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Exam 1: Business Income, Deductions, and Accounting Methods

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Question 1

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David purchased a deli shop on February 1^st of last year and began to operate it as a sole proprietorship. David reports his personal taxes using the cash method over a calendar year, and he wants to use the cash method and fiscal year for his sole proprietorship. He has summarized his receipts and expenses through January 31^st of this year as follows: What income should David report from his sole proprietorship?

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$27,500 = $112,000 − $84,500.
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Question 2

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Uniform capitalization of indirect inventory costs is required for most very large taxpayers.

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B) False

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Question 3

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Murphy uses the accrual method and reports on a calendar year. This year Murphy signed a binding contract to provide consulting services to Kirby beginning next year. Murphy incurred $15,000 to train his staff for this particular project. In addition, Murphy estimates that he will incur another $60,000 to complete the Kirby contract. What amount, if any, can Murphy deduct this year for the services expected to be rendered next year?

Bob operates a clothing business using the accrual method over a calendar year. In October of last year, Bob contracted with his father, Tim, for consulting advice. Tim is a cash-basis calendar-year taxpayer and he billed Bob for $6,000 of consulting fees. This amount was comparable to amounts charged by other consultants (a reasonable amount). Bob paid $2,500 of the consulting fee by December 31^st of last year, but the remaining $3,500 was not paid until January of this year. When can Bob deduct the consulting fee?

The 12-month rule allows taxpayers to deduct the entire amount of certain prepaid business expenses.

Colbert operates a catering service on the accrual method. In November of year 1 Colbert received a payment of $9,000 for 18 months of catering services to be rendered from December 1^st of year 1 through May 31^st of year 3. When must Colbert recognize the income if his accounting methods are selected to minimize income recognition?

Crystal operates a business that provides typing and delivery services. This year Crystal spent $2,500 to purchase special shirts that identify her employees and provide some notoriety for her business. The shirts are especially colorful and include logos on the front pocket and the back. Besides salary payments, Crystal also compensates her employees by offering to pay whole life insurance premiums for any that want to provide insurance coverage for their beneficiaries. This year Crystal paid $5,000 in life insurance premiums. What amount of these payments can Crystal deduct? Crystal is on the cash method and calendar year.

A business generally adopts a fiscal or calendar year by using that year-end on the first tax return for the business.

Ranger Athletic Equipment uses the accrual method and reports on a calendar year. Ranger provides two-year warranties on all sales of equipment. This year Ranger estimated warranty expense for book purposes, and he accrued $1 million of warranty expenses. However, during the year Ranger only spent $400,000 repairing equipment under the warranty. What can Ranger deduct for warranty expense on the tax return for this year?

A fiscal tax year can end on the last day of any month other than December.

Which of the following is a true statement?

Werner is the president and CEO of Acme, Inc., and this year he took a prospective client to dinner. During the dinner Werner and the client discussed a proposed contract for over $6 million as well as personal matters. After dinner Werner took the client to a football game and no business was discussed. Werner paid $1,220 for an expensive (but not extravagant) dinner and spent $600 for tickets to the game. What is the deductible amount of these expenses?

Which of the following is NOT considered a related party for the purpose of limitation on accruals to related parties?

The deduction for business interest expense is limited to the sum of (1) business interest income and (2) 30 percent of the adjusted taxable income of the taxpayer for the taxable year.

This year Clark leased a car to drive between his office and various work sites. Clark carefully recorded that he drove the car 23,000 miles this year and paid $7,200 of operating expenses ($2,700 for gas, oil, and repairs, and $4,500 for lease payments) . What amount of these expenses may Clark deduct as business expenses?

Which of the following is a true statement?

When a taxpayer borrows money and invests the loan proceeds in municipal bonds, the interest paid by the taxpayer on the debt will not be deductible.

Which of the following is an explanation for why insurance premiums on a key employee are not deductible?

Joe is a self-employed electrician who operates his business on the accrual method. This year Joe purchased a shop for his business, and for the first time at year-end he received a bill for $4,500 of property taxes on his shop. Joe didn't pay the taxes until after year-end but prior to filing his tax return. Which of the following is a true statement?

Although expenses associated with illegal activities are not deductible, political contributions can be deducted as long as the donation is not made to a candidate for public office.