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Free Questions › CPA › Taxation and Regulation
Free CPA Taxation and Regulation Practice Questions & Answers
500 exam-style Taxation and Regulation questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 211
In a partnership LIQUIDATING distribution, basis is allocated in the order:
Select an option first.
Correct answer: A — CASH first, then UNREALISED RECEIVABLES and INVENTORY (at carryover basis), then OTHER property
Explanation: The ORDER: (1) CASH; (2) unrealised RECEIVABLES and INVENTORY at their carryover basis; (3) OTHER property absorbs the remaining basis. If only cash and ordinary-income assets are received and basis remains, a LOSS is recognised. If any OTHER property comes out, the remaining basis is absorbed into it and NO loss arises.
Question 212
A partner who receives a distribution of INVENTORY and sells it within 5 years recognises:
Select an option first.
Correct answer: D — ORDINARY income — distributed inventory retains its ordinary character for 5 years
Explanation: Distributed INVENTORY retains its ORDINARY character for FIVE YEARS after the distribution. Sold within that window, any gain is ORDINARY. This anti-abuse rule prevents a partner from receiving inventory, holding it briefly, and converting ordinary income into capital gain. Unrealised RECEIVABLES retain their ordinary character FOREVER.
Question 213
The §199A deduction reduces:
Select an option first.
Correct answer: A — TAXABLE INCOME (it is taken BELOW the line) — it does NOT reduce AGI or self-employment tax
Explanation: §199A is taken BELOW the line: it reduces TAXABLE INCOME but NOT AGI, and NOT self-employment tax. Because it does not reduce AGI, it cannot help a taxpayer clear an AGI-based phase-out — a point of real planning significance. It is available whether the taxpayer itemises or takes the standard deduction.
Question 214
A trust or estate is taxed on:
Select an option first.
Correct answer: B — Income it RETAINS; income DISTRIBUTED to beneficiaries is deducted (the distribution deduction) and taxed to the BENEFICIARY
Explanation: A trust/estate is a CONDUIT: it receives a DISTRIBUTION DEDUCTION for income distributed (limited to DNI — distributable net income), and the BENEFICIARY is taxed on it, retaining its character. Income RETAINED is taxed to the trust — at highly compressed brackets that reach the top rate very quickly, which is why distributions are usually made.
Question 215
DNI (distributable net income) serves to:
Select an option first.
Correct answer: A — LIMIT the distribution deduction and the amount taxable to beneficiaries, AND determine the CHARACTER of the distributed income
Explanation: DNI performs THREE functions: it CAPS the trust's distribution deduction; it CAPS the amount taxable to the beneficiaries; and it determines the CHARACTER of what the beneficiaries receive (tax-exempt income stays tax-exempt in their hands). DNI generally EXCLUDES capital gains allocated to corpus.
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Question 216
A C corporation's taxable income is reduced by the DRD, but the DRD may NOT create or increase:
Select an option first.
Correct answer: A — An NOL — EXCEPT that the taxable-income limitation is waived precisely WHEN the full DRD would create or increase one
Explanation: This rule is deliberately circular and heavily tested. The DRD is limited to a percentage of taxable income — BUT that limitation does NOT apply if applying the full DRD would CREATE or INCREASE an NOL. So the limitation binds only in the MIDDLE range, where the corporation has income but not enough of it.
Question 217
An S corporation's AAA may be:
Select an option first.
Correct answer: A — NEGATIVE (from losses), but DISTRIBUTIONS may NOT create or increase a negative AAA balance
Explanation: AAA CAN go NEGATIVE as a result of LOSSES. However, DISTRIBUTIONS may NOT create or increase a negative AAA. So a corporation with a negative AAA making a distribution moves straight to the next tier (AEP dividend, or return of basis if no AEP).
Question 218
A partner contributes SERVICES in exchange for a CAPITAL interest. The partner recognises:
Select an option first.
Correct answer: D — ORDINARY INCOME equal to the FMV of the capital interest received
Explanation: Receiving a CAPITAL interest (a share of existing partnership assets) for SERVICES produces ORDINARY INCOME equal to the FMV of the interest — §721 does NOT protect service contributions. A PROFITS interest (a share only of FUTURE profits), by contrast, is generally NOT taxable on receipt.
Question 219
A PROFITS interest received for services is generally:
Select an option first.
Correct answer: A — NOT taxable on receipt (under safe-harbour guidance), because it has no liquidation value
Explanation: A PROFITS INTEREST — conferring rights only to FUTURE profits, with no share of existing capital — is generally NOT taxable on receipt under long-standing safe-harbour guidance, because its LIQUIDATION VALUE is zero. This is the foundation of the 'carried interest' structure used throughout private equity.
Question 220
A corporation's NOL carryforward is limited to 80% of taxable income. That 80% is computed:
Select an option first.
Correct answer: D — On taxable income determined WITHOUT regard to the NOL deduction itself (and certain other deductions)
Explanation: The 80% limitation is applied to taxable income computed WITHOUT regard to the NOL deduction (and without the §199A and §250 deductions). Otherwise the calculation would be circular. Any unused NOL carries forward INDEFINITELY.
