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Exam 9: Business Income, Deductions, and Accounting Methods

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Question 1

Multiple Choice

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

A) Compensation paid to the taxpayer's spouse in excess of salary payments to other employees.
B) Amounts paid to a subsidiary corporation for services where the amount is in excess of the cost of comparable services by competing corporations.
C) Cost of entertaining a former client when there is no possibility of any future benefits from a relation with that client.
D) All of these are likely to be unreasonable in amount.
E) None of these is likely to be unreasonable in amount.

F) D) and E)
G) None of the above

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Question 2

True/False

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Although expenses associated with illegal activities are not deductible, political contributions can be deducted as long as the donation is not made to a candidate for public office.

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 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?

A loss deduction from a casualty of a business asset is only available if the asset is completely destroyed.

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?

Even a cash method taxpayer must consistently use accounting methods that "clearly reflect income" for tax purposes.

Which of the following is NOT likely to be allowed as a current deduction for a landscaping and nursery business?

Manley operates a law practice on the accrual method and calendar year. At the beginning of the year Manley's firm had an allowance for doubtful accounts with a balance of $15,000. At the end of the year, Manley recorded bad debt expense of $23,000 and the balance of doubtful accounts had increased to $18,000. What is Manley's deduction for bad debt expense this year?

The phase "ordinary and necessary" has been defined to mean that an expense must be essential and indispensable to the conduct of a business.

Todd operates a business using the cash basis of accounting. At the end of last year, Todd was granted permission to switch his sales on account to the accrual method. Last year Todd made $420,000 of sales on account and $64,000 was uncollected at the end of the year. What is the Todd's §481 adjustment for this year?

Which of the following is a true statement about a request for a change in accounting method?

Rock Island Corporation generated taxable income (before the domestic production activities deduction) of $10 million this year. The total income included $4,500,000 of qualified production activities income. The company paid $500,000 in W-2 wages to generate the qualified production activity income. What is Rock Island's domestic production activities deduction for the year?

Jones operates an upscale restaurant and he pays experienced cooks $35,000 per year. This year he hired his son as an apprentice cook. Jones agreed to pay his son $40,000 per year. Which of the following is a true statement about this transaction?

The all-events test for income determines the period in which income will be recognized for tax purposes.

According to the Internal Revenue Code §162, deductible trade or business expenses must be one of the following?

The domestic production activities deduction is a deduction for the incremental cost of manufacturing tangible assets in the United States.

Sole proprietorships must use the same tax year as the proprietor of the business.

The 12-month rule allows taxpayers to deduct the entire amount of certain prepaid business expenses.

Crystal operates a business that provides typing and delivery services. This year Crystal spent $2,500 to purchase special shirts that identify her employees and provide some notoriety for her business. The shirts are especially colorful and include logos on the front pocket and back. Besides salary payments, Crystal also compensates her employees by offering to pay whole life insurance premiums for any that want to provide insurance coverage for their beneficiaries. This year Crystal paid $5,000 in life insurance premiums. What amount of these payments can Crystal deduct? Crystal is on the cash method and calendar year.

Gabby operates a pizza delivery service. This year she paid delivery personnel $18,000 in salary. She carefully documented the use of the auto (11,700 miles this year) and her $7,350 of vehicle expenses (for gas, oil, repairs, and auto lease payments). What amount of these expenses may Gabby deduct as business expenses? Gabby is on the cash method and calendar year.