Exam 1: Business Income, Deductions, and Accounting Methods

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

Shelley is self-employed in Texas and recently attended a two-day business conference in New Jersey. After Shelley attended the conference, she had dinner with an old friend who lived nearby. Shelley documented her expenditures (described below). What amount can Shelley deduct?

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

Mike operates a fishing outfitter as an accrual-method sole proprietorship. On March 1 ^st of this year, Mike received $15,000 for three outfitting trips. This is the first time Mike agreed to such a payment and he is obligated to outfit one trip per year for the next three summers, beginning this year. How much income must Mike recognize in each of the next three years if he is attempting to minimize his tax burden?

When a taxpayer borrows money and invests the loan proceeds in municipal bonds, the interest paid by the taxpayer on the debt will not be deductible.

Judy is a self-employed musician who performs for a variety of events. This year, Judy was fined $250 by the city for violating the city's noise ordinance with a relatively loud performance. As a consequence, Judy contributed $1,000 to a campaign committee formed to recall the city's mayor. Judy normally hires three part-time employees to help her schedule events and transport equipment. Judy paid a total of $33,000 to her employees through June of this year. In June, Judy fired her part-time employees and hired her husband to replace them. However, Judy paid him $55,000 rather than $33,000. Judy is on the cash method and calendar year, and she wants to know what amount of these expenditures is deductible as business expenses.

Ronald is a cash-method taxpayer who made the following expenditures this year. Which expenditure is completely deductible in this period as a business expense?

A short tax year can end on any day of any month other than December.

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

Ranger Athletic Equipment uses the accrual method and reports on a calendar year. Ranger provides two-year warranties on all sales of equipment. This year, Ranger estimated warranty expense for book purposes, and he accrued $1 million of warranty expenses. However, during the year Ranger only spent $400,000 repairing equipment under the warranty. What can Ranger deduct for warranty expense on the tax return for this year?

Which of the following is a true statement?

Bob operates a clothing business using the accrual method over a calendar year. In October of last year, Bob contracted with his father, Tim, for consulting advice. Tim is a cash-basis calendar-year taxpayer, and he billed Bob for $6,000 of consulting fees. This amount was comparable to amounts charged by other consultants (a reasonable amount). Bob paid $2,500 of the consulting fee by December 31 ^st of last year, but the remaining $3,500 was not paid until January of this year. When can Bob deduct the consulting fee?

Dick pays insurance premiums for his employees. What type of insurance premium is not deductible as compensation paid to the employee?

David purchased a deli shop on February 1^st of last year and began to operate it as a sole proprietorship. David reports his personal taxes using the cash method over a calendar year, and he wants to use the cash method and fiscal year for his sole proprietorship. He has summarized his receipts and expenses through January 31^st of this year as follows: What income should David report from his sole proprietorship?

Anne is a self-employed electrician who reports her business income using the accrual method over a calendar year. On September 1 ^st of this year, Anne paid $2,280 of interest on a loan. The interest accrues evenly over 19 months ($120 per month) from June 1 ^st of this year through December 31 ^st of next year. In addition, on September 1 ^st Anne also paid $2,700 for 18 months of professional liability insurance ($150 per month). What amount of interest and insurance can Anne deduct this year?

The full-inclusion method requires cash-basis taxpayers to include prepayments for goods or services into realized income.

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

Uniform capitalization of indirect inventory costs is required for mostvery large taxpayers.

Big Homes Corporation is an accrual-method calendar-year taxpayer that manufactures and sells modular homes. This year, for the first time Big Homes was forced to offer a rebate on the purchase of new homes. At year-end, Big Homes had paid $13,400 in rebates and was liable for an additional $8,200 in rebates to buyers. What amount of the rebates, if any, can Big Homes deduct this year?

Judy is a self-employed musician who performs for a variety of events. This year, Judy was fined $330 by the city for violating the city's noise ordinance with a relatively loud performance. As a consequence, Judy contributed $840 to a campaign committee formed to recall the city's mayor. Judy normally hires three part-time employees to help her schedule events and transport equipment. Judy paid a total of $34,600 to her employees through June of this year. In June, Judy fired her part-time employees and hired her husband to replace them. However, Judy paid him $53,400 rather than $34,600. Judy is on the cash method and calendar year, and she wants to know what amount of these expenditures is deductible as business expenses.