2016 Wiley CPAexcel ® exam review FOCUS NOTES Regulation Cover Design: Wiley Cover image: © turtleteeth/iStockphoto Copyright © 2016 by John Wiley & Sons, Inc All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-750-4470, or on the Web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, or online at http://www.wiley.com/go/permission Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books For more information about Wiley products, visit our Web site at http://www.wiley.com ISBN: 978-1-119-12009-4 (paperback); 978-1-119-24093-8 (ebk); 978-1-119-24092-1 (ebk) Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 Contents Preface v About the Author vii About the Contributors vii Module 23: Module 24: Module 25: Module 26: Module 27: Module 28: Module 29: Module 30: Module 31: Module 32: Module 33: Module 34: Module 35: Professional and Legal Responsibilities Federal Securities Acts Business Structure Contracts Sales Commercial Paper Secured Transactions Bankruptcy Debtor-Creditor Relationships Agency Regulation of Business Employment, Environment, and Antitrust Property Individual Taxation 16 28 52 66 80 93 101 114 118 122 145 154 iii Module 36: Module 37: Module 38: Module 39: Transactions in Property Partnership Taxation Corporate Taxation Other Taxation Topics 208 215 224 253 Index 276 Contents iv Preface This publication is a comprehensive, yet simplified study program It provides a review of all the basic skills and concepts tested on the CPA exam, and teaches important strategies to take the exam faster and more accurately This tool allows you to take control of the CPA exam This simplified and focused approach to studying for the CPA exam can be used: • • • As a handy and convenient reference manual To solve exam questions To reinforce material being studied Included is all of the information necessary to obtain a passing score on the CPA exam in a ­concise and easy-to-use format Due to the wide variety of information covered on the exam, a number of techniques are included: • • • Acronyms and mnemonics to help candidates learn and remember a variety of rules and checklists Formulas and equations that simplify complex calculations required on the exam Simplified outlines of key concepts without the details that encumber or distract from ­learning the essential elements v • • • Techniques that can be applied to problem solving or essay writing, such as preparing a multiple-step income statement, determining who will prevail in a legal conflict, or developing an audit program Pro forma statements, reports, and schedules that make it easy to prepare these items by simply filling in the blanks Proven techniques to help you become a smarter, sharper, and more accurate test taker This publication may also be useful to university students enrolled in Intermediate, Advanced and Cost Accounting; Auditing, Business Law, and Federal Income Tax classes; or Economics and Finance classes Good luck on the exam, Ray Whittington, PhD, CPA Preface vi About the Author Ray Whittington, PhD, CPA, CMA, CIA, is the dean of the Driehaus College of Business at DePaul University Prior to joining the faculty at DePaul, Professor Whittington was the Director of Accountancy at San Diego State University From 1989 through 1991, he was the Director of Auditing Research for the American Institute of Certified Public Ac­countants (AICPA), and he previously was on the audit staff of KPMG He previously served as a member of the Audit­ing Standards Board of the AICPA and as a member of the Accounting and Review Services Committee and the Board of Re­gents of the Institute of Internal Auditors Professor Whittington has published numerous textbooks, articles, mono­graphs, and continuing education courses About the Contributors Edward C Foth, PhD, CPA, Administrator of the Master of Science in Taxation Program at DePaul University Pro­fessor Foth is the author of CCH Incorporated’s Study Guide for Federal Tax Course, Study