CPA Exam — Tax Compliance and Planning (TCP) — All Questions

Corvid Inc., a calendar-year C corporation, has a $500,000 net operating loss carryforward from 2021. Its 2025 taxable income before any NOL deduction is $400,000. What is its 2025 NOL deduction and the carryforward to 2026?

• a.$200,000 deducted; $300,000 carried forward
• b.$500,000 deducted; nothing carried forward
• c.$320,000 deducted; $180,000 carried forward✓
• d.$400,000 deducted; $100,000 carried forward

For NOLs arising in tax years beginning after 2017, IRC §172(a)(2) limits the deduction to 80% of taxable income computed without the NOL deduction: 80% × $400,000 = $320,000. The remaining $180,000 carries forward indefinitely under §172(b)(1)(A). Deducting $400,000 ignores the 80% limit. Deducting $500,000 exceeds taxable income. $200,000 applies a 50% limit that does not exist.

Aster Corp., a C corporation, has a $30,000 net capital loss in 2025 and $200,000 of ordinary income. It had net capital gains of $10,000 in 2022, $5,000 in 2023 and none in 2024. After carrybacks, how much of the 2025 capital loss is carried forward?

• a.$30,000
• b.$0
• c.$27,000
• d.$15,000✓

A corporation deducts capital losses only against capital gains (IRC §1211(a)), so none of the loss offsets the $200,000 of ordinary income. Under §1212(a)(1), the net capital loss is carried back three years, earliest first: $10,000 to 2022 and $5,000 to 2023. The remaining $15,000 carries forward up to five years as a short-term capital loss. $30,000 ignores the carrybacks. $27,000 applies the individual $3,000 allowance, which corporations do not get. $0 assumes the loss offsets ordinary income.

Investors buy 60% of Loss Co.'s stock, triggering an ownership change under §382. Just before the change, Loss Co.'s stock was worth $2,000,000. Assume a long-term tax-exempt rate of 3.5%. What is the annual §382 limitation on its pre-change NOLs?

• a.$70,000✓
• b.$1,600,000
• c.$42,000
• d.No limit, because less than 80% changed hands

IRC §382(b)(1) sets the annual limitation at the value of the old loss corporation's stock immediately before the ownership change, multiplied by the long-term tax-exempt rate: $2,000,000 × 3.5% = $70,000. The limit uses the value of all the stock, not the 60% acquired, so $42,000 is wrong. $1,600,000 applies the 80% NOL deduction limit, which is a different rule. An ownership change requires only a more-than-50-percentage-point shift, not 80%.

Abe transfers land (basis $40,000, value $100,000) to newly formed Delta Corp. for 80% of its stock. Bea receives the other 20% for services she will perform for Delta. What are the tax results?

• a.Abe recognizes no gain; Bea has compensation income✓
• b.Abe recognizes no gain, and Bea has no income because §351 applies
• c.Abe recognizes $60,000 of gain because Bea's shares break control
• d.Both recognize gain equal to the value of the stock they receive

Stock issued for services is not issued for property (IRC §351(d)(1)), so Bea is not a transferor under §351 and has compensation income equal to the stock's value. Abe alone owns 80% of the stock after the exchange, which meets the §368(c) control test, so §351 shields his $60,000 gain. Bea's shares do not break control because Abe's 80% suffices on its own. §351 protects property transfers, not services. Abe's gain is deferred, not recognized.

In a transaction qualifying under §351, Eli transfers land (basis $50,000, value $120,000) to his controlled corporation for stock worth $100,000 and $20,000 of cash. What are Eli's recognized gain and his basis in the stock?

• a.Gain $20,000; stock basis $50,000✓
• b.Gain $0; stock basis $30,000
• c.Gain $70,000; stock basis $100,000
• d.Gain $20,000; stock basis $70,000

Realized gain is $70,000. Under IRC §351(b), gain is recognized only up to the $20,000 of boot. Under §358(a)(1), stock basis is $50,000 (property basis) − $20,000 (cash) + $20,000 (gain recognized) = $50,000. The corporation's basis in the land is $70,000 under §362(a), carryover basis plus the gain recognized, and that is the figure the $70,000 stock-basis option borrows. Recognizing nothing ignores the boot. Recognizing all $70,000 would make the exchange fully taxable.

