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US Certified Public Accountant (AICPA Uniform CPA Examination) · Taxation and Regulation

CPA REG Federal taxation of entities: practice questions with answers

6 free exam-style questions on Federal taxation of entities for CPA REG Taxation and Regulation. Try each one, then open the answer to read the explanation. Fincora has 97 original questions on this syllabus area.

Question 1

Tressel Pumps Inc., an accrual-method calendar-year C corporation, reports the following items in its 2026 financial statements. Which item creates a temporary book-tax difference?

  1. A Premiums paid on a life insurance policy on its CEO, with Tressel as beneficiary
  2. B A penalty paid to a state environmental agency for a permit violation
  3. C An increase in the allowance for doubtful accounts charged to bad-debt expense
  4. D Interest received on bonds issued by a state turnpike authority
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Answer: C. A temporary difference arises when an item is recognized in both book and taxable income but in different years, so it reverses. A permanent difference never reverses.

- Allowance for doubtful accounts: book uses the allowance method; tax allows only the direct write-off method for business bad debts (§166). Book expense now, tax deduction when accounts are written off: temporary.
- Municipal (state or local) bond interest: excluded from gross income (§103): permanent.
- Key-person life insurance premiums (corporation is beneficiary): nondeductible (§264): permanent.
- Fines and penalties paid to a government: nondeductible (§162(f)): permanent.

Question 2

Tolland Logistics Inc., an accrual-method calendar-year C corporation, accrued year-end bonuses of $240,000 for 2026 to employees, none of whom owns any of its stock. It paid $170,000 of the bonuses on March 6, 2027 and the remaining $70,000 on March 22, 2027. All bonuses were expensed for books in 2026. What Schedule M-1 adjustment, if any, does Tolland make for the bonuses in 2026?

  1. A No adjustment is needed
  2. B Subtract $70,000 from book income
  3. C Add $170,000 to book income
  4. D Add $70,000 to book income
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Answer: D. An accrual-method employer deducts accrued compensation in the year of accrual only if it is paid within 2 1/2 months after the year-end; otherwise it is treated as deferred compensation, deductible when paid (§404(a)(5) and Reg. §1.404(b)-1T).

- 2 1/2 months after December 31, 2026 = March 15, 2027.
- Paid March 6, 2027: $170,000, deductible in 2026.
- Paid March 22, 2027: $70,000, deductible in 2027.

Book expense $240,000 - tax deduction $170,000 = $70,000 added back on Schedule M-1. This is a temporary difference that reverses in 2027.

Question 3

Aldwych Dental Supply Inc., a calendar-year C corporation, filed Form 7004 on April 9, 2027 to extend the due date of its 2026 Form 1120. It made no payment with Form 7004. It filed the return on October 12, 2027 and paid the balance due of $36,000 with it. Which statement is correct?

  1. A The return was late, because the extended due date was September 15, 2027.
  2. B Form 7004 was late, because the original due date was March 15, 2027.
  3. C The return was timely, and no interest is due, because the tax was paid with it.
  4. D The return was timely, but interest runs on the $36,000 from April 15, 2027.
Show the answer

Answer: D. - A calendar-year C corporation's Form 1120 is due on the 15th day of the 4th month after year-end: April 15, 2027 for 2026 (§6072(a)).
- Form 7004, filed by that date, gives an automatic 6-month extension of time to file, to October 15, 2027 (§6081(b)). The October 12 filing was timely.
- An extension of time to file is not an extension of time to pay. Tax unpaid at April 15, 2027 bears interest from that date until paid (§6601), and late-payment penalties may also apply.

Question 4

Fallowmere Inc., a domestic calendar-year corporation, plans to elect S corporation status for 2027. Which of the following facts would make it ineligible?

  1. A Some shares are held by the estate of a shareholder who died in 2026.
  2. B One shareholder is a §501(c)(3) public charity that received shares as a gift.
  3. C It has voting and nonvoting common shares with identical economic rights.
  4. D One shareholder is a citizen and resident of Canada who lives in Toronto.
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Answer: D. An S corporation must be a domestic corporation (not an ineligible corporation) with no more than 100 shareholders, only permitted shareholders and one class of stock (§1361(b)).

- Permitted shareholders: US citizen or resident individuals, estates, certain trusts and §501(c)(3) organizations. Nonresident aliens, partnerships and corporations are not permitted.
- One class of stock: all shares must have identical rights to distributions and liquidation proceeds; differences in voting rights are ignored (§1361(c)(4)).

So only the Canadian nonresident shareholder makes Fallowmere ineligible.

Question 5

Amara's outside basis in Bellmere Partners is $35,000. In a current (nonliquidating) distribution, Bellmere distributes to her $12,000 of cash and a parcel of land with a basis to the partnership of $30,000 and a fair market value of $45,000. What is Amara's basis in the land, and what gain does she recognize?

  1. A Land basis $30,000; no gain recognized
  2. B Land basis $45,000; gain of $22,000
  3. C Land basis $23,000; no gain recognized
  4. D Land basis $30,000; gain of $7,000
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Answer: C. Current distributions (§731, §732(a)):

1. Cash first: $35,000 - $12,000 = $23,000 remaining basis. Cash does not exceed basis, so no gain (§731(a)(1)).
2. Land basis = lesser of the partnership's basis ($30,000) or the partner's remaining outside basis ($23,000) = $23,000 (§732(a)(2)).
3. Amara's outside basis is reduced to $0. The land's $22,000 of untaxed appreciation is preserved in its lower basis.

Question 6

Two limited liability companies were formed in 2026, and neither has filed Form 8832 or Form 2553. Hornbeam LLC has one member, Rowan Corp., a C corporation. Sedge LLC has two members, both individuals. How is each LLC classified for federal income tax purposes?

  1. A Hornbeam: disregarded, treated as a division of Rowan; Sedge: C corporation
  2. B Hornbeam: C corporation; Sedge: C corporation, because both members have limited liability
  3. C Hornbeam: C corporation; Sedge: partnership
  4. D Hornbeam: disregarded, treated as a division of Rowan; Sedge: partnership
Show the answer

Answer: D. Under the check-the-box regulations (Reg. §301.7701-3(b)(1)), a domestic eligible entity that makes no election is classified by default as:

- One owner: disregarded entity. If the owner is a corporation, the LLC is treated as a branch or division of it (Hornbeam's items go on Rowan's Form 1120); if the owner is an individual, as a sole proprietorship.
- Two or more owners: partnership (Sedge files Form 1065).

Either LLC may instead elect to be an association taxable as a corporation on Form 8832.

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