Guide for CCH Federal Taxation: Comprehensive Topics, and coauthor of their S Corporation Guide Professor Foth prepared the answer expla­nations vii to the multiple-choice and task-based simulation questions in Income Taxes, wrote new questions, selected the mix of questions, and updated items to reflect revisions in the tax law Brad McDonald, JD, is an instructor of Business Law and Statistics at Northern Illinois University He has taught business law since 1987 and has taught the Business Law section of the Northern Illinois CPA review course since 1998 He wrote and revised most of the Business Law modules He prepared and revised answer explanations for the multiple-choice and simulation questions About the Contributors viii Tax Due Tentative Amount Total taxable transfers × Tax rates (from table) = Tentative tax amount Unified Credit • • Credit designed to remove relatively small gifts and estates from the transfer tax The exemption equivalent of the credit is $5.34 million, for both gift and estate tax purposes for 2014 Focus on Other Taxation Topics—Module 39 267 Other Credits Credit for death tax paid to foreign country on real estate owned in that country Gift taxes paid on prior transfers (actually considered prepayment of liability rather than credit, but has same effect as credit to reduce balance due) Generation-Skipping Tax Owed on transfers (both gifts and inheritances) two or more generations below transferor • • • • Transfers to grandchildren, great-nieces, and great-nephews normally included Not applicable if immediate generation below is deceased (no GST on transfer to grandchild if the transferor’s child is deceased) Exemption equivalent for GST same dollar amount as gift and estate tax exemption ($5.34 million for 2014) GST owed in addition to applicable gift and estate taxes Focus on Other Taxation Topics—Module 39 268 Property Received by Inheritance or Gift Inheritance Excluded from recipient’s gross income Basis—Fair market value reported on estate return • • Value at date of death (use this if no estate tax return filed) Value at alternate valuation date if elected on estate return (earlier of date of distribution to recipient or fair value exactly six months after death) Holding period—automatically long-term Focus on Other Taxation Topics—Module 39 269 Gift Receipt of gift excluded from recipient’s gross income Donee’s basis for gain—Basis (and holding period) same as donor’s Donee’s basis for loss—Lesser of gain basis, or FMV at date of gift • • If FMV at date of gift is used to determine a loss, then holding period begins on date of gift If donee’s selling price is below gain basis and above loss basis, then no gain or loss Focus on Other Taxation Topics—Module 39 270 Tax Return Due Dates Assuming taxable year ended December 31 Tax Return Due Date Individual income tax return Amended individual income tax return April 15 of following year Within years from when original return filed (early return treated as filed on due date) April 15 of following year Gift tax return Trust income tax return Estate income tax return Partnership tax return April 15 of following year April 15 of following year April 15 of following year Corporate tax return March 15 of following year S corporation tax return March 15 of following year S corporation status election March 15 of current year Exempt organization tax return May 15 of following year Estate tax return months after date of death Focus on Other Taxation Topics—Module 39 271 Income Tax Return Preparers Procedures for Return Preparation Make reasonable effort to obtain client information to answer all questions on return, except • • • Information not readily available and not significant in determining tax liability Meaning of question is unclear Answer is voluminous and return states data will be supplied upon examination Need not verify client information • • • Must make reasonable inquiries when information appears incorrect or