In a §351 exchange, Fay transfers a building (basis $150,000, value $400,000) subject to a $200,000 mortgage that the corporation assumes, for stock worth $200,000. There is no tax-avoidance purpose. What are her recognized gain and stock basis?

• a.Gain $50,000; stock basis $50,000
• b.Gain $50,000; stock basis $0✓
• c.Gain $0; stock basis $0
• d.Gain $200,000; stock basis $150,000

Assumed liabilities are generally not boot (IRC §357(a)). But under §357(c), liabilities exceeding the total basis of the property transferred, $200,000 − $150,000 = $50,000, are gain. Stock basis under §358 is $150,000 − $200,000 of liabilities (treated as money) + $50,000 of gain = $0. Recognizing no gain would leave a negative basis, which §357(c) exists to prevent. Treating the whole liability as boot overstates the gain. A $50,000 basis double-counts the gain.

Fir Corp. has no current E&P and $30,000 of accumulated E&P. It distributes $100,000 of cash to its sole shareholder, whose stock basis is $50,000. How is the distribution treated?

• a.$30,000 dividend, $50,000 return of basis and $20,000 capital gain✓
• b.$50,000 return of basis and $50,000 capital gain
• c.$30,000 dividend and $70,000 capital gain
• d.$100,000 dividend

A distribution is a dividend to the extent of current and then accumulated E&P (IRC §316(a)), here $30,000. The excess reduces stock basis under §301(c)(2) until basis reaches zero, which takes $50,000. Anything beyond that, $20,000, is gain from the sale or exchange of property under §301(c)(3), capital gain for a stock held as an investment. The other splits skip the dividend layer, the basis layer or both.

Holly Corp., a C corporation, completely liquidates by distributing land (basis $200,000, value $500,000) to its sole shareholder, whose stock basis is $100,000. What are the shareholder's recognized gain and basis in the land?

• a.No gain; land basis $100,000
• b.Gain $400,000; land basis $200,000
• c.Gain $400,000; land basis $500,000✓
• d.Gain $300,000; land basis $200,000

Under IRC §331(a), amounts received in complete liquidation are treated as full payment for the stock: $500,000 − $100,000 = $400,000 of gain. The shareholder's basis in the land is its value under §334(a). Separately, the corporation recognizes $300,000 of gain under §336(a), so the gain is taxed twice. $300,000 is the corporation's gain, not the shareholder's. Only a qualifying parent-subsidiary liquidation under §332 is tax-free. Carryover basis applies only under §334(b).

Parent Corp. owns 85% of the only class of stock of Sub Corp. and has owned it for five years. Sub adopts a plan of complete liquidation and distributes all its assets. Which statement describes the treatment of the property Sub distributes to Parent?

• a.Sub recognizes gain; Parent's receipt of the property is tax-free
• b.Parent recognizes no gain, but takes a basis equal to the value
• c.Neither recognizes gain, and Parent takes Sub's basis in the property✓
• d.Parent has capital gain, and it takes a value basis in the property

IRC §332 exempts a parent that owns at least 80% of the vote and value (§1504(a)(2)) from gain or loss on a subsidiary's complete liquidation. IRC §337(a) exempts the subsidiary on distributions to that 80% distributee, and §334(b)(1) gives the parent a carryover basis. Distributions to the 15% minority shareholder remain taxable to Sub under §336, but the question asks only about Parent. A value basis would follow only from a taxable liquidation.

Pine Corp., a domestic C corporation, owns stock in four corporations. Which of them can join Pine in filing a consolidated return?

