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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 211
A C corporation paying a SALARY rather than a DIVIDEND achieves:
Select an option first.
Correct answer: C — ONE layer of tax — salary is DEDUCTIBLE to the corporation, whereas a dividend is not
Explanation: SALARY is DEDUCTIBLE — so paying compensation instead of dividends AVOIDS the double tax. This is why closely-held C corporations 'zero out' income with salaries and bonuses. The constraint is REASONABLE COMPENSATION at the OTHER end: an excessive salary is recharacterised as a DIVIDEND.
Question 212
A closely-held C corporation 'zeroing out' income with salary faces the risk of:
Select an option first.
Correct answer: C — UNREASONABLE COMPENSATION — the excess is recharacterised as a non-deductible DIVIDEND
Explanation: The MIRROR IMAGE of the S corporation problem. In an S CORP the IRS attacks salaries that are too LOW (to grab payroll tax). In a C CORP it attacks salaries that are too HIGH (to deny the deduction and create a dividend). Both are reasonable-compensation fights, running in opposite directions.
Question 213
A LOAN from a shareholder to their C corporation, if recharacterised as EQUITY:
Select an option first.
Correct answer: A — Turns 'interest' into a NON-DEDUCTIBLE DIVIDEND and 'repayment' into a taxable distribution
Explanation: THIN CAPITALISATION: if the debt-equity ratio is excessive and the 'loan' lacks genuine debt characteristics (a written note, a fixed maturity, a market rate, actual repayment), the IRS recharacterises it as EQUITY. Interest becomes a NON-DEDUCTIBLE dividend, and repayments become taxable distributions. Documentation and genuine terms matter.
Question 214
To support DEBT (not equity) treatment for a shareholder loan, the loan should have:
Select an option first.
Correct answer: D — A WRITTEN NOTE, a FIXED MATURITY, a MARKET interest rate, and actual ENFORCEMENT/repayment
Explanation: A defensible shareholder loan looks like a REAL loan: a written note; a fixed maturity date; a market rate of interest actually PAID; a reasonable debt-equity ratio; and actual ENFORCEMENT if payments are missed. A perpetual, interest-free, undocumented advance is equity in all but name.
Question 215
A §1202 QSBS gain exclusion is available only if the corporation:
Select an option first.
Correct answer: A — Was a C CORPORATION at ISSUANCE, met the GROSS ASSET test, and satisfies the 80% ACTIVE BUSINESS test
Explanation: §1202 requires: ORIGINAL ISSUE from a C CORPORATION; the corporation's GROSS ASSETS below the ceiling AT ISSUANCE (and immediately after); an 80% ACTIVE BUSINESS test throughout; and a holding period of MORE THAN 5 YEARS. Every one is a hard gate.
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Question 216
An SSTB CANNOT qualify for §1202 because:
Select an option first.
Correct answer: C — The ACTIVE BUSINESS test EXCLUDES most service businesses — law, health, consulting, financial services, and businesses whose principal asset is the reputation or skill of employees
Explanation: §1202's ACTIVE BUSINESS requirement EXCLUDES most SERVICE businesses — health, law, engineering, accounting, consulting, financial services, brokerage, athletics, performing arts, and any business whose principal asset is the skill or reputation of its employees. QSBS is aimed at product and technology companies, not professional practices.
Question 217
A §1045 ROLLOVER allows a QSBS holder to:
Select an option first.
Correct answer: A — DEFER gain by reinvesting in OTHER QSBS within 60 DAYS — useful when the 5-year holding period was not met
Explanation: §1045 permits a taxpayer holding QSBS for MORE THAN 6 MONTHS to ROLL the gain into OTHER QSBS within 60 DAYS, DEFERRING it and TACKING the holding period. It is the rescue provision when a sale occurs before the 5-year §1202 clock has run — a serial founder's tool.
Question 218
A C corporation's §162(m) limitation caps the deduction for:
Select an option first.
