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Free Questions › CPA › Tax Compliance and Planning
Free CPA Tax Compliance and Planning Practice Questions & Answers
400 exam-style Tax Compliance and Planning questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 151
Both the AET and the PHC tax can be AVOIDED by:
Select an option first.
Correct answer: D — DISTRIBUTING the earnings — both taxes target UNDISTRIBUTED income
Explanation: Both penalty taxes target UNDISTRIBUTED earnings, so DISTRIBUTING eliminates them. A dividend (or a consent dividend) removes the base. Electing S status also solves the problem prospectively — but watch the BUILT-IN GAINS tax and the passive investment income trap on conversion.
Question 152
The BUILT-IN GAINS tax applies to a corporation that:
Select an option first.
Correct answer: A — CONVERTED from C to S and disposes of appreciated assets within the 5-year recognition period
Explanation: The BIG tax (21% at the CORPORATE level) applies only to a C-to-S CONVERT selling assets that were appreciated at conversion, within the 5-YEAR recognition period. Holding past year 5 ELIMINATES it entirely — the planning strategy is simply PATIENCE.
Question 153
The BIG tax is eliminated by:
Select an option first.
Correct answer: C — WAITING — holding the appreciated assets past the 5-year recognition period
Explanation: The BIG tax simply EXPIRES after the 5-YEAR recognition period. If a C-to-S convert can defer selling its appreciated assets past year 5, the entire corporate-level tax disappears. This is one of the rare tax problems solved purely by patience.
Question 154
An S corporation with ACCUMULATED E&P and excess PASSIVE INVESTMENT INCOME for 3 consecutive years:
Select an option first.
Correct answer: D — Has its S ELECTION TERMINATED — plus a corporate-level tax in the interim years
Explanation: An S corporation with AE&P (from a prior C corporation life) whose PASSIVE INVESTMENT INCOME exceeds 25% of gross receipts for THREE CONSECUTIVE years has its election TERMINATED. CRITICALLY, the trap only fires where AE&P EXISTS — which is why PURGING AE&P (via a bypass election) is a real planning move.
Question 155
The planning response to the passive investment income trap is to:
Select an option first.
Correct answer: B — PURGE the ACCUMULATED E&P — distribute it via a BYPASS election, removing the trigger entirely
Explanation: The trap requires AE&P. A BYPASS ELECTION allows AAA to be skipped and AE&P distributed FIRST — deliberately purging it. Once AE&P is zero, the passive investment income limitation CANNOT apply, and the corporation may hold as much passive income as it likes.
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Question 156
A CONSOLIDATED return requires an affiliated group with:
Select an option first.
Correct answer: C — 80% of VOTE and 80% of VALUE
Explanation: A CONSOLIDATED return requires an AFFILIATED GROUP: a common parent owning at least 80% of VOTING POWER and 80% of VALUE of each includible subsidiary. The benefit: losses of one member OFFSET profits of another, and intercompany transactions are deferred.
Question 157
The principal benefit of a consolidated return is:
Select an option first.
Correct answer: B — OFFSETTING one member's LOSSES against another's PROFITS
Explanation: CONSOLIDATION lets a loss-making subsidiary's losses OFFSET a profitable affiliate's income IMMEDIATELY, rather than being trapped as a separate-company NOL. Intercompany gains are also DEFERRED until the asset leaves the group. The election is generally BINDING.
Question 158
A SEP-IRA allows a self-employed person to contribute:
Select an option first.
Correct answer: A — A percentage of net SE earnings up to an annual dollar cap — far more than an IRA
Explanation: A SEP-IRA permits contributions far exceeding an IRA limit — up to a percentage of net self-employment earnings, capped annually. A SOLO 401(k) may permit even MORE (combining employee deferral and employer contribution), which makes it the usual choice for a one-person business.
Question 159
A SOLO 401(k) often permits a LARGER contribution than a SEP because it:
Select an option first.
Correct answer: C — Combines an EMPLOYEE deferral AND an EMPLOYER contribution
Explanation: A SOLO 401(k) allows the owner to contribute BOTH as EMPLOYEE (elective deferral, plus catch-up if eligible) AND as EMPLOYER (a percentage of compensation). At lower income levels this substantially exceeds a SEP, which offers only the employer piece.
Question 160
Fringe benefits for a MORE-THAN-2% S corporation shareholder are:
Select an option first.
Correct answer: D — Generally TAXABLE to the shareholder (treated like a partner) — a disadvantage versus a C corporation
Explanation: A more-than-2% S corporation shareholder is treated like a PARTNER for fringe benefit purposes — health insurance and other benefits are TAXABLE to them (though health premiums may be deducted above the line). A C CORPORATION shareholder-employee receives them TAX-FREE. This is a genuine C corporation advantage.
Question 161
The choice between an S corporation and an LLC/partnership turns largely on:
Select an option first.