• a.A domestic C corporation in which Pine owns 90% of the vote but 70% of the value
• b.A domestic C corporation in which Pine owns 85% of the vote and value✓
• c.A domestic C corporation in which Pine owns 75% of the vote and value
• d.A foreign corporation in which Pine owns 100% of the stock

An affiliated group requires the parent to own stock with at least 80% of the total voting power and at least 80% of the total value (IRC §1504(a)(2)), and only includible corporations may join. A foreign corporation is excluded under §1504(b)(3). Seventy percent of value fails the value test even though vote exceeds 80%. Seventy-five percent fails both tests.

Sub (basis $100,000) sells land to its parent, Par, for $180,000 in 2025. Both are members of a consolidated group. Par still holds the land at year-end and sells it to an outsider for $200,000 in 2026. How much gain does the group report in each year?

• a.$80,000 in 2025 and $20,000 in 2026
• b.$0 in 2025 and $20,000 in 2026
• c.$80,000 in 2025 and $100,000 in 2026
• d.$0 in 2025 and $100,000 in 2026✓

Under the intercompany transaction rules of Treas. Reg. §1.1502-13, Sub's $80,000 intercompany gain is deferred and taken into account when Par's corresponding item arises. That happens in 2026, when Par sells outside the group and recognizes $20,000. The group then reports Sub's $80,000 and Par's $20,000, a total of $100,000. Reporting $80,000 in 2025 treats members as separate taxpayers. Reporting only $20,000 in 2026 loses Sub's gain entirely.

Maple Corp., a U.S. corporation, buys inventory in the United States and resells it to customers in Canada. Title passes to the buyers in Canada. What is the source of Maple's income from these sales?

• a.Half U.S. and half foreign source
• b.Sourced by the residence of the seller
• c.Foreign source✓
• d.U.S. source

IRC §862(a)(6) treats income from buying inventory within the United States and selling it outside the United States as foreign-source income. Under Treas. Reg. §1.861-7(c), a sale takes place where the seller's rights, title and interest pass to the buyer. The residence-of-seller rule of §865(a) does not apply to inventory (§865(b)). No rule splits income from purchased inventory evenly between U.S. and foreign sources.

Which of the following items of income received by a U.S. corporation is U.S.-source income?

• a.Interest on a note issued by a domestic corporation✓
• b.Royalties for the use of its patent in Germany
• c.Fees for engineering services its staff performed in Mexico
• d.Dividends from a foreign corporation with no U.S. business

IRC §861(a)(1) sources interest on obligations of domestic corporations and noncorporate U.S. residents in the United States. Dividends from a foreign corporation with no U.S. effectively connected income are foreign source (§862(a)(2)). Services are sourced where performed (§862(a)(3)). Royalties are sourced where the property is used (§862(a)(4)).

Crest Inc., a U.S. corporation, earns: $500,000 for services performed in the U.S.; $200,000 for services performed in Canada; $100,000 of royalties for a patent used only in Canada; and $50,000 of interest from a domestic corporation. How much is foreign-source income?

• a.$200,000
• b.$850,000
• c.$300,000✓
• d.$350,000

Services are sourced where performed (IRC §861(a)(3), §862(a)(3)), so the $200,000 for Canadian services is foreign source. Royalties are sourced where the property is used (§862(a)(4)), so the $100,000 is also foreign. Interest from a domestic corporation is U.S. source (§861(a)(1)). Foreign-source income is $300,000. $200,000 omits the royalties. $350,000 wrongly adds the domestic interest. $850,000 is total income.

A foreign corporation's single class of stock is owned: 40% by USCo (a U.S. corporation), 15% by Ava (a U.S. citizen), 8% by Ben (a U.S. citizen), and 37% by unrelated foreign persons. None of the owners is related to another. Is it a controlled foreign corporation (CFC)?

• a.No; no single U.S. person owns more than 50%
• b.No; U.S. shareholders must own at least 80%
• c.Yes; U.S. persons together own 63% of the stock
• d.Yes; its U.S. shareholders own 55% of the stock✓

A U.S. shareholder is a U.S. person owning 10% or more of the vote or value (IRC §951(b)). USCo (40%) and Ava (15%) qualify, but Ben (8%) does not. A CFC is a foreign corporation more than 50% owned, by vote or value, by U.S. shareholders (§957(a)). 55% meets that test. Counting Ben's 8% confuses U.S. persons with U.S. shareholders. The test is aggregate, not per owner, and the threshold is more than 50%.

