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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 241
A partner's outside basis is $30,000. Their share of partnership debt DROPS by $45,000. They recognise:
Select an option first.
Correct answer: B — A $15,000 CAPITAL GAIN — the debt reduction is a DEEMED CASH DISTRIBUTION exceeding basis
Explanation: A DECREASE in a partner's share of partnership debt is a DEEMED CASH DISTRIBUTION. $45,000 deemed cash exceeds the $30,000 basis by $15,000 — recognised as CAPITAL GAIN, with NO actual cash received. This 'phantom gain' catches real estate partners when the partnership pays down debt.
Question 242
A §754 election: a partner buys an interest for $500,000; their share of inside basis is $320,000. The §743(b) step-up is:
Select an option first.
Correct answer: C — $180,000 — benefiting the BUYING partner ONLY
Explanation: §743(b) adjustment = purchase price $500,000 − share of inside basis $320,000 = a $180,000 STEP-UP, benefiting the TRANSFEREE ONLY. Without a §754 election, the buyer inherits the LOW inside basis — less depreciation and more gain on a later sale. Always ask whether the partnership has the election.
Question 243
A business earns $500,000. As an S corp the owner takes a $200,000 salary; QBI is $300,000; W-2 wages are $200,000. Above the threshold, the QBI deduction is:
Select an option first.
Correct answer: D — $60,000 — 20% of the $300,000 QBI, which is BELOW the $100,000 wage cap (50% x $200,000)
Explanation: Tentative = 20% × $300,000 = $60,000. Wage cap = 50% × $200,000 = $100,000. The cap does NOT bind, so the full $60,000 is allowed. Raising the salary further would REDUCE QBI without increasing the deduction — the salary is already high enough.
Question 244
Same business, but the salary is only $60,000. QBI is $440,000; wages $60,000. The QBI deduction is:
Select an option first.
Correct answer: B — $30,000 — capped at 50% of the $60,000 wages, versus a tentative $88,000
Explanation: Tentative = 20% × $440,000 = $88,000. Wage cap = 50% × $60,000 = $30,000. The CAP BINDS HARD — the deduction collapses to $30,000. The low salary saved FICA but COST $58,000 of QBI deduction (worth ~$21,000 at 37%). The FICA saving on $140,000 of avoided salary is only ~$4,000 of Medicare tax. The LOW salary is a LOSING strategy here.
Question 245
A taxpayer sells QSBS after 4 YEARS and 10 months. The §1202 exclusion is:
Select an option first.
Correct answer: D — ZERO — the 5-year holding period FAILED; but §1045 permits a ROLLOVER into other QSBS within 60 days
Explanation: §1202 requires MORE THAN 5 YEARS. At 4 years 10 months, the exclusion is ENTIRELY LOST. The rescue: §1045 permits a ROLLOVER of the gain into OTHER QSBS within 60 DAYS, DEFERRING the gain and TACKING the holding period. Two months of patience — or a §1045 rollover — is the difference between full exclusion and full taxation.
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Question 246
A C corporation with $1m of profit: 21% corporate tax, then a 23.8% dividend tax. If the owner instead takes a $1m SALARY (37% rate), the tax is:
Select an option first.
Correct answer: A — $370,000 (salary route) PLUS payroll tax — but the salary is DEDUCTIBLE, avoiding the corporate layer entirely
Explanation: SALARY route: $1m deductible salary → NO corporate tax; the owner pays 37% = $370,000, plus Medicare tax. DIVIDEND route: 21% corporate ($210,000) + 23.8% on the $790,000 remainder ($188,020) = $398,020. SALARY WINS — which is why closely-held C corporations 'zero out' income with compensation. The constraint is REASONABLE COMPENSATION.
Question 247
The same C corporation cannot deduct an unreasonably high salary. If $400,000 of a $1m salary is deemed excessive:
Select an option first.
Correct answer: C — The $400,000 is recharacterised as a NON-DEDUCTIBLE DIVIDEND — the corporation loses the deduction (paying 21% = $84,000) and the owner is taxed on a dividend
Explanation: The excess $400,000 becomes a CONSTRUCTIVE DIVIDEND: the corporation LOSES the $400,000 deduction (costing $84,000 of corporate tax) and the owner is taxed at DIVIDEND rates rather than wage rates. The owner may actually pay LESS personally — but the LOST CORPORATE DEDUCTION makes the family WORSE OFF overall.