Correct answer: A — COVERED EMPLOYEE compensation at $1 million per year (public companies) — with no performance-based exception post-TCJA
Explanation: §162(m) caps the deduction for a PUBLIC company's covered employees at $1 MILLION each. The TCJA ELIMINATED the performance-based compensation EXCEPTION, so even bonuses and option gains above $1m are now NON-DEDUCTIBLE. It has substantially changed executive compensation design.
Question 219
The §163(j) BUSINESS INTEREST limitation caps the deduction at:
Select an option first.
Correct answer: C — Business interest INCOME + 30% of ATI + floor plan interest — with an INDEFINITE carryforward of the excess
Explanation: §163(j) limits business interest to: business interest INCOME + 30% of ADJUSTED TAXABLE INCOME + floor plan financing interest. The DISALLOWED excess carries forward INDEFINITELY. A SMALL BUSINESS EXCEPTION applies below a gross receipts threshold, and REAL PROPERTY trades may ELECT OUT (accepting ADS depreciation in exchange).
Question 220
A REAL PROPERTY trade or business may ELECT OUT of §163(j), but must then:
Select an option first.
Correct answer: D — Use ADS (slower) DEPRECIATION on its real property — trading faster depreciation for full interest deductibility
Explanation: The ELECTION OUT is a genuine trade-off: a real property business escapes the interest limitation entirely, but must use ADS (longer recovery periods, no bonus depreciation on the real property). For a HIGHLY LEVERAGED property, full interest deductibility usually wins. The election is IRREVOCABLE.
Question 221
The §163(j) SMALL BUSINESS exception applies to taxpayers with:
Select an option first.
Correct answer: D — AVERAGE ANNUAL GROSS RECEIPTS at or below the threshold over the prior 3 years
Explanation: The SMALL BUSINESS EXCEPTION exempts taxpayers whose average annual gross receipts over the prior 3 years fall at or below the statutory threshold (VERIFY the current amount — it is indexed). Most small and mid-sized businesses escape §163(j) entirely on this basis.
Question 222
The EXCESS BUSINESS LOSS limitation applies:
Select an option first.
Correct answer: D — AFTER basis, at-risk and passive — it is the FOURTH and final hurdle
Explanation: §461(l) is the FOURTH hurdle, applied AFTER basis, at-risk and passive. It CAPS the net business loss deductible against NON-business income (wages, investment income). The disallowed excess becomes an NOL CARRYFORWARD. Candidates who stop at three hurdles miss it.
Question 223
An excess business loss becomes:
Select an option first.
Correct answer: A — An NOL CARRYFORWARD — deferred, not destroyed
Explanation: The disallowed EXCESS BUSINESS LOSS converts into an NOL CARRYFORWARD, usable in future years (subject to the 80% limitation). It is a TIMING restriction, not a permanent disallowance — but the deferral can be costly in present-value terms.
Question 224
A taxpayer with a large business loss and large WAGE income is limited by:
Select an option first.
Correct answer: B — The EXCESS BUSINESS LOSS rule — it caps how much business loss can shelter NON-business (wage) income
Explanation: §461(l) exists precisely to stop a high-wage taxpayer using a large business loss to wipe out their salary. The excess is deferred as an NOL. This is the provision that constrains the classic 'buy a loss-making business to shelter my W-2' strategy.
Question 225
An entity's STATE tax planning increasingly turns on:
Select an option first.
Correct answer: A — ECONOMIC NEXUS and APPORTIONMENT — most states now use a SINGLE SALES FACTOR
Explanation: Post-WAYFAIR, ECONOMIC NEXUS (sales thresholds) can create a filing obligation with NO physical presence. And most states now apportion using a SINGLE SALES FACTOR — favouring in-state employers selling out of state, and penalising out-of-state sellers into the state.
Question 226
A PASS-THROUGH ENTITY TAX (PTET) election allows owners to:
Select an option first.
Correct answer: D — WORK AROUND the federal SALT cap — the entity pays the state tax and DEDUCTS it, bypassing the individual's cap
Explanation: The PTET workaround: the PASS-THROUGH ENTITY pays the state income tax and DEDUCTS it as a business expense (entity-level deductions are not subject to the individual SALT cap). Owners receive a state credit. The IRS has BLESSED this, and most states with an income tax now offer it. It is one of the highest-value elections available to pass-through owners.