Under the 2016 U.S. Model Income Tax Convention, which of the following activities by a foreign enterprise would create a permanent establishment in the other country?

• a.An independent commission agent acting in the ordinary course of its business
• b.A dependent agent who habitually concludes binding contracts✓
• c.A construction project in the country that lasts nine months
• d.A warehouse used solely to store and deliver the enterprise's goods

Article 5(5) of the 2016 U.S. Model deems a permanent establishment to exist where a person, other than an independent agent, habitually exercises authority to conclude contracts binding the enterprise. Article 5(4) excludes facilities used solely for storage, display or delivery. Under Article 5(3), a building site or construction project is a permanent establishment only if it lasts more than twelve months. Article 5(6) excludes independent agents acting in the ordinary course of their business.

Gia, the sole shareholder of an S corporation, starts the year with $10,000 of stock basis. The corporation has $6,000 of ordinary income and an $8,000 capital loss for the year, and distributes $12,000 of cash to her. What is the result?

• a.$2,000 of the distribution is capital gain, and the loss is fully allowed
• b.The distribution is tax-free, and the $8,000 loss is fully allowed
• c.The loss is fully allowed, and the distribution produces $4,000 of capital gain
• d.Distribution tax-free; $4,000 of the loss allowed, $4,000 suspended✓

Treas. Reg. §1.1367-1(f) orders the basis adjustments: income increases first ($10,000 + $6,000 = $16,000), then distributions ($16,000 − $12,000 = $4,000), then losses. The distribution does not exceed basis, so it is tax-free under §1368(b)(1). Only $4,000 of the $8,000 loss is allowed, and the other $4,000 is suspended under §1366(d)(2). Applying the loss before the distribution reverses the regulation's order.

Hal's S corporation stock basis is zero. In Year 1 he lends the corporation $20,000 and is allocated a $15,000 loss. In Year 2 his share of net income is $8,000, and there are no distributions. At the end of Year 2, what are his stock basis and debt basis?

• a.Stock basis $0; debt basis $20,000
• b.Stock basis $0; debt basis $13,000✓
• c.Stock basis $3,000; debt basis $20,000
• d.Stock basis $8,000; debt basis $5,000

The Year 1 loss is deductible against debt basis under IRC §1366(d)(1)(B) and reduces it to $5,000 (§1367(b)(2)(A)). Under §1367(b)(2)(B), a later net increase restores the reduced debt basis before any of it increases stock basis. The $8,000 restores debt basis to $13,000, and stock basis stays $0. Adding the income to stock basis first gets the order backward. Full restoration to $20,000 would need $15,000 of net increase.

Jae, the sole shareholder of an S corporation, contributes land (basis $80,000, value $150,000) subject to a $30,000 mortgage that the corporation assumes, in exchange for more stock. There is no tax-avoidance purpose. What is the increase in Jae's stock basis from the contribution?

• a.$80,000
• b.$120,000
• c.$150,000
• d.$50,000✓

Jae is in control, so §351 applies, and no gain arises because the $30,000 liability is less than the $80,000 basis (IRC §357(a) and §357(c)). Under §358(a) and §358(d), the stock basis equals the property's $80,000 basis less the $30,000 of liabilities assumed, which are treated as money received: $50,000. $80,000 ignores the liability. $150,000 and $120,000 use the land's value, which §358 does not.

An S corporation with no accumulated E&P distributes land (basis $20,000, value $50,000) to Kay, its sole shareholder, whose stock basis before any current-year items is $40,000. The corporation has no other items for the year. What are Kay's results?