incomplete Should ask about availability of support where required by IRS (e.g., log for travel and entertainment expenses or receipt for charitable contributions over $250) Should refer to past returns of client when feasible Focus on Other Taxation Topics—Module 39 272 Procedures in Preparation (continued) When CPA becomes aware of error on return • • • Inform the client (written communication of important advice preferred, but not required) Recommend appropriate correction or notification Consider withdrawing from relationship if client refuses to correct (must not notify IRS without client permission) Focus on Other Taxation Topics—Module 39 273 Tax Preparer Penalties Minor violations • • • • • • Disclose confidential information from client’s return Endorse or deposit client’s refund for preparer’s benefit Fail to sign return as preparer Fail to provide client with copy of filed return Fail to keep copies of client returns for at least three years Fail to keep list for at least three years of employees preparing returns Major violations • • Understatement of tax liability due to an undisclosed position for which there is not substantial authority (at least 40% probability of success): penalty is greater of $1,000 or 50% of income to be derived from return or claim Willful attempt to understate tax liability, or intentional or reckless disregard of rules and regulations; penalty is greater of $5,000 or 50% of income to be derived from return or claim Focus on Other Taxation Topics—Module 39 274 Tax Preparer Penalties (continued) No violation • • • • Adequate disclosure and a showing that there was a reasonable basis (at least 20% probability of success) for the position Reasonable cause for the understatement and the preparer acted in good faith Use estimates when client did not maintain adequate records Rely on information supplied by client not appearing incorrect or inconsistent Focus on Other Taxation Topics—Module 39 275 Index Acceptance, 54, 67 Accountants’ Liability, Accounting Method, 156 Accumulated Earnings Tax, 233 ADA & Rehabilitation Act, 139 Additional for AGI Deductions, 172 ADEA, 138 Adjusted Basis, 209 Adjustments for AGI, 164 Affiliated Corporation Transactions, 243 Affirmative Action, 140 Agency, 118 Agency Relationship, 118 AICPA Statements on Responsibilities for Tax Services, 13 Alternative Minimum Tax (AMT), 191, 192, 193, 234, 235, 236 Alternatives to Bankruptcy, 113 American Opportunity Credit (Modified HOPE Credit), 189 Amount Realized, 208 Antitrust, 141 Articles of Incorporation, 40 Assignment, 62 Attachment, 95 Auditor Common Law Liability, Auditor Liability Under Federal Securities Laws, 10 Avoidance, 103 Avoiding Liability, 89 Bailments, 150 Bankruptcy, 101 Breach of Contract, 64, 77 Business Combinations, 50 Business Expenses (Schedule C), 166 Business Reorganizations—Chapter 11, 110 Buyer’s Remedies, 78 Carryover Rules, 198 Casualty or Theft Losses, 182 Changes in Liabilities, 216 Characteristics of Corporations, 38 Charitable Contributions, 230 Child Tax Credit, 188 Civil Rights Act (CRA), 137 Claims for Refunds, 201 Clayton Act, 144 Clean Air Act, 123 Co-Ownership, 147 COBRA, 134 COD, 73 Collateral, 93 Commercial Paper, 80 Compensation for Services, 157 Comprehensive Environmental Response Compensation and Liability Act (CERCLA or Superfund), 126 Computing Corporate Income Tax, 226 Computing Taxable Income of Trusts and Estates, 257 Consideration, 55 Contract Liability, 119 Contract Liability of Parties, 87 Contracts, 52 Contribution of Assets, 215 Contribution of Services, 215 Contributions, 175 Contributions to Retirement Plans, 169 Conversion from C to S Corporation, 247 276 Copyrights, 152 Corporate Complete Liquidation, 241 Corporate Income Tax, 224 Corporate Reorganizations, 242 Corporations, 38 Cosureties, 117 Court Confirmation of Plan, 111 Coverdell Education Savings Accounts (ESAs), 171 Credit Card Debt, 100 Credit for Elderly or Disabled, 187 Credits, 