Correct answer: A — SE TAX SAVINGS (favouring the S corp) versus FLEXIBILITY and DEBT BASIS (favouring the partnership)
Explanation: The core trade-off. S CORPORATION: distributive share escapes SE tax — a real saving. PARTNERSHIP/LLC: special allocations, debt creates outside basis, no reasonable-compensation fight, easier to admit partners with appreciated property. The right answer depends on the numbers and the structure.
Question 162
A business with SIGNIFICANT DEBT and owners wanting to deduct losses favours:
Select an option first.
Correct answer: C — A PARTNERSHIP/LLC — partnership debt creates OUTSIDE BASIS, permitting greater loss deduction
Explanation: Partnership DEBT increases a partner's OUTSIDE BASIS — so a leveraged real estate partnership can pass through losses far exceeding the partner's cash investment. S CORPORATION shareholders get NO basis from entity debt, so their losses are trapped. For a debt-financed venture, this is often decisive.
Question 163
A business wanting SPECIAL ALLOCATIONS (e.g. all depreciation to one investor) must be:
Select an option first.
Correct answer: A — A PARTNERSHIP/LLC — S corporations must allocate STRICTLY per share, per day
Explanation: S corporations must allocate STRICTLY PER SHARE, PER DAY — no exceptions. PARTNERSHIPS may make SPECIAL ALLOCATIONS with SUBSTANTIAL ECONOMIC EFFECT. Any deal requiring a preferred return, a waterfall, or disproportionate allocations must be a partnership/LLC.
Question 164
A business planning a future IPO or venture capital raise favours:
Select an option first.
Correct answer: C — A C CORPORATION — VCs and institutions generally cannot be S corporation shareholders, and QSBS requires C corp stock
Explanation: S corporations may NOT have CORPORATE or PARTNERSHIP shareholders — which excludes most VC funds. They may also have only ONE class of stock, excluding preferred. A venture-backed company must be a C CORPORATION — and that also opens the door to §1202 QSBS.
Question 165
A CONVERSION from a partnership to a C corporation is usually:
Select an option first.
Correct answer: D — TAX-FREE under §351 — but it STARTS the §1202 5-year clock and creates double taxation going forward
Explanation: A partnership-to-C-corp conversion generally qualifies under §351 (tax-free). But note: (1) the §1202 5-YEAR CLOCK starts at ISSUANCE — so the conversion must happen at least 5 years before the exit; and (2) only the appreciation AFTER conversion qualifies for QSBS.
Question 166
A C corporation converting to an S corporation faces:
Select an option first.
Correct answer: B — The BUILT-IN GAINS tax (for 5 years) and the PASSIVE INVESTMENT INCOME trap (if AE&P exists)
Explanation: C-to-S conversion carries TWO traps: (1) the BIG TAX on appreciated assets sold within 5 years; and (2) the PASSIVE INVESTMENT INCOME termination trap, which fires only if AE&P exists. Also note C corporation NOLs generally CANNOT be used by the S corporation.
Question 167
A C corporation's NOLs after converting to S status are:
Select an option first.
Correct answer: D — Generally SUSPENDED — they cannot offset S corporation pass-through income (though they may offset the BIG tax)
Explanation: C corporation NOLs are generally SUSPENDED during S status — they CANNOT offset the pass-through income flowing to shareholders. They MAY be used against the BUILT-IN GAINS tax, and they survive if the corporation ever returns to C status. This is a real cost of conversion for a company with large NOLs.
Question 168
A corporation with large NOLs generally should NOT elect S status because:
Select an option first.
Correct answer: A — The NOLs become largely UNUSABLE — they cannot offset the pass-through income
Explanation: A C corporation sitting on large NOLs has a valuable asset that S status largely STRANDS. Better to remain a C corporation, USE the NOLs against future corporate income (subject to the 80% limit), and consider converting once they are exhausted.
Question 169
The QBI deduction's W-2 wage limitation encourages a business above the threshold to:
Select an option first.
Correct answer: D — PAY ADEQUATE W-2 WAGES — the deduction is capped at 50% of W-2 wages (or 25% + 2.5% of UBIA)
Explanation: Above the threshold, the QBI deduction is capped at the GREATER of 50% of W-2 WAGES, or 25% of W-2 wages + 2.5% of UBIA. This creates a real tension for an S corporation owner: paying a LOWER salary saves payroll tax but SHRINKS the QBI cap. The optimum requires modelling both effects together.
Question 170
For a capital-intensive business with FEW employees, the QBI cap may be met via:
Select an option first.
Correct answer: C — The UBIA alternative — 25% of W-2 wages + 2.5% of the unadjusted basis of qualified PROPERTY
Explanation: The UBIA alternative exists precisely for CAPITAL-INTENSIVE, LOW-PAYROLL businesses — a real estate rental with no employees would otherwise get NO deduction under the wage-only test. 2.5% of the property's unadjusted basis can generate a substantial cap.
Question 171
AGGREGATION of businesses for QBI purposes may:
Select an option first.