Question 227
The PTET election is valuable because the individual SALT deduction is:
Select an option first.
Correct answer: A — CAPPED — so state taxes paid personally may deliver NO federal benefit, while entity-level payment IS deductible
Explanation: The individual SALT deduction is CAPPED, so a high-earning pass-through owner may get NO federal deduction for the state tax on their business income. The PTET moves the payment to the ENTITY, where it is fully deductible as a business expense. The federal saving can be substantial, and it is essentially free.
Question 228
A DOMESTIC PRODUCTION or R&D CREDIT is generally more valuable than a deduction because:
Select an option first.
Correct answer: D — A CREDIT reduces TAX dollar-for-dollar; a deduction reduces only TAXABLE INCOME (worth its face x the marginal rate)
Explanation: A $100,000 CREDIT saves $100,000 of tax. A $100,000 DEDUCTION saves $100,000 × the marginal rate — perhaps $21,000 for a C corporation. Credits are worth roughly 5x more per dollar at corporate rates, which is why identifying and claiming credits is high-value work.
Question 229
The R&D credit's requirement that research be TECHNOLOGICAL in nature means:
Select an option first.
Correct answer: A — The activity must rely on the PHYSICAL or BIOLOGICAL sciences, ENGINEERING or COMPUTER SCIENCE — and involve a process of EXPERIMENTATION to eliminate UNCERTAINTY
Explanation: The FOUR-PART TEST: (1) a PERMITTED PURPOSE (a new or improved function, performance, reliability or quality); (2) TECHNOLOGICAL in nature (hard sciences); (3) ELIMINATION OF UNCERTAINTY; and (4) a PROCESS OF EXPERIMENTATION. Software development often qualifies; market research and routine quality control do not.
Question 230
§174 now requires R&D expenditures to be:
Select an option first.
Correct answer: A — CAPITALISED and AMORTISED (5 years domestic / 15 years foreign) — a major cash-flow change
Explanation: §174 now requires SPECIFIED RESEARCH EXPENDITURES to be CAPITALISED and AMORTISED — 5 years domestic, 15 years foreign — rather than expensed immediately. This created a severe cash-flow problem for R&D-heavy companies, which may now owe tax despite having no book profit. VERIFY the current state of the law; this has been the subject of repeated legislative attention.
Question 231
QBI is $400,000; taxable income before QBI is $350,000; net capital gains are $50,000. The QBI deduction is:
Select an option first.
Correct answer: A — $60,000 — the LESSER of 20% of QBI ($80,000) or 20% of (taxable income LESS capital gains) = 20% x $300,000
Explanation: OVERALL LIMIT = 20% × (Taxable income − Net capital gains) = 20% × ($350,000 − $50,000) = $60,000. Tentative = 20% × $400,000 = $80,000. Deduction = the LESSER = $60,000. Forgetting to subtract capital gains gives $70,000 — the intended trap.
Question 232
A non-SSTB above the threshold: QBI $600,000; W-2 wages $100,000; UBIA $1,200,000. The wage/UBIA cap is:
Select an option first.
Correct answer: A — $55,000 — the GREATER of 50% of wages ($50,000) or 25% of wages + 2.5% of UBIA ($25,000 + $30,000)
Explanation: Cap = GREATER of (a) 50% × $100,000 = $50,000, or (b) 25% × $100,000 + 2.5% × $1,200,000 = $25,000 + $30,000 = $55,000. The GREATER is $55,000. The tentative 20% × $600,000 = $120,000 is capped at $55,000. The UBIA alternative WINS here — which is exactly why it exists.
Question 233
Same facts but UBIA is only $200,000. The cap is:
Select an option first.