186 Damages, 65 Debtor’s Plan, 112 Deductions, 173, 228, 229, 258 Default by Debtor, 99 Defenses, 140 Defenses Against a Negotiable Instrument, 85 Defenses of Sureties, 116 Delegation, 62 Denial of Discharge, 109 Dependency Exemptions, 184, 185 Dependent Care Credit, 188 Depreciable Personal Property, 205 Depreciable Real Property, 203 Depreciation, 203 Depreciation Method, 204, 206 Determining Gain or Loss, 222 Directors & Officers, 42 Discharge, 63, 111 Dissolution, 51 Distributable Net Income (DNI), 259 Distribution of Assets, 105 Distributions, 220 Dividends, 46, 160, 161 Dividends-Received Deduction, 231 Documents of Title, 90, 91 Duties of Directors & Officers, 45 Earned Income Credit, 187 Election, 246 Eligibility Requirements, 245 Employee Retirement Income Security Act (ERISA), 132 Employment, 127 Employment and Self-Employment Tax, 190 Enforceability, 59, 68 Enforcement, 141 Environmental Law, 122 Equal Pay Act, 137 Estate and Gift Tax, 261 Estates, 253 Exceptions to Discharge, 108 Excess Payroll Taxes, 194 Exemption, 258 Exemptions, 183 Exemptions for Smaller and Emerging Companies, 27 Express Warranties, 75 Federal Insurance Contributions Act (FICA), 131 Federal Securities Regulations, 16 Federal Unemployment Tax Act (FUTA), 133 Federal Water Pollution Control Act (Clean Water Act), 124 Filing Issues, 260 Filing Requirements, 200 Filing Status, 196 Firm offer, 66 FLSA (Fair Labor Standards Act), 135 FMLA (Family and Medical Leave Act), 134 Foreign Tax Credit, 237 Formation of Contracts, 52 Index 277 Formation of Partnerships, 33, 215 Fraud, Generation-Skipping Tax, 268 Gift, 270 Goods In Transit, 69 Gross Income, 157, 227, 257 Guaranteed Payments to Partners, 218 Half-Year Convention, 206 Health and Safety, 128 Holder in Due Course (HDC), 84 Horizontal Restraints, 142 Important Property Documents, 148 Income Tax Return Preparers, 272 Individual Income Tax, 154, 155 Inheritance, 269 Insider Trading, 23 Intellectual Property, 151 Interest, 159 Interest Expense, 180 Investment Securities, 92 Involuntary Filing—Chapter 7, 102 Itemized Deductions, 174 Leases, 150 Liability, 119 Liability as a Tax Preparer, 15 Liability of Entering and Exiting Partners, 32 Liability Under 33 Act, Liability Under 34 Act, Lifetime Learning Credit, 189 Limited Liability, 49 Limited Liability Arrangements, 35 Limited Liability Companies (LLCs), 37 Limited Liability Partnerships (LLPs), 36 Limited Partnerships, 35 Liquidating Distributions, 221 Married Couples, 196 Medical Expenses, 177 Medicare Contribution Tax on Net Investment Income, 194 Mergers, 144 Mergers and Acquisitions, 242 Mid-Month Convention, 204 Mid-Quarter Convention, 206 Miscellaneous Expenses, 178, 179 Monopolization, 143 Moving Expenses, 165 National Labor Relations Act (NLRA), 136 Negligence, Negotiable Instruments, 80 Noise Control Act, 125 Non-liquidating Distributions, 220 Non Liquidating Distributions to Stockholders, 239 Obligations of Common Carriers, 71 Obligations of Cosureties, 117 Obligations of Sureties, 114 Occupational Safety & Health Act (OSHA), 128 Offer, 53, 66 Order of Distribution, 105 Other Credits, 268 Other Income, 162, 163 Other Instruments, 90 Other Itemized Deductions, 176 Other Rights of Shareholders, 47, 48 Ownership, 145, 146 Parol Evidence Rule, 60 Partners’ Authority, 30 Partner’s Basis, 219 Partners’ Distributive Shares, 218 Partners’ Liability, 31 Partners’ Property Rights, 29 Partners’ Rights, 28 Partnership, 28 Partnership Characteristics, 28 Index 278 Partnership Dissolution, 33, 34 Partnership Taxation, 215 Partnership’s Tax Year, 216 Patents, 152 Penalties for Late Payment, 195 Perfection, 96 Personal defenses, 86 Personal Exemptions, 183 Personal Holding Company (PHC) Tax, 232 Personal Property, 145 Powers of Bankruptcy Trustee, 103 Powers of the Board of Directors, 43 Presentor’s Warranty Liability, 88 Primary Liability, 87 Priorities Among Claims, 97, 98 Priority Claims, 106 Private Securities Litigation Reform