholder.

A corporation has one class of common stock outstanding, but some shares are voting and others are nonvoting; all shares have identical rights to distributions and liquidation proceeds. Can it be an S corporation?

• a.No; voting and nonvoting shares are two classes of stock
• b.Yes, if nonvoting shares are under 50 percent
• c.Yes; voting differences alone don't make a second class✓
• d.No, unless the nonvoting holders consent to the election

An S corporation may not have more than one class of stock (IRC 1361(b)(1)(D)), but IRC 1361(c)(4) provides that differences in voting rights among shares of common stock are disregarded for that purpose. With identical distribution and liquidation rights, the corporation has one class. There is no percentage limit on nonvoting shares; all shareholders must consent to the election in any case.

A corporation has 103 shareholders: a married couple, their three adult children, and 98 unrelated individuals. All are U.S. citizens, and there is one class of stock. Does it meet the S corporation shareholder limit?

• a.No; just the married couple counts as one holder
• b.Yes, if the children hold less than 10 percent
• c.No; it has 103 shareholders, which is over the 100 limit
• d.Yes; the family counts as one shareholder, making 99✓

IRC 1361(b)(1)(A) limits an S corporation to 100 shareholders, but IRC 1361(c)(1) treats all members of a family (a common ancestor, lineal descendants, and their spouses) as one shareholder. The couple and their children count as one, so there are 99 shareholders. There is no ownership-percentage condition on the family rule.

An eligible calendar-year corporation files Form 2553, with all shareholders' consents, on March 20, 2025, and asks for no late-election relief. When does its S election take effect?

• a.March 20, 2025
• b.April 1, 2025
• c.January 1, 2025
• d.January 1, 2026✓

IRC 1362(b)(1) makes an election effective for the current year only if it is made in the preceding year or by the 15th day of the third month of the current year, here March 15, 2025. An election made after that date is treated as made for the following taxable year (1362(b)(3)), so it takes effect January 1, 2026, unless the IRS grants late-election relief under 1362(b)(5). Elections are not effective mid-year.

On February 20, 2025, shareholders holding 60 percent of a calendar-year S corporation's shares consent to revoke its S election, without specifying a future date. What is the result?

• a.The revocation takes effect February 20, 2025
• b.The revocation is invalid without unanimous consent
• c.The revocation takes effect January 1, 2025✓
• d.The revocation takes effect January 1, 2026

IRC 1362(d)(1)(B) allows revocation with the consent of shareholders holding more than one-half of the shares, so 60 percent is enough. Under 1362(d)(1)(C), a revocation made on or before the 15th day of the third month of the year is effective on the first day of that year; one made later is effective the next year, unless a prospective date is specified (1362(d)(1)(D)).

On August 10, 2025, a shareholder of a calendar-year S corporation sells some of her shares to a nonresident alien. When does the S election terminate?

• a.When the IRS sends notice
• b.As of January 1, 2025
• c.On August 10, 2025✓
• d.As of January 1, 2026

A nonresident alien is an ineligible shareholder (IRC 1361(b)(1)(C)), so the corporation stops being a small business corporation on the sale date. Under IRC 1362(d)(2)(B), a termination for ceasing to be a small business corporation is effective on and after the date of cessation, so the year splits into an S short year and a C short year. No IRS action is needed.

A corporation's S election terminated effective January 1, 2025. Without IRS consent, what is the first taxable year for which it may make a new S election?

• a.Any year, as soon as it meets the eligibility rules
• b.2030, its fifth year after the 2025 termination year✓
• c.2028, after three full years as a C corporation
• d.2026, the year after the termination took effect

IRC 1362(g) bars a corporation whose election was terminated from re-electing for any taxable year before its fifth taxable year that begins after the first taxable year for which the termination is effective, unless the Secretary consents. The first year of termination is 2025; the fifth year beginning after it is 2030.

Which S corporation faces termination of its election because of passive investment income?

• a.One with no C-year earnings and profits and passive income of 60% of receipts for 4 years
• b.One with C-year earnings and profits and passive income of 20% of receipts for 3 years
• c.One with C-year earnings and profits and passive income over 25% of receipts for 3 years✓
• d.One with C-year earnings and profits and passive income over 25% in 2 of the last 3 years

IRC 1362(d)(3) terminates an S election when the corporation has accumulated earnings and profits at the close of each of 3 consecutive taxable years and more than 25 percent of its gross receipts in each of those years is passive investment income. A corporation with no accumulated earnings and profits (for example, one that was never a C corporation) cannot fail the test, and the percentage must be exceeded in all three consecutive years.

When preparing Form 1120-S, which item must be separately stated to shareholders rather than included in ordinary business income?