Correct answer: C — $50,000 — 50% of wages beats 25% of wages + 2.5% of UBIA ($25,000 + $5,000 = $30,000)
Explanation: (a) 50% × $100,000 = $50,000. (b) 25% × $100,000 + 2.5% × $200,000 = $25,000 + $5,000 = $30,000. GREATER = $50,000. With LOW UBIA, the wage test wins; with HIGH UBIA (the prior question), the UBIA test wins. You must compute BOTH every time.
Question 234
An S corporation owner takes a $60,000 salary on $300,000 of profit. Above the QBI threshold, the QBI cap (50% of wages) is:
Select an option first.
Correct answer: D — $30,000 — 50% of the $60,000 salary
Explanation: QBI cap = 50% × W-2 wages = 50% × $60,000 = $30,000. But 20% of QBI ($240,000 after salary) would be $48,000 — so the LOW salary has COST $18,000 of QBI deduction. This is the tension: a low salary saves FICA but shrinks the QBI cap.
Question 235
Same facts, salary raised to $120,000. The QBI cap becomes:
Select an option first.
Correct answer: D — $60,000 — 50% of $120,000; and 20% of the reduced QBI ($180,000) = $36,000, so the deduction is now $36,000
Explanation: Cap = 50% × $120,000 = $60,000. Tentative QBI deduction = 20% × ($300,000 − $120,000) = $36,000. Now the CAP no longer binds ($36,000 < $60,000), so the FULL $36,000 is allowed — versus $30,000 at the low salary. Raising the salary by $60,000 GAINED $6,000 of QBI deduction, against roughly $1,700 of extra Medicare tax. Worth modelling.
Question 236
A C corporation earns $1,000,000 and DISTRIBUTES all after-tax profit. The combined effective rate (21% corporate; 23.8% dividend) is:
Select an option first.
Correct answer: A — 39.8%
Explanation: Corporate tax = 21% × $1,000,000 = $210,000, leaving $790,000. Dividend tax = 23.8% × $790,000 = $188,020. Total = $398,020, an effective rate of 39.8%. Compare a pass-through: 37% less a 20% QBI deduction ≈ 29.6%. The pass-through wins decisively on distributed profits.
Question 237
Same $1,000,000, but the C corporation RETAINS everything. The current effective rate is:
Select an option first.
Correct answer: A — 21% — the shareholder layer is DEFERRED until distribution
Explanation: Retained: only the 21% CORPORATE tax applies now. The second layer is DEFERRED until distribution (or erased if the stock qualifies for §1202, or if the shareholder dies and the heirs get a step-up). This is the C corporation's real advantage — but the ACCUMULATED EARNINGS TAX constrains how long you can play it.
Question 238
A pass-through owner in the 37% bracket with a full 20% QBI deduction faces an effective rate of:
Select an option first.
Correct answer: D — 29.6% — 37% x (1 - 0.20)
Explanation: Effective rate = 37% × (1 − 0.20) = 29.6%. This is the figure to compare against the C corporation's 21% (retained) or 39.8% (distributed). Note the QBI deduction does NOT reduce self-employment tax, so an SE-taxed owner faces more than this.
Question 239
An S corporation shareholder has $40,000 stock basis and $25,000 debt basis. A $75,000 loss is allocated. The deductible loss is:
Select an option first.
Correct answer: A — $65,000 — stock basis plus debt basis; $10,000 is suspended
Explanation: Losses reduce STOCK basis first ($40,000), then DEBT basis ($25,000) = $65,000 deductible. The remaining $10,000 is SUSPENDED and carried forward until basis is restored. (Note: only DIRECT loans create debt basis — a guarantee gives nothing.)
Question 240
A partner contributes property (basis $80,000) subject to a $50,000 liability; they have a 25% partnership interest. Outside basis is:
Select an option first.
Correct answer: B — $42,500 — $80,000 less the $50,000 debt shifted away, plus the 25% share ($12,500)
Explanation: Outside basis = contributed basis $80,000 − the full $50,000 liability (a deemed distribution) + the partner's 25% share of it ($12,500, a deemed contribution) = $42,500. Net debt relief = 75% × $50,000 = $37,500.
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