Question 221
A corporation that redeems a shareholder's stock treats it as a SALE (not a dividend) if the redemption is:
Select an option first.
Correct answer: A — SUBSTANTIALLY DISPROPORTIONATE, a COMPLETE TERMINATION of interest, NOT ESSENTIALLY EQUIVALENT to a dividend, or a PARTIAL LIQUIDATION
Explanation: A redemption qualifies for SALE (capital gain) treatment under §302 if it is: (1) NOT ESSENTIALLY EQUIVALENT to a dividend; (2) SUBSTANTIALLY DISPROPORTIONATE (the shareholder's ownership drops below 80% of its former percentage AND below 50% overall); (3) a COMPLETE TERMINATION; or (4) a PARTIAL LIQUIDATION. Otherwise it is a DIVIDEND to the extent of E&P.
Question 222
In testing a redemption, the ATTRIBUTION rules deem a shareholder to own stock held by:
Select an option first.
Correct answer: A — Their spouse, children, grandchildren and parents, and stock held through entities
Explanation: §318 ATTRIBUTION: an individual is deemed to own stock held by their SPOUSE, CHILDREN, GRANDCHILDREN and PARENTS (note: NOT siblings, and NOT grandparents), plus stock held through partnerships, estates, trusts and corporations. Attribution can defeat an apparent 'complete termination' — though a family-attribution WAIVER is available in limited circumstances.
Question 223
An estate's income tax return is filed on:
Select an option first.
Correct answer: C — Form 1041 — and the estate may elect a FISCAL year, unlike a trust
Explanation: Form 1041 is the income tax return for an ESTATE or TRUST. (Form 706 is the ESTATE TAX return — a transfer tax on the value of the estate, a wholly different thing.) An ESTATE may elect a FISCAL year; a TRUST must generally use a CALENDAR year.
Question 224
The 65-day rule permits a trust to:
Select an option first.
Correct answer: B — Treat distributions made within 65 DAYS after year-end as if made on the LAST DAY of the prior year
Explanation: The 65-DAY RULE (a §663(b) election) allows a trust or estate to treat distributions made within the first 65 DAYS of the new year as if made on the LAST DAY of the PRIOR year. Because trusts hit the top bracket at very low income levels, this is a valuable tool for shifting income to lower-bracket beneficiaries after the year has closed.
Question 225
A SIMPLE trust must:
Select an option first.
Correct answer: D — DISTRIBUTE ALL income currently, make NO charitable contributions, and distribute NO corpus
Explanation: A SIMPLE trust must: DISTRIBUTE ALL income currently; make NO charitable contributions; and distribute NO corpus during the year. Any trust failing these is a COMPLEX trust. An estate is ALWAYS treated as complex. The distinction affects the computation of the distribution deduction and the exemption amount.
Question 226
The federal GIFT tax annual exclusion applies:
Select an option first.
Correct answer: D — PER DONEE, PER YEAR — a donor may exclude the annual amount to EACH of any number of donees
Explanation: The annual exclusion applies PER DONEE, PER YEAR. A donor may give the exclusion amount to any NUMBER of donees each year without using any lifetime exemption. GIFT SPLITTING by a married couple doubles it. Note the gift must be of a PRESENT interest — a gift to a trust with no present enjoyment does not qualify.
Question 227
The unified credit applies to:
Select an option first.
Correct answer: A — BOTH gift and estate tax — lifetime taxable gifts CONSUME the exemption available at death
Explanation: The exemption is UNIFIED: lifetime taxable gifts CONSUME the amount available at death. Taxable gifts are cumulative and are added back in computing the estate tax, with a credit for gift tax already paid. PORTABILITY allows a surviving spouse to inherit the deceased spouse's UNUSED exclusion — but it must be ELECTED on a timely-filed estate tax return.
Question 228
The marital deduction for transfers to a spouse is:
Select an option first.
Correct answer: D — UNLIMITED for a US citizen spouse — deferring, not eliminating, the transfer tax until the surviving spouse's death
Explanation: The MARITAL DEDUCTION is UNLIMITED for a US CITIZEN spouse — but it DEFERS rather than eliminates the tax, since the property is then in the survivor's estate. For a NON-CITIZEN spouse, the unlimited deduction is NOT available (a QDOT is required), because the government cannot be sure of taxing the survivor's estate.
Question 229
A gift of a FUTURE interest:
Select an option first.
Correct answer: D — Does NOT qualify for the annual exclusion — only PRESENT interests do
Explanation: The annual exclusion requires a PRESENT INTEREST — the donee must have an immediate, unrestricted right to use, possess or enjoy the property. A gift to a trust where the beneficiary cannot access the funds is a FUTURE interest and gets NO exclusion. A CRUMMEY power (a temporary right of withdrawal) is the standard workaround.
Question 230
A generation-skipping transfer tax applies to transfers to:
Select an option first.
Correct answer: A — A SKIP PERSON — generally a grandchild or someone two or more generations below the transferor
Explanation: The GST tax applies to transfers to a SKIP PERSON — a person two or more generations below the transferor (a grandchild), or a trust whose beneficiaries are all skip persons. It exists to prevent families from avoiding a generation's worth of estate tax by skipping directly to grandchildren. A separate GST exemption is available.