Correct answer: C — HELP by combining a HIGH-INCOME/LOW-WAGE business with a LOW-INCOME/HIGH-WAGE one — but SSTBs may NOT be aggregated
Explanation: AGGREGATION combines the QBI, W-2 wages and UBIA of commonly-controlled businesses — helping where one has income but no wages and another has wages but little income. Requirements: common ownership (50%+), the same tax year, and none may be an SSTB. Once elected, aggregation must be applied CONSISTENTLY.
Question 172
An SSTB owner BELOW the lower threshold:
Select an option first.
Correct answer: C — Gets the FULL 20% QBI deduction — the SSTB limitation does NOT apply below the threshold
Explanation: BELOW the lower threshold, EVERYONE — including SSTBs — gets the full 20% QBI deduction with NO wage or UBIA limitation. The SSTB restriction and the wage/UBIA caps apply only as income rises through the phase-in range. This makes keeping taxable income below the threshold genuinely valuable for a professional.
Question 173
A strategy to keep an SSTB owner below the QBI threshold includes:
Select an option first.
Correct answer: A — MAXIMISING retirement plan contributions, HSA contributions and other deductions to reduce TAXABLE INCOME
Explanation: Because the SSTB phase-out is driven by TAXABLE INCOME, reducing it can preserve the deduction: maximise a solo 401(k) or defined benefit plan, fund an HSA, bunch charitable deductions. At the margin, a dollar of retirement contribution can be worth far more than its face value by rescuing the QBI deduction.
Question 174
A DEFINED BENEFIT (cash balance) plan is attractive for:
Select an option first.
Correct answer: C — OLDER, HIGH-INCOME owners — contribution limits are actuarially driven and can far exceed defined contribution limits
Explanation: A DEFINED BENEFIT / CASH BALANCE plan allows contributions determined ACTUARIALLY — for an older, high-income owner with few employees, this can permit contributions several times a 401(k) limit. It is the most powerful deduction available to a successful professional practice, though it carries funding obligations.
Question 175
The ACCOUNTABLE PLAN allows an employer to reimburse expenses:
Select an option first.
Correct answer: A — TAX-FREE to the employee and DEDUCTIBLE by the employer — if there is business connection, substantiation, and return of excess
Explanation: An ACCOUNTABLE PLAN requires: (1) a BUSINESS CONNECTION; (2) SUBSTANTIATION within a reasonable time; and (3) RETURN OF EXCESS advances. Meeting all three makes reimbursements TAX-FREE to the employee and DEDUCTIBLE by the business. Failing them makes the payments TAXABLE WAGES.
Question 176
Post-TCJA, an EMPLOYEE's unreimbursed business expenses are:
Select an option first.
Correct answer: C — NOT DEDUCTIBLE — which makes an ACCOUNTABLE PLAN essential for reimbursement
Explanation: Miscellaneous itemised deductions subject to the 2% floor are SUSPENDED — so an employee's unreimbursed business expenses are NOT DEDUCTIBLE AT ALL. This makes an ACCOUNTABLE PLAN (reimbursing tax-free) far more valuable than it once was, and its absence a real cost to employees.
Question 177
A §179 deduction cannot:
Select an option first.
Correct answer: B — CREATE OR INCREASE A LOSS — it is capped at active business taxable income
Explanation: §179 has THREE limits: the annual DOLLAR CAP; a dollar-for-dollar PHASE-OUT above a spending threshold; and the ACTIVE BUSINESS TAXABLE INCOME limit — §179 CANNOT create a loss. The disallowed excess carries forward. BONUS depreciation, by contrast, CAN create a loss.
Question 178
BONUS depreciation differs from §179 in that bonus:
Select an option first.
Correct answer: C — CAN create or increase a LOSS, and applies AUTOMATICALLY unless the taxpayer elects out
Explanation: BONUS depreciation has NO taxable income limitation (it CAN create an NOL) and applies AUTOMATICALLY unless the taxpayer ELECTS OUT (by class). §179 requires an affirmative election and cannot create a loss. Note the ORDER: §179 first, then bonus, then MACRS.
Question 179
The order of cost recovery is:
Select an option first.
Correct answer: C — §179 FIRST, then BONUS, then MACRS on the remaining basis
Explanation: The ORDER is fixed: §179 → BONUS → MACRS. Getting the sequence wrong changes every downstream number. And the planning question is whether to take accelerated deductions AT ALL — a taxpayer expecting HIGHER rates later may prefer to ELECT OUT of bonus and spread the deductions into higher-rate years.
Question 180
A taxpayer expecting HIGHER tax rates in future years might:
Select an option first.
Correct answer: C — ELECT OUT of bonus depreciation — spreading deductions into future, higher-rate years where they are worth more
Explanation: The counterintuitive move. If rates will be HIGHER later, a deduction is WORTH MORE later. Electing OUT of bonus depreciation spreads the deductions across future high-rate years. This must be weighed against the time value of money — but it is a genuine planning decision, not an automatic 'take everything now'.
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