• a.$10,000 gain on the distribution itself; land basis $50,000
• b.$30,000 gain passes through; stock basis $40,000; land basis $20,000
• c.No gain, stock basis then $20,000 and land basis $20,000
• d.$30,000 gain passes through; stock basis $20,000; land basis $50,000✓

The S corporation recognizes $30,000 of gain under IRC §311(b), applied through §1371(a). The gain passes through to Kay under §1366 and raises her basis to $70,000 (§1367(a)(1)). The $50,000 distribution then reduces basis to $20,000 without gain (§1368(b)), and her basis in the land is its value (§301(d)). Leaving out the gain, or measuring the distribution before adding it to basis, gives the wrong results.

An S corporation has $10,000 in its accumulated adjustments account (AAA) and $15,000 of accumulated E&P from its C corporation years. It distributes $30,000 to its sole shareholder, whose stock basis is $40,000. No elections are made. How is the distribution treated?

• a.$10,000 tax-free basis reduction and $20,000 capital gain
• b.$25,000 dividend and $5,000 tax-free basis reduction
• c.$15,000 dividend and $15,000 tax-free basis reduction✓
• d.$30,000 tax-free, reducing stock basis to $10,000

Under IRC §1368(c), a distribution from an S corporation with accumulated E&P comes first from the AAA (tax-free to the extent of basis, $10,000), then as a dividend to the extent of accumulated E&P ($15,000), and then as a further recovery of basis ($5,000). So $15,000 is a dividend and $15,000 reduces basis. Treating it all as tax-free ignores the E&P. $25,000 overstates the dividend. Capital gain arises only once basis is exhausted.

Mia and Ned each own 50% of a calendar-year S corporation. At the end of the day on April 30, 2025, Mia sells all her shares to Oscar. The corporation earns $365,000 of ordinary income spread evenly over the year, and no election is made to close the books. How is the income allocated?

• a.Mia $122,500; Oscar $60,000; Ned $182,500
• b.Mia $91,250; Oscar $91,250; Ned $182,500
• c.Mia $0; Oscar $182,500; Ned $182,500
• d.Mia $60,000; Oscar $122,500; Ned $182,500✓

IRC §1377(a)(1) allocates S corporation items pro rata by day and share. Under Treas. Reg. §1.1377-1(a)(2)(ii), the seller is the shareholder for the day of the sale. Mia therefore holds the shares for January 1 through April 30, 120 days: 120 × $1,000 × 50% = $60,000. Oscar gets the remaining 245 days: 245 × $1,000 × 50% = $122,500. Ned gets half of the year, $182,500. Allocating everything to the year-end owner, or splitting evenly by half-year, ignores the per-day rule.

An S corporation (never a C corporation) distributes land (basis $100,000, value $300,000) to its sole shareholder in complete liquidation. The shareholder's stock basis before the liquidation is $120,000. What are the shareholder's results?

• a.$200,000 passed-through gain and $180,000 capital gain on the stock
• b.$200,000 passed-through gain and a $20,000 capital loss on the stock✓
• c.No gain or loss, because liquidations of S corporations are tax-free
• d.$180,000 capital gain on the stock and no passed-through gain

Under IRC §336(a), the corporation recognizes $200,000 of gain on the distribution. It passes through under §1366 and raises the shareholder's basis to $320,000 (§1367). Under §331, the shareholder then receives property worth $300,000 for stock with a $320,000 basis, a $20,000 capital loss. The net is $180,000, taxed once. Skipping the pass-through gain misstates both the character and the basis. Counting the gain twice ignores the basis increase. The liquidation is not tax-free.

Nia contributes a building (basis $60,000, value $200,000) subject to a $40,000 mortgage to a new partnership for a 25% interest. The partnership assumes the mortgage, and partners share liabilities in proportion to their 25% interests. What is Nia's outside basis?

• a.$20,000
• b.$30,000✓
• c.$60,000
• d.$0

Under IRC §722, Nia's basis starts at the $60,000 basis of the property. The partnership's assumption of the mortgage is a deemed distribution of money under §752(b), but only net of her 25% share, which is a deemed contribution under §752(a): $40,000 − $10,000 = $30,000 of net decrease. $60,000 − $30,000 = $30,000. No gain arises because the net decrease is less than her basis (§731(a)). $20,000 ignores her retained share of the debt. $0 treats the result as a gain case.