Question 248
An S corporation shareholder guarantees a $500,000 bank loan. Their stock basis is $0. A $200,000 loss is allocated. The deductible loss is:
Select an option first.
Correct answer: B — $0 — a GUARANTEE creates NO basis; the loss is entirely SUSPENDED
Explanation: A GUARANTEE creates NO S corporation basis. With $0 basis, the ENTIRE $200,000 loss is SUSPENDED. THE FIX: the shareholder BORROWS PERSONALLY from the bank and LENDS the proceeds to the corporation — creating $500,000 of genuine DEBT BASIS and unlocking the loss. The economics are identical; the tax result is transformed.
Question 249
A PARTNER guaranteeing a $500,000 partnership loan, with $0 basis, allocated a $200,000 loss, may deduct:
Select an option first.
Correct answer: D — Up to $200,000 — the guarantee makes the debt RECOURSE to them, INCREASING their outside basis
Explanation: THE SHARPEST CONTRAST IN ENTITY CHOICE. A PARTNER'S guarantee makes the debt RECOURSE to them, and recourse debt is allocated to the guaranteeing partner — INCREASING outside basis. An S CORPORATION shareholder'S guarantee creates NOTHING. Identical economics, opposite tax outcomes.
Question 250
A start-up founder must choose between an LLC and a C corporation. They expect a $50m exit in 7 years. They should choose:
Select an option first.
Correct answer: B — A C CORPORATION — §1202 QSBS could EXCLUDE an enormous gain, dwarfing 7 years of double taxation on (likely minimal) profits
Explanation: For a venture expecting a LARGE EXIT, §1202 QSBS is decisive: it requires C CORPORATION stock held MORE THAN 5 YEARS. Seven years comfortably clears it. The double-tax cost is trivial for a start-up with little or no profit — and the exclusion at exit can be worth millions. The entity decision must be made at FORMATION.
Question 251
The same founder expects the venture to generate LOSSES for 5 years, then be sold at a modest gain. They should choose:
Select an option first.
Correct answer: D — A PASS-THROUGH — the losses FLOW OUT to offset other income now; a C corp would TRAP them as an NOL
Explanation: THE FACTS FLIP THE ANSWER. With LOSSES and a MODEST exit, QSBS is worth little — but the LOSSES are worth a lot NOW if they flow through. A C corporation TRAPS them as an NOL (usable only against future corporate income, capped at 80%). A pass-through releases them immediately. Same question, opposite answer.
Question 252
A founder who started as an LLC and converts to a C corporation in year 4, selling in year 7, finds that §1202:
Select an option first.
Correct answer: C — Applies ONLY to appreciation AFTER the conversion — and the 5-year clock started at CONVERSION, so at 3 years it FAILS entirely
Explanation: TWO failures compound. (1) The §1202 5-YEAR CLOCK starts at ISSUANCE (the conversion) — at 3 years, it FAILS ENTIRELY. (2) Even if it had run, only POST-CONVERSION appreciation would qualify. Converting LATE is a costly mistake, and it cannot be fixed retroactively.
Question 253
A partnership with a §754 election in place; a partner dies with a $3m FMV interest and a $1m share of inside basis. The heir receives:
Select an option first.
Correct answer: C — A $2m §743(b) STEP-UP in inside basis — unlocking depreciation and eliminating built-in gain, for THAT HEIR ONLY
Explanation: The heir's OUTSIDE basis steps up to $3m under §1014. The §754/§743(b) adjustment steps up their share of INSIDE basis by $2m — so they get depreciation on the full $3m and no built-in gain on a sale. WITHOUT the election, they would hold $3m of outside basis but be allocated gain based on the $1m inside basis. A fortune turns on a checkbox.
Question 254
The same partner held S CORPORATION stock instead. At death the heir receives:
Select an option first.