Act of 1995, 11, 12 Prizes and Awards, 158 Procedures for Return Preparation, 272, 273 Product Liability, 76 Promoters, 41 Property, 145 Property Distributions, 239, 240 Property for Stock, 225 Property Received by Inheritance or Gift, 269 Property Transactions, 208 Proxies, 23 Qualifying Debtors, 112 Real Defenses, 85 Real Property, 146 Realized Gain or Loss, 208 Recording Documents, 149 Recovery Period, 203, 205 Registration, 22 Regulation of Accountants, 1, Rejection, 54 Related-Taxpayer Transactions, 212 Rent and Royalty Expenses (Schedule E), 167, 168 Repayment Plans—Chapter 13, 112 Reporting, 22 Requirements for Combinations, 50 Requirements for Negotiability, 81 Retirement and Security Income, 131 Rights & Obligations, 61 Rights of Directors, 42 Rights of Officers, 44 Rights of Sureties, 115 Risk of Loss, 70 Robinson—Patman Act, 144 Roth IRAs, 170 S Corporation Earnings, 249, 250 S Corporations, 39, 245 S Corporations–A Pass-Through Entity, 245 Sale of Partnership Interest, 222 Sale on Approval, 72 Sale or Return, 73 Sales, 66 Sarbanes-Oxley Act of 2002, 24 Schedule M-1, 238 Schedule M-2, 238 Schedule M-3, 238 Sec 1245 Depreciation Recapture, 210 Secondary Liability, 87 Section 179 Expense Election, 207 Section 351 Transfer to Controlled Corporation, 224 Section 1244 Stock, 244 Secured Creditors, 105 Secured Transactions, 93 Index 279 Securities Act of 1933, 16, 17 Securities Exchange Act of 1934, 21 Securities Exempt from Registration, 18 Security Agreement, 94 Seller’s Remedies, 77 Seller’s Warranties, 74 Services for Stock, 224 Shareholders, 46 Shareholder’s Basis, 251 Sherman Act, 142 Software Technology Rights, 153 Special Circumstances, 79 Special Sales, 72 Special Transactions, 213, 214 Spin-offs and Split-offs, 242 Standard Deduction, 173 Standards for Tax Practice, 13 Statutes of Limitations, 202 Summary of Auditor Liability, Superfund, 126 Supplemental Tax Schedules, 238 Suretyship, 114 Tax Due, 267 Tax Payments, 194 Tax Preparer Penalties, 274, 275 Tax Return Due Dates, 271 Tax Return Schedules, 199 Taxable Estate, 264, 265, 266 Taxable Gifts, 262, 263 Taxation of Beneficiaries, 259 Taxation of Estates and Trusts, 253 Taxation of Gains & Losses, 222 Taxation of Gains and Losses, 211 Taxation of Partnerships, 217 Taxation of S Corporations, 248 Taxation of Trusts, 256 Taxes, 181 Tentative Amount, 267 Terminating Agent’s Authority, 121 Termination, 223 Termination of S Corporation Status, 252 Title, 69, 70 Tort Liability, 120 Trade Secrets, 153 Trademarks, 151 Transactions Exempt from Registration, 19, 20 Transferor’s Warranty Liability, 88 Transfers of Negotiable Instruments, 82 Treasury Department Circular 203, 14 Trust Operations, 255 Trusts, 254 Tying Arrangements, 144 Types of Endorsements, 83 Types of Sureties, 114 Types of Trusts, 254 Unified Credit, 267 Unions and Collective Bargaining, 136 Unmarried Couples, 197 Unsecured Creditors, 107 Validity, 57, 58 Validity & Enforceability, 56 Vertical Restraints, 142 Voidable Preferences, 104 Voluntary Filing—Chapter 7, 101 Wall Street Reform and Consumer Protection (Dodd-Frank) Act of 2010, 25, 26 Warranty Liability of Parties, 88 Warranty of Fitness, 75 Warranty of Merchantability, 74 Warranty of Title, 74 When to File, 200 Who Must File, 200 Workers’ Compensation, 129, 130 Index 280 WILEY END USER LICENSE AGREEMENT Go to www.wiley.com/go/eula to access Wiley’s ebook EULA ... 2016 Wiley CPAexcel ® exam review FOCUS NOTES Regulation Cover Design: Wiley Cover image: © turtleteeth/iStockphoto Copyright © 2016 by John Wiley & Sons, Inc All rights... take control of the CPA exam This simplified and focused approach to studying for the CPA exam can be used: • • • As a handy and convenient reference manual To solve exam questions To reinforce... simplified study program It provides a review of all the basic skills and concepts tested on the CPA exam, and teaches important strategies to take the exam faster and more accurately This tool