Omar contributes land (basis $50,000, value $300,000) subject to a $120,000 mortgage to a partnership for a 20% interest. The partnership assumes the mortgage, and liabilities are shared by the 20% interests. What are Omar's recognized gain and outside basis?

• a.Gain $0; outside basis $0
• b.Gain $70,000; outside basis $0
• c.Gain $46,000; outside basis $0✓
• d.Gain $46,000; outside basis $46,000

The net deemed distribution is the $120,000 of debt shifted to the partnership, less Omar's 20% share of it ($24,000): $96,000 (IRC §752(a)-(b)). It exceeds his $50,000 basis by $46,000, which is gain under §731(a)(1), and basis is reduced to zero (§733). $70,000 is the excess of the full liability over basis, ignoring his retained share. No gain would leave a negative basis. Gain recognized does not also become basis here.

Quinn's outside basis is $40,000. In a nonliquidating distribution she receives $10,000 of cash and land with a partnership basis of $50,000 and a value of $70,000. What are her recognized gain, her basis in the land and her remaining outside basis?

• a.$20,000 gain; land basis $50,000; outside basis $0
• b.No gain; land basis $70,000; outside basis $0
• c.No gain; land basis $30,000; outside basis $0✓
• d.No gain; land basis $50,000; outside basis $0

The cash ($10,000) does not exceed her basis, so no gain is recognized (IRC §731(a)(1)). In a nonliquidating distribution, property takes the partnership's basis, but not more than the partner's outside basis reduced by cash (§732(a)(2)): $40,000 − $10,000 = $30,000. Outside basis then falls to zero (§733). Carrying over $50,000 would give more basis than she had. No gain arises on distributions of property other than money. Section 732 does not give the partner a value basis.

Sol's outside basis is $90,000 when the partnership liquidates his interest by distributing $20,000 of cash and land (partnership basis $30,000). The partnership has no unrealized receivables or inventory. What is Sol's basis in the land?

• a.$70,000✓
• b.$50,000
• c.$30,000
• d.$90,000

In a liquidating distribution, property other than money takes a basis equal to the partner's outside basis reduced by money distributed in the same transaction (IRC §732(b)): $90,000 − $20,000 = $70,000. No loss is recognized, because property other than money, receivables and inventory was distributed (§731(a)(2)). Using the $30,000 partnership basis would leave $40,000 of basis unused. $90,000 ignores the cash. $50,000 subtracts the cash and the partnership's basis.

Tia's outside basis is $50,000 when the partnership liquidates her interest by distributing $30,000 of cash and inventory with a partnership basis of $5,000. What does she recognize?

• a.No loss, with a $20,000 basis in the inventory
• b.A $15,000 capital loss, with a $5,000 basis in the inventory✓
• c.A $15,000 ordinary loss, with a $5,000 basis in the inventory
• d.A $20,000 capital loss, with a $0 basis in the inventory

When a liquidating distribution consists only of money, unrealized receivables and inventory, IRC §731(a)(2) allows a loss equal to outside basis over the money plus the basis of the receivables and inventory: $50,000 − ($30,000 + $5,000) = $15,000. The inventory keeps the partnership's $5,000 basis, because §732(c)(1) does not let it be stepped up. The loss is from the sale of the partnership interest (§731(a)), so it is capital (§741), not ordinary. Giving inventory a $20,000 basis would violate §732(c).

Uma buys a one-third partnership interest for $150,000. Her share of the partnership's inside basis in its assets is $90,000, and the partnership has a §754 election in effect. What adjustment results?

• a.No adjustment, because she bought an existing interest
• b.A $60,000 decrease in inside basis for Uma alone
• c.A $60,000 increase in inside basis for Uma alone✓
• d.A $60,000 increase in the common basis of all partners

With a §754 election in effect, IRC §743(b) adjusts the basis of partnership property on a transfer of an interest, by the excess of the transferee's outside basis ($150,000) over her share of inside basis ($90,000). The +$60,000 adjustment applies only to the transferee partner. It does not change common basis. A decrease would arise only if her share of inside basis exceeded what she paid.

