Exam 1: Business Income, Deductions, and Accounting Methods

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.

Which of the following is a true statement?

After a business meeting with a prospective client Holly took the client to dinner and the theatre. Holly paid $290 for the meal and $250 for the theatre tickets, amounts that were reasonable under the circumstances. What amount of these expenditures can Holly deduct as a business expense?

Which of the following expenses are completely deductible?

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

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?

Which of the following is a true statement about a request for a change in accounting method?

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

The Internal Revenue Code authorizes deductions for trade or business activities if the expenditure is "ordinary and necessary".

The domestic production activities deduction is a deduction for the incremental cost of manufacturing tangible assets in the United States.

Brad operates a storage business on the accrual method. On July 1 Brad paid $48,000 for rent on his storage warehouse and $18,000 for insurance on the contents of the warehouse. The rent and insurance covers the next 12 months. What is Brad's deduction for the rent and insurance?

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?

Beth operates a plumbing firm. In August of last year she signed a contract to provide plumbing services for a renovation. Beth began the work that August and finished the work in December of last year. However, Beth didn't bill the client until January of this year and she didn't receive the payment until March when she received payment in full. When should Beth recognize income under the accrual method of accounting?

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?

Crystal operates a business that provides typing and delivery services. This year Crystal spent $2,500 to purchase special shirts that identify her employees and provide some notoriety for her business. The shirts are especially colorful and include logos on the front pocket and back. Besides salary payments, Crystal also compensates her employees by offering to pay whole life insurance premiums for any that want to provide insurance coverage for their beneficiaries. This year Crystal paid $5,000 in life insurance premiums. What amount of these payments can Crystal deduct? Crystal is on the cash method and calendar year.

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.

Colby Motors uses the accrual method and reports on a calendar year. In December of last year, Colby acquired auto repair equipment. As part of the acquisition, Colby purchased a warranty agreement that requires the seller of the equipment to provide repairs on the equipment for three years. Colby paid the cost of the warranty, $15,000, in January of this year. What can Colby deduct for the cost of the warranty on the tax return for last year?

Jones operates an upscale restaurant and he pays experienced cooks $35,000 per year. This year he hired his son as an apprentice cook. Jones agreed to pay his son $40,000 per year. Which of the following is a true statement about this transaction?

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?

Todd operates a business using the cash basis of accounting. At the end of last year, Todd was granted permission to switch his sales on account to the accrual method. Last year Todd made $420,000 of sales on account and $64,000 was uncollected at the end of the year. What is the Todd's §481 adjustment for this year?