Correct answer: B — A step-up in STOCK basis ONLY — the corporation's INSIDE basis remains LOW, and there is NO §754 equivalent
Explanation: THE S CORPORATION'S ESTATE PLANNING WEAKNESS. Stock basis steps up — but the CORPORATION'S inside basis in its assets does NOT, and there is NO §754 mechanism to fix it. If the corporation then sells its assets, the gain flows through and is TAXED, despite the heir's high stock basis. A PARTNERSHIP would have solved this. For an asset-heavy business intended to pass at death, this is a decisive argument.
Question 255
A taxpayer's business loss is $800,000; wages are $600,000. After basis, at-risk and passive tests are cleared, the EXCESS BUSINESS LOSS rule:
Select an option first.
Correct answer: D — CAPS the loss deductible against the NON-BUSINESS (wage) income — the excess becomes an NOL CARRYFORWARD
Explanation: §461(l) is the FOURTH hurdle. Even after clearing basis, at-risk and passive, the loss deductible against NON-BUSINESS income (the $600,000 of wages) is CAPPED. The disallowed excess becomes an NOL CARRYFORWARD — deferred, not destroyed. This is the provision that blocks 'buy a losing business to shelter my salary'.
Question 256
A corporation with a $10m NOL is acquired, triggering §382. Equity value is $20m; the long-term tax-exempt rate is 3%. The ANNUAL NOL limit is:
Select an option first.
Correct answer: B — $600,000 — $20m x 3%; the $10m NOL would take nearly 17 years to use
Explanation: §382 limit = $20m × 3% = $600,000 PER YEAR. A $10m NOL would take nearly 17 YEARS to absorb — and in present-value terms it is worth a fraction of its face amount. This is why NOLs are heavily DISCOUNTED (or ignored) in acquisition pricing, and why §382 must be modelled before a deal.
Question 257
A C corporation with excess cash and no business need faces the accumulated earnings tax. The BEST responses are:
Select an option first.
Correct answer: C — DISTRIBUTE the earnings, or DOCUMENT a specific, plausible business need (a planned acquisition, expansion, or capital budget)
Explanation: TWO defences. (1) DISTRIBUTE — the AET taxes only UNDISTRIBUTED earnings, so a dividend removes the base. (2) DOCUMENT a SPECIFIC business need — a written expansion plan, a capital budget, an identified acquisition target. Note that buying passive INVESTMENTS makes it WORSE, and may trigger the PHC tax as well.
Question 258
The holding period for LONG-TERM capital gain treatment is:
Select an option first.
Correct answer: B — MORE THAN ONE YEAR
Explanation: MORE THAN ONE YEAR (one year and a day). Exactly one year is SHORT-TERM. The rate difference between short-term (ordinary rates) and long-term (0/15/20%) can exceed 20 percentage points — so a single day of holding can be worth a great deal.
Question 259
The basis of INHERITED property is:
Select an option first.
Correct answer: C — FMV at the DATE OF DEATH — a STEP-UP (or step-down)
Explanation: §1014 gives inherited property a basis equal to FMV at death — a STEP-UP that PERMANENTLY ELIMINATES all appreciation during the decedent's life. The holding period is AUTOMATICALLY LONG-TERM. This is the single most powerful provision in property planning.
Question 260
The basis of GIFTED property (when FMV exceeds the donor's basis) is:
Select an option first.
Correct answer: D — The DONOR'S basis (carryover), and the holding period TACKS
Explanation: A gift transfers the DONOR'S BASIS (carryover), plus the gift tax attributable to the appreciation. The built-in gain COMES WITH IT. Contrast INHERITANCE, which STEPS UP basis and erases the gain — the core reason to HOLD appreciated assets until death rather than gift them.
Question 261
The planning implication of the step-up at death is:
Select an option first.
Correct answer: A — HOLD appreciated assets until death (the gain is erased) and GIFT high-basis or loss assets during life
Explanation: The rule that governs a great deal of planning: HOLD APPRECIATED assets until death — the step-up ERASES the gain permanently. GIFT high-basis assets (little gain to lose). NEVER GIFT LOSS property — the built-in loss is DESTROYED by the dual-basis rule.
Question 262
GIFTING property with a built-in LOSS is a mistake because:
Select an option first.