A new partnership's partners are Alpha Corp. (30%, year ends June 30), Beta Corp. (30%, year ends June 30) and four individuals holding 10% each on a calendar year. Absent a business purpose election, what taxable year must the partnership use?

• a.Any fiscal year the partners choose
• b.The calendar year
• c.The year giving the least aggregate deferral
• d.A year ending June 30✓

IRC §706(b)(1)(B)(i) requires the majority interest taxable year: the year of partners owning, in total, more than 50% of profits and capital (§706(b)(4)). Alpha and Beta together hold 60% with June 30 years. The principal partner test and the least-aggregate-deferral rule come into play only if no majority interest year exists. Partners cannot simply choose a fiscal year.

Vic, who owns a 60% interest in a partnership, sells his entire interest to an outside buyer on July 1. The remaining partners continue the business. What is the effect on the partnership?

• a.It continues; its tax year closes only for Vic✓
• b.Its tax year closes for all partners on July 1
• c.It continues, and Vic reports his full-year share of income
• d.It terminates because more than 50% of the interests were sold

IRC §708(b)(1) treats a partnership as terminated only if no part of its business continues to be carried on by its partners in a partnership. The rule that a sale of 50% or more of the interests within twelve months terminated a partnership was repealed for tax years beginning after 2017. Under §706(c)(2)(A), the tax year closes for a partner who sells his entire interest, and §706(d) allocates items for the varying interests. Vic reports only his share through the date of sale.

Wes sells his partnership interest for $100,000; his outside basis is $40,000. His share of the partnership's cash-basis accounts receivable (basis $0) is $30,000. The partnership has no other §751 property. How is his $60,000 gain characterized?

• a.$30,000 ordinary income and $30,000 capital gain✓
• b.$60,000 ordinary income
• c.$30,000 capital gain and $30,000 tax-free
• d.$60,000 capital gain

The sale of a partnership interest generally produces capital gain (IRC §741). IRC §751(a) treats the amount attributable to unrealized receivables and inventory as ordinary income. Cash-basis receivables are unrealized receivables (§751(c)), so $30,000 of the gain is ordinary and the remaining $30,000 is capital. Treating it all as capital ignores §751(a). Treating it all as ordinary overreaches. The whole $60,000 is gain, so no part of it is tax-free.

Xavi receives a 20% capital interest, worth $40,000, in an existing partnership in exchange for past services, contributing no property. What is the tax result to him?

• a.No income until the partnership liquidates
• b.$40,000 of ordinary income✓
• c.No income, because §721 applies
• d.$40,000 of capital gain

Section 721 protects contributions of property, not services. Under Treas. Reg. §1.721-1(b)(1), the value of an interest in partnership capital transferred to a partner as compensation for services is income under §61 when transferred for past services. That is $40,000 of ordinary income, and it becomes part of his outside basis. Capital gain treatment and deferral are both inconsistent with the regulation.

A trust instrument requires all income to be distributed currently and allows no charitable gifts. This year the trustee also distributes $20,000 of corpus under a discretionary power. How is the trust classified for this year?

• a.As a simple trust, because income must be distributed
• b.As a simple trust for income and a complex trust for corpus
• c.As a grantor trust, because the trustee has discretion
• d.As a complex trust, because corpus was distributed✓

IRC §651(a) applies only in a year when the trust must distribute all income currently, makes no charitable gifts and distributes nothing other than current income. The corpus distribution makes it a complex trust under §661 for this year. Trustee discretion alone does not make it a grantor trust; grantor trust status depends on powers held by the grantor or nonadverse parties (§§671–679). A trust has one classification for a given year.

Zoe creates a revocable living trust, names herself trustee and funds it with investment securities. How is the trust's income taxed while she is alive?

