Exam 1: Business Income, Deductions, and Accounting Methods

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

Bill operates a proprietorship using the cash method of accounting, and this year he received the following payments:   -$100 in cash from a customer for services rendered this year -a promise to pay $200 from a customer for services rendered this year -tickets to a football game worth $250 as payment for services performed last year -a check for $170 for services rendered this year that Bill forgot to cash How much income should Bill realize on Schedule C?

Which of the following is a True statement?

Adjusted taxable income for calculating the business interest limitation is defined as taxable income of the taxpayer computed without regard to any item of income, gain, deduction, or loss which is not properly allocable to a trade or business.

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.

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

Which of the following is a True statement about the limitation on business interest deductions?

Which of the following types of transactions may not typically be accounted for using the cash method for small proprietorships?

The IRS would most likely apply the arm's length transaction test to determine which of the following?

Mike operates a fishing outfitter as an accrual-method sole proprietorship. On March 1ˢᵗ 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?

Don operates a taxi business, and this year one of his taxis was damaged in a traffic accident. The taxi was originally purchased for $32,000 and the adjusted basis was $2,000 at the time of the accident. The taxi was repaired at a cost of $2,500 and insurance reimbursed Don $700 of this cost. What is the amount of Don's casualty loss deduction?

Only half the cost of a business meal is deductible even if the meal is associated with the active conduct of business.

Anne is a self-employed electrician who reports her business income using the accrual method over a calendar year. On September 1ˢᵗ of this year Anne paid $2,280 of interest on a loan. The interest accrues evenly over 19 months ($120 per month) from June 1ˢᵗ of this year through December 31ˢᵗ of next year. In addition, on September 1ˢᵗ 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?

Business activities are distinguished from personal activities in that business activities are motivated by the pursuit of profits.

Rock Island Corporation generated taxable income (before deductions for depreciation, interest expense and net operating loss carryovers) of $1 million this year. Taxable income was computed on $50 million of revenues and included $50,000 of interest income. The company paid $450,000 in interest expense. What is Rock Island's maximum business interest deduction for the year?

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

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

All taxpayers must account for taxable income using a calendar year.

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?

A fiscal tax year can end on the last day of any month other than December.