• a.Regular MACRS depreciation
• b.Charitable contributions✓
• c.Cost of goods sold
• d.Salaries paid to shareholders

IRC 1366(a)(1)(A) requires separate statement of items whose separate treatment could affect a shareholder's tax, such as charitable contributions, which are subject to individual limits. Reasonable salaries to shareholder-employees, ordinary MACRS depreciation and cost of goods sold enter into nonseparately computed ordinary business income under 1366(a)(1)(B).

Lena's stock basis in an S corporation is $20,000 at the start of the year, and she has no debt basis. Her shares of this year's items are: ordinary business income $15,000; tax-exempt interest $1,000; nondeductible expenses $2,000; long-term capital loss $5,000. She received a $30,000 cash distribution and made no special ordering election. How much of the capital loss may she deduct this year?

• a.$5,000, with nothing carried forward
• b.$2,000, with $3,000 carried forward
• c.$4,000, with $1,000 carried forward✓
• d.$0, since the distribution came first

Under Treas. Reg. 1.1367-1(f), basis is first increased for income ($20,000 + $15,000 + $1,000 = $36,000), then reduced for distributions ($6,000 left, so the distribution is tax-free), then for nondeductible expenses ($4,000 left), and last for losses. Only $4,000 of the $5,000 loss is allowed (IRC 1366(d)(1)); $1,000 carries forward indefinitely (1366(d)(2)). $5,000 would require the elective ordering rule of 1.1367-1(g).

Max owns stock in an S corporation that has never been a C corporation. His stock basis is $10,000 before he receives a $16,000 cash distribution, and there are no other items for the year. How is the distribution treated?

• a.All $16,000 is dividend income, reported on Schedule B
• b.$10,000 is tax-free and $6,000 is ordinary wage income
• c.All $16,000 is tax-free, leaving him with negative basis
• d.$10,000 is tax-free and $6,000 is gain from a sale of the stock✓

For an S corporation with no accumulated earnings and profits, IRC 1368(b) treats a distribution as a tax-free recovery of stock basis, and any excess over basis as gain from the sale or exchange of property, generally capital gain for stock held as a capital asset. Stock basis cannot go below zero (IRC 1367(a)(2)), and there are no C-corporation earnings to create a dividend.

Nora lent her S corporation $10,000 on a written note. Losses in earlier years reduced her basis in the note to $6,000, and her stock basis is zero. This year the corporation earns $5,000 of ordinary income, makes no distributions, and repays the $10,000 note in full in October. What is the tax result for Nora?

• a.No gain, and her stock basis increases by the whole $5,000 of income
• b.$4,000 of gain, and her stock basis increases by the $5,000 of income
• c.$4,000 of gain, because the note's basis was $6,000 when repaid
• d.No gain; the note's basis is restored to $10,000 before repayment✓

IRC 1367(b)(2)(B) applies a net increase in basis first to restore debt basis reduced in earlier years. Under Treas. Reg. 1.1367-2(c)-(d), when a debt is repaid during the year, the year's net increase is applied first to restore the basis of the repaid debt, effective immediately before the repayment, to the extent needed to avoid gain. $4,000 of the $5,000 restores the note to $10,000, so the $10,000 repayment produces no gain, and the remaining $1,000 increases stock basis.

A partnership reports: sales revenue $500,000; operating expenses $300,000; a $60,000 guaranteed payment to a partner for services; a $10,000 section 1231 gain; $4,000 of charitable contributions; and a $6,000 long-term capital gain. What is its ordinary business income on Form 1065?

• a.$140,000✓
• b.$150,000
• c.$136,000
• d.$200,000

Guaranteed payments are deductible in computing partnership ordinary income (IRC 707(c), 162(a)), so $500,000 - $300,000 - $60,000 = $140,000. Section 1231 gains, capital gains and charitable contributions are separately stated items under IRC 702(a) and do not enter ordinary business income. $200,000 omits the guaranteed payment, $150,000 adds the 1231 gain, and $136,000 subtracts the contributions.

Ola's basis in her partnership interest is $40,000 at the start of the year. This year she is allocated $30,000 of ordinary income and $2,000 of tax-exempt interest, her share of partnership liabilities rises by $10,000, and she receives a $25,000 cash distribution. What is her basis at year-end?

• a.$57,000✓
• b.$82,000
• c.$47,000
• d.$55,000

IRC 705(a) increases basis for the distributive share of taxable income and tax-exempt income and decreases it for distributions. IRC 752(a) treats an increase in a partner's share of liabilities as a cash contribution, which increases basis. $40,000 + $30,000 + $2,000 + $10,000 - $25,000 = $57,000. $47,000 omits the liability increase, $55,000 omits the tax-exempt interest, and $82,000 omits the distribution.