• a.To the trust, at trust income tax rates
• b.Entirely to Zoe, as owner of a grantor trust✓
• c.To the named remainder beneficiaries
• d.To the trust, after a distribution deduction

IRC §676(a) treats the grantor as owner of any portion of a trust she can revest in herself, and a revocable trust gives her that power. Under §671, she includes all of the trust's income, deductions and credits on her own return. The trust is not a separate taxpayer for income tax, and the remainder beneficiaries have no current income from it.

A simple trust has $20,000 of dividends, $10,000 of taxable interest, a $15,000 capital gain allocated to corpus, and a $3,000 trustee fee charged to income. It distributes all $27,000 of its accounting income. What is the trust's taxable income?

• a.$15,000
• b.$14,700✓
• c.$0
• d.$41,700

Distributable net income excludes capital gains allocated to corpus and not distributed (IRC §643(a)(3)): $20,000 + $10,000 − $3,000 = $27,000. The income distribution deduction is the lesser of income required to be distributed and DNI (§651), $27,000. That leaves the $15,000 gain, less the $300 exemption for a trust required to distribute all income (§642(b)(2)(B)): $14,700. $15,000 omits the exemption. $41,700 ignores the distribution deduction. $0 treats the gain as distributed.

A complex trust has $30,000 of taxable interest and $10,000 of tax-exempt municipal interest, with no expenses. It distributes $40,000 to its beneficiary. What is the trust's income distribution deduction?

• a.$20,000
• b.$30,000✓
• c.$10,000
• d.$40,000

Distributable net income includes tax-exempt interest (IRC §643(a)(5)), so DNI is $40,000 and the distribution carries out both classes proportionately (§662(b)). IRC §661(c) denies a deduction for the portion of the distribution made up of DNI items not included in the trust's gross income, here the $10,000 of tax-exempt interest. The deduction is $30,000. $40,000 ignores §661(c). $10,000 is the disallowed tax-exempt portion. $20,000 has no basis.

A §501(c)(3) public charity undertakes each of the following activities. Which one violates an absolute prohibition and puts its exempt status at risk?

• a.Paying its executive director a reasonable salary
• b.Operating a thrift shop that sells donated clothing
• c.Spending an insubstantial part of its activities on lobbying
• d.Endorsing a candidate for the state legislature✓

IRC §501(c)(3) requires that an organization not participate or intervene in any political campaign on behalf of, or in opposition to, any candidate for public office. That prohibition has no de minimis exception. Lobbying is limited only to no substantial part of activities. Reasonable compensation is not private inurement. Selling donated merchandise is expressly excluded from unrelated trade or business (§513(a)(3)).

Which of the following is unrelated business taxable income for a §501(c)(3) animal welfare charity?

• a.Fees from a laundry it regularly runs for the public✓
• b.Proceeds of a thrift shop selling donated merchandise
• c.Rent from a debt-free office building the charity owns
• d.Dividends from the charity's investment portfolio

IRC §513(a) defines an unrelated trade or business as one regularly carried on that is not substantially related to the exempt purpose, and a public laundry service has no connection to animal welfare. Dividends are excluded from UBTI by §512(b)(1). Rents from real property are excluded by §512(b)(3), unless the property is debt-financed under §514. Sales of donated merchandise are excluded by §513(a)(3).

A §501(c)(3) organization has $50,000 of gross income from an unrelated trade or business and $30,000 of directly connected deductions. What is its unrelated business taxable income, and must it file Form 990-T?

• a.$20,000; yes, because gross UBI is $1,000 or more
• b.$19,000; no, because it already files Form 990
• c.$20,000; no, because UBTI is under $25,000
• d.$19,000; yes, because gross UBI is $1,000 or more✓

UBTI is gross unrelated income less directly connected deductions, reduced by the $1,000 specific deduction of IRC §512(b)(12): $50,000 − $30,000 − $1,000 = $19,000. Treas. Reg. §1.6012-2(e) requires Form 990-T when gross income included in computing UBTI is $1,000 or more. $20,000 omits the specific deduction. Filing Form 990 does not replace Form 990-T. The $25,000 figure is not a 990-T threshold.