CPA Regulation (REG) : Individual Income Tax - Sources of Taxable Income
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Example Questions
Example Question #1 : Flow Through Income Items
Aston and Becker are equal partners in AB Partnership. In the tax year, the ordinary income of the partnership is $20,000, and the partnership has a long-term capital gain of $12,000. Aston's basis in AB was $40,000, and he received distributions of $5,000 during the year. What is Aston's share of AB's ordinary income?
$10,000
$18,500
$15,000
$16,000
$10,000
The question asks about Aston’s share of ordinary income. While Aston receives an equal share of the long-term capital gain, it will be taxed as a capital gain, not ordinary income. Distributions (especially non-liquidating) are generally not taxable. This leaves only Aston’s equal share of the $20,000 ordinary income, or $10,000.
Example Question #2 : Flow Through Income Items
Which of the following is both an item that is an allowable tax deduction to the partnership, reported separately on the individual partner’s Schedule K-1, and then included on the partner’s individual tax return?
Depreciation of equipment used in the business
Salaries paid to non-partner employees
Guaranteed payments paid to partners
Advertising expenditures
Guaranteed payments paid to partners
Guaranteed payments are roughly equivalent to salary payments to partners for services performed. As a result, they are a deductible operating expense to the partnership, reported as income on the individual partner’s tax return, and guaranteed payments are one of the items specifically reported on the Schedule K-1.
Example Question #3 : Flow Through Income Items
An individual partner received a Schedule K-1 from a partnership for year 2 reporting the following items:
Ordinary business income $45,000
Interest income 8,000
Net Section 1231 loss 5,000
Cash distribution 6,000
$42,000
$52,000
$54,000
$48,000
$48,000
The cash distribution is not a taxable event. The remaining items are all included as additions or deductions from ordinary income: ordinary business income (addition), interest income (addition), and the net Section 1231 loss (deduction). Section 1231 gains and losses are usually treated as ordinary gains and losses.
Example Question #4 : Individual Income Tax Sources Of Taxable Income
The holding period of a partnership interest acquired in exchange for a contributed capital asset begins on the date:
The partner’s holding period of the capital asset began
The partner is admitted to the partnership
The partner is first credited with the proportionate share of partnership capital
The partner transfers the asset to the partnership
The partner’s holding period of the capital asset began
The holding period of a partnership acquired in exchange for a contributed capital asset begins on the date the partner’s holding period of the capital asset began.
Example Question #4 : Individual Income Tax Sources Of Taxable Income
On January 1, Year 2, ABC acquired a 50% interest in DEF Partnership by contributing property with an adjusted basis of $7,000 and a fair market value of $9,000, subject to a mortgage of $3,000. What was ABC’s basis in DEF at January 1, Year 2?
$4,000
$5,500
$3,500
$7,500
$5,500
Basis $7,000 – Debt relief ($3,000 * 50%) $1,500 = $5,500 of basis.
Example Question #5 : Individual Income Tax Sources Of Taxable Income
A gain that represents a partner’s share of “hot assets” would be treated as:
Capital gains
Ordinary income
Neither
Both
Ordinary income
An exception to the sale of capital asset sales in partnerships would be when a “hot asset” is sold. The treatment here would be as ordinary income.
Example Question #1 : Individual Income Tax Sources Of Taxable Income
Passive activity losses of an individual taxpayer can generally be used to offset
A guaranteed payment received from a partnership.
Interest income on U.S. Treasury notes.
Dividends income from a foreign corporation.
Income from the rental of a residence.
Income from the rental of a residence.
Income from the rental of residence is considered passive activity, and as such passive activity losses may be taken up to the extent of passive activity gains. None of the other items are regarded as passive activity income: guaranteed payments are treated as ordinary income; dividends and interest are treated as portfolio income (a distinct category from passive income).
Example Question #1 : Passive Income & Losses
A partner in a real estate partnership had a basis of $5,000 at the beginning of the year and a basis of $10,000 at year end. The partner's at-risk amount at year end was $8,000. The partner's Form K-1 listed $12,000 as the partner's share of the partnership's ordinary loss. What amount can the partner deduct on the partner's tax return?
$10,000
$12,000
$5,000
$8,000
$8,000
For flow-through entities issuing Schedule K-1 to its partners, an individual partner’s loss limitation cannot exceed the at-risk amount. Any excess loss may be carried forward by the partner indefinitely. Since this partner’s at-risk amount is $8,000, the deducted loss cannot exceed $8,000
Example Question #2 : Passive Income & Losses
Alan created a trust for the benefit of his son, George. Alan does not have the right to change any terms of the trust once established and has no right to income. All trust income is to be distributed to George on an annual basis. How should the trust income be reported?
To Alan, reported only on his Form 1040.
Reported on Form 1041, with a Schedule K-1 issued to George.
To George, reported only on his Form 1040.
Reported on Form 1041, with a Schedule K-1 issued to Alan.
Reported on Form 1041, with a Schedule K-1 issued to George.
For estates and trusts, only income to beneficiaries is report on Form 1041 and Schedule K-1. Since George is the beneficiary, he is the recipient of the Schedule K-1, not his father.
Example Question #9 : Individual Income Tax Sources Of Taxable Income
A and B are equal members in AB LLC which has not elected to be treated as a corporation. A contributes cash of $7,000 and B contributes a machine with an adjusted basis of $5,000 and FMV of $10,000, subject to a liability of $3,000. What is B’s basis in AB LLC?
$5,000
$2,000
$10,000
$3,500
$3,500
The LLC has not elected to be treated as a corporation. Therefore, it will be treated as a partnership. B’s basis will be the adjusted basis of the contributed property minus 50% of the liability which is assumed by the other partner. $5,000 - $1,500 = $3,500.
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