Correct answer: D — The BUILT-IN LOSS is DESTROYED — the donee's loss basis is limited to FMV at the date of gift
Explanation: When FMV is BELOW the donor's basis, the donee's LOSS basis is limited to that FMV — so the built-in loss simply EVAPORATES. The correct move: SELL the loss property yourself, CLAIM the loss, and GIFT THE CASH. Never gift loss property.
Question 263
The DUAL BASIS rule applies when, at the date of gift:
Select an option first.
Correct answer: D — FMV is BELOW the donor's basis — creating one basis for gain and another for loss
Explanation: When FMV < donor's basis: GAIN basis = the donor's basis; LOSS basis = FMV at gift. A sale price BETWEEN the two produces NEITHER gain NOR loss — the 'no man's land'. This is the mechanism that destroys the built-in loss.
Question 264
§1031 like-kind exchange treatment, post-TCJA, applies ONLY to:
Select an option first.
Correct answer: D — REAL PROPERTY held for business or investment
Explanation: Post-TCJA, §1031 applies ONLY to REAL PROPERTY. Personal property (equipment, vehicles, artwork, crypto) NO LONGER qualifies. The provision permits INDEFINITE deferral of gain — and combined with the step-up at death, that deferral can become PERMANENT ELIMINATION.
Question 265
'SWAP TILL YOU DROP' refers to:
Select an option first.
Correct answer: B — Deferring gain through successive §1031 exchanges until DEATH, when the step-up ERASES the deferred gain permanently
Explanation: The most powerful strategy in real estate: exchange repeatedly under §1031, DEFERRING the gain each time, then DIE holding the property. §1014 STEPS UP the basis to FMV, and the entire accumulated deferred gain — potentially decades' worth — is PERMANENTLY ERASED. Deferral becomes elimination.
Question 266
In a §1031 exchange, gain is recognised to the extent of:
Select an option first.
Correct answer: D — BOOT received — the LESSER of realised gain or boot
Explanation: Recognised gain = the LESSER of (a) realised gain or (b) BOOT received. LOSS is NEVER recognised in a §1031 exchange, even with boot — that asymmetry means you should NEVER exchange property with a built-in LOSS. Sell it instead and claim the loss.
Question 267
You should NEVER use §1031 for property with a built-in LOSS because:
Select an option first.
Correct answer: D — LOSS is NEVER RECOGNISED in a §1031 exchange — selling instead would allow you to CLAIM it
Explanation: §1031 DEFERS gains AND DISALLOWS losses. Exchanging loss property means you forgo a deductible loss AND carry the depressed basis forward. The correct move: SELL it, CLAIM the loss, and buy the replacement property outright.
Question 268
The §1031 identification and exchange deadlines are:
Select an option first.
Correct answer: D — 45 days to IDENTIFY and 180 days to CLOSE — both ABSOLUTE, with no reasonable-cause extension
Explanation: 45 DAYS to identify the replacement property; 180 DAYS (or the return due date, if earlier) to close. Both are ABSOLUTE. Missing either destroys the exchange entirely. A QUALIFIED INTERMEDIARY holds the proceeds to prevent CONSTRUCTIVE RECEIPT — touching the cash, even briefly, kills the deferral.
Question 269
A QUALIFIED INTERMEDIARY is used in a §1031 exchange to:
Select an option first.
Correct answer: C — PREVENT CONSTRUCTIVE RECEIPT of the sale proceeds by the taxpayer
Explanation: If the taxpayer ever has ACTUAL or CONSTRUCTIVE RECEIPT of the proceeds, the exchange FAILS and the gain is fully taxable. A QUALIFIED INTERMEDIARY holds the funds throughout, so the taxpayer never touches them. Using one is not optional in practice.
Question 270
§1245 recapture treats gain as ORDINARY to the extent of:
Select an option first.
Correct answer: B — ALL DEPRECIATION previously taken (capped at the gain), on PERSONAL property
Explanation: §1245 (PERSONAL property) recaptures ALL depreciation as ORDINARY income, up to the gain. Any remaining gain is §1231. §1250 (REAL property) recaptures only depreciation in EXCESS of straight-line — which, post-1986, is essentially none.
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