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Exam 9: Business Income, Deductions, and Accounting Methods

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Question 1

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Rock Island Corporation generated taxable income (before deductions for depreciation, interest expense and net operating loss carryovers) of $1 million this year. Taxable income was computed on $50 million of revenues and included $50,000 of interest income. The company paid $450,000 in interest expense. What is Rock Island's maximum business interest deduction for the year?

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$335,000 = $50,000 + [30% × ($1,000,000 - $50,000)] The business interest deduction is the amount of interest income plus 30% of the taxable income computed without regard to (1) any item of income, gain, deduction, or loss which is not properly allocable to a trade or business; (2) any business interest or business interest income; (3) the amount of any net operating loss deduction; and (4) deductions allowable for depreciation, amortization, or depletion.

Question 2

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

A) True
B) False

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Question 3

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Mike started a calendar year business on September 1^st of this year by paying 12 months of rent on his shop at $1,000 per month. What is the maximum amount of rent that Mike can deduct this year under each type of accounting method?

Employees cannot deduct the cost of uniforms if the uniforms are also appropriate for normal wear.

Bill operates a proprietorship using the cash method of accounting, and this year he received the following payments: -$100 in cash from a customer for services rendered this year -a promise to pay $200 from a customer for services rendered this year -tickets to a football game worth $250 as payment for services performed last year -a check for $170 for services rendered this year that Bill forgot to cash How much income should Bill realize on Schedule C?

When does the all-events test under the accrual method require the recognition of income from the sale of goods?

The test for whether an expenditure is reasonable in amount is whether the expenditure was for an "arm's length" amount.

Beth operates a plumbing firm. In August of last year she signed a contract to provide plumbing services for a renovation. Beth began the work that August and finished the work in December of last year. However, Beth didn't bill the client until January of this year and she didn't receive the payment until March when she received payment in full. When should Beth recognize income under the accrual method of accounting?

Mike operates a fishing outfitter as an accrual-method sole proprietorship. On March 1^st of this year Mike received $15,000 for three outfitting trips. This is the first time Mike agreed to such a payment and he is obligated to outfit one trip per year for the next three summers beginning this year. How much income must Mike recognize in each of the next three years if he is attempting to minimize his tax burden?

Taxpayers must maintain written contemporaneous records of business purpose when traveling in order to claim a deduction for the expenditures.

Riley operates a plumbing business and this year the 3-year old van he used in the business was destroyed in a traffic accident. The van was originally purchased for $20,000 and the adjusted basis was $5,800 at the time of the accident. Although the van was worth $6,000 at the time of accident, insurance only paid Riley $1,200 for the loss. What is the amount of Riley's casualty loss deduction?

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.

Colby Motors uses the accrual method and reports on a calendar year. In December of last year, Colby acquired auto repair equipment. As part of the acquisition, Colby purchased a warranty agreement that requires the seller of the equipment to provide repairs on the equipment for three years. Colby paid the cost of the warranty, $15,000, in January of this year. What can Colby deduct for the cost of the warranty on the tax return for last year?

Otto operates a bakery and is on the cash method and calendar year. This year one of Otto's ovens caught fire and was partially destroyed. Otto bought it a few years ago for $20,000 and claimed depreciation of $12,000 up to the fire. Otto was charged $4,400 for repairs to the oven but the insurance company paid Otto $1,500 for the damage. What is Otto's casualty loss deduction?

Which of the following cannot be selected as a valid tax year end?

In order to deduct a portion of the cost of a business meal which of the following conditions must be met?

George operates a business that generated revenues of $50 million and allocable taxable income of $1.25 million. Included in the computation of allocable taxable income were deductible expenses of $240,000 of business interest and $250,000 of depreciation. What is the maximum business interest deduction that George will be eligible to claim this year?

Which of the following business expense deductions is most likely to be unreasonable in amount?

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?

Bryon operates a consulting business and he usually works alone. However, during the summer Bryon will sometimes hire undergraduate students to collect data for his projects. This past summer Bryon hired Fred, the son of a prominent businessman, for a part-time summer job. The summer job usually pays about $17,000, but Bryon paid Fred $27,000 to gain favor with Fred's father. What amount of Fred's summer wages can Bryon deduct for tax purposes? Bryon is on the cash method and calendar year.