Pam contributes land with an adjusted basis of $30,000 and a fair market value of $50,000, not subject to any liability, to a partnership for a partnership interest. What are the tax results?

• a.No gain; her interest has a $50,000 basis, and the land keeps $30,000
• b.No gain; her interest takes $30,000, and the land steps up to $50,000
• c.No gain; her interest and the partnership's land basis are both $30,000✓
• d.$20,000 of gain; both her interest and the land take a $50,000 basis

IRC 721(a) provides that no gain or loss is recognized on a contribution of property to a partnership in exchange for an interest. The partner's basis in her interest is the adjusted basis of the property contributed (IRC 722), and the partnership takes the property with the contributor's adjusted basis (IRC 723). Both are $30,000; the built-in $20,000 gain is preserved, not taxed.

Quin's basis in his partnership interest is $12,000. In a current (non-liquidating) distribution, he receives land in which the partnership's adjusted basis is $20,000 and no cash. What is the result?

• a.$8,000 of loss; his basis in the land is $12,000
• b.No gain; his basis in the land is $20,000
• c.No gain; his basis in the land is $12,000✓
• d.$8,000 of gain; his land basis is $20,000

IRC 731(a)(1) recognizes gain on a distribution only when money exceeds the partner's basis; no money was distributed. Under IRC 732(a), the partner takes the partnership's basis in distributed property, but not more than his basis in his interest reduced by any money distributed, so the land's basis is limited to $12,000, and his interest basis falls to zero. No loss is recognized on a current distribution.

A new partnership has three partners: a corporation with a June 30 fiscal year that owns a 60 percent interest in profits and capital, and two calendar-year individuals who own 20 percent each. Absent a business-purpose election, what tax year must the partnership use?

• a.The calendar year
• b.Any year it chooses
• c.A year ending September 30
• d.A year ending June 30✓

IRC 706(b)(1)(B)(i) requires a partnership to use its majority interest taxable year, the year of one or more partners holding an aggregate interest in profits and capital of more than 50 percent (706(b)(4)). The corporate partner alone holds 60 percent, so the partnership uses a June 30 year. The calendar year would apply only if neither the majority-interest nor the principal-partners rule produced a year.

An LLC owned by one individual has never filed Form 8832 or Form 2553. How is it classified for federal income tax purposes?

• a.As a disregarded entity, reported on the owner's return✓
• b.As an S corporation, the default for single-owner LLCs
• c.As a C corporation that files Form 1120 and pays the tax
• d.As a partnership that files its own Form 1065 each year

Under Treas. Reg. 301.7701-3(b)(1), a domestic eligible entity that does not elect otherwise is a partnership if it has two or more members and is disregarded as separate from its owner if it has a single owner. A single-member LLC can elect to be taxed as a corporation on Form 8832 (and then as an S corporation on Form 2553), but corporate status is never its default.

A nonprofit trade association of regional plumbing contractors promotes the industry's common business interests, and none of its net earnings benefit any private individual. Under which section is it most likely exempt?

• a.Section 501(c)(4)
• b.Section 501(c)(7)
• c.Section 501(c)(6)✓
• d.Section 501(c)(3)

IRC 501(c)(6) exempts business leagues, chambers of commerce, real estate boards and boards of trade that are not organized for profit and whose net earnings do not inure to any private individual; an industry trade association fits. Section 501(c)(3) covers charitable, educational and similar organizations, 501(c)(4) covers social welfare organizations, and 501(c)(7) covers social clubs.

A section 501(c)(3) art museum has these income sources. Which is unrelated business taxable income?

• a.Royalties received for licensing the museum's name and logo
• b.Profit from a public catering business run by paid staff✓
• c.Sales at a gift shop staffed entirely by unpaid volunteers
• d.Dividends earned on the museum's endowment investments

IRC 513(a) defines an unrelated trade or business as one not substantially related to the exempt purpose, but excludes a business in which substantially all the work is done without compensation. IRC 512(b)(1) and (b)(2) exclude dividends and royalties from unrelated business taxable income. A catering business open to the public with paid staff is unrelated and regularly carried on, so its profit is taxable under IRC 511.

In 2025 a C corporation's general business credit exceeds the limit on credits it can use against its tax. What happens to the unused credit?

• a.It is carried back 1 year and then forward up to 20 years✓
• b.It is carried forward indefinitely but cannot be carried back
• c.It is carried back 3 years and then forward up to 5 years
• d.It is refunded to the corporation as an overpayment of tax

IRC 39(a)(1) makes an unused general business credit a carryback to the preceding taxable year and a carryforward to each of the 20 following years. The general business credit is not refundable, and the 3-back, 5-forward pattern belongs to corporate capital losses under IRC 1212(a).