Question 231
A corporation's charitable contribution of INVENTORY to a qualified charity for the care of the ill or needy may be deducted at:
Select an option first.
Correct answer: C — Basis PLUS HALF the appreciation — capped at TWICE basis (an enhanced deduction)
Explanation: An ENHANCED deduction is available for contributions of INVENTORY used for the care of the ill, needy or infants: BASIS + 50% of the appreciation, capped at TWICE BASIS. It is one of the few instances where a corporation may deduct more than basis for ordinary income property.
Question 232
A corporation's Schedule M-1 ADDS BACK to book income:
Select an option first.
Correct answer: A — FEDERAL INCOME TAX EXPENSE, non-deductible fines, 50% of meals, and excess book depreciation
Explanation: M-1 ADDS BACK items deducted for BOOK but NOT for TAX: federal income tax expense, fines and penalties, the non-deductible half of meals, key-person life insurance premiums, and excess book depreciation. It SUBTRACTS items in book income but NOT taxable: municipal interest, life insurance proceeds, and excess tax depreciation.
Question 233
The §163(j) business interest limitation does NOT apply to a taxpayer with:
Select an option first.
Correct answer: D — AVERAGE ANNUAL GROSS RECEIPTS at or below the small business threshold over the prior 3 years
Explanation: The SMALL BUSINESS EXCEPTION exempts taxpayers whose average annual gross receipts over the prior 3 years do not exceed the statutory threshold (VERIFY — it is indexed). Otherwise, business interest is limited to business interest income + 30% of ATI + floor plan interest, with the excess carried forward indefinitely.
Question 234
A corporation's estimated tax underpayment penalty is avoided by a LARGE corporation (taxable income of $1M+ in any of the 3 prior years) by paying:
Select an option first.
Correct answer: C — 100% of the CURRENT year's tax — a large corporation generally may NOT use the prior-year safe harbour (except for the 1st instalment)
Explanation: A LARGE CORPORATION (taxable income of $1 million or more in ANY of the 3 preceding years) generally may NOT rely on the prior-year safe harbour — it must pay 100% of the CURRENT year's tax. The one exception is the FIRST instalment, which may be based on the prior year, with any shortfall recaptured in the second.
Question 235
Foreign-derived intangible income (FDII) provides a deduction that results in an effective rate of approximately:
Select an option first.
Correct answer: D — 13.125% — an incentive for US corporations to serve foreign markets from the US
Explanation: The §250 FDII deduction (37.5% of FDII) produces an effective rate of about 13.125%, incentivising US corporations to hold IP domestically and export. Its counterpart, the GILTI deduction (50%), produces roughly 10.5% — a stick discouraging offshoring. FDII is the carrot; GILTI is the stick.
Question 236
GILTI is included in the income of:
Select an option first.
Correct answer: C — US SHAREHOLDERS owning 10% or more of a controlled foreign corporation, CURRENTLY — regardless of distribution
Explanation: GILTI (global intangible low-taxed income) is included CURRENTLY in the income of 10%-or-greater US shareholders of a CFC — whether or not anything is distributed. Like Subpart F, it is an ANTI-DEFERRAL regime, designed to stop US groups parking income in low-tax jurisdictions indefinitely.
Question 237
A CFC is a foreign corporation in which US shareholders (10%+ owners) own:
Select an option first.
Correct answer: A — MORE THAN 50% of the voting power or value
Explanation: A CONTROLLED FOREIGN CORPORATION exists when US SHAREHOLDERS — defined as US persons owning 10% or more — together own MORE THAN 50% of the voting power or value. Note the two-step definition: you must be a 10% owner to be counted, and the counted owners must together exceed 50%.
Question 238
Subpart F income is taxed to US shareholders:
Select an option first.
Correct answer: D — CURRENTLY, without any distribution — it targets passive and easily-shifted income
Explanation: SUBPART F income (passive income, foreign base company income, insurance income) is taxed CURRENTLY to 10%+ US shareholders of a CFC, with NO distribution required. It is the original anti-deferral regime, aimed at preventing US taxpayers from parking mobile, passive income offshore.
Question 239
An entity's income allocated to a state is generally determined by:
Select an option first.
Correct answer: B — APPORTIONMENT formulas — historically sales, payroll and property, with many states now using SINGLE SALES FACTOR
Explanation: State APPORTIONMENT historically used a three-factor formula (property, payroll and sales). Most states have moved to a SINGLE SALES FACTOR, which favours in-state employers with out-of-state customers. NEXUS (the connection required before a state may tax) is now increasingly ECONOMIC rather than merely physical, following Wayfair.
Question 240
A shareholder transfers property (basis $50,000; FMV $90,000) to a corporation in a valid §351, receiving stock worth $70,000 and $20,000 cash. Gain recognised is:
Select an option first.
Correct answer: B — $20,000 — the LESSER of realised gain ($40,000) or boot ($20,000)
Explanation: Realised gain = $90,000 − $50,000 = $40,000. Boot = $20,000 cash. Recognised = the LESSER = $20,000.
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