Certified Public Accountant (CPA) Regulation 4 — Questions and Answers
Question 1: Which of the following describes the 'economic substance doctrine' in tax law?
- Transactions must generate actual economic profit beyond tax benefits to be respected (Correct answer)
- All transactions with foreign parties must be disclosed
- Corporations must disclose all related-party transactions
- Taxpayers can deduct losses only if the activity has a profit motive
Correct answer: Transactions must generate actual economic profit beyond tax benefits to be respected
The economic substance doctrine requires transactions to have meaningful economic substance and business purpose beyond mere tax avoidance.
Question 2: An individual taxpayer has a $15,000 passive activity loss. How can this loss be used in the current year?
- It can offset any type of income up to $15,000
- It can only offset passive activity income (Correct answer)
- It can offset portfolio income only
- It must be permanently disallowed
Correct answer: It can only offset passive activity income
Passive activity losses can only offset passive activity income in the current year; excess losses are suspended.
Question 3: Which of the following is a characteristic of a limited liability company (LLC) taxed as a partnership?
- Members have unlimited personal liability
- The LLC pays entity-level federal income tax
- Members report their share of income on their personal returns (Correct answer)
- The LLC must have at least two classes of membership interests
Correct answer: Members report their share of income on their personal returns
An LLC taxed as a partnership is a pass-through entity; members report their distributive share of income on their personal tax returns.
Question 4: Under the Sarbanes-Oxley Act, the audit committee of a public company must include at least one member who qualifies as a:
- Certified Public Accountant
- Financial expert (Correct answer)
- Attorney
- Former SEC employee
Correct answer: Financial expert
SOX Section 407 requires public companies to disclose whether at least one audit committee member is a financial expert.
Question 5: A taxpayer contributes property with a basis of $20,000 and FMV of $50,000 to a partnership in exchange for a 40% interest. What is the taxpayer's initial basis in the partnership interest?
- $20,000 (Correct answer)
- $50,000
- $0
- $30,000
Correct answer: $20,000
Under IRC Section 722, a partner's initial basis in a partnership interest equals the adjusted basis of the property contributed.
Question 6: Which of the following best describes 'constructive receipt' for cash-basis taxpayers?
- Income is taxed only when physically deposited in a bank
- Income is taxed when credited to the taxpayer's account or otherwise made available (Correct answer)
- Income is taxed when the taxpayer actually spends the funds
- Income is taxed when the payor deducts the payment
Correct answer: Income is taxed when credited to the taxpayer's account or otherwise made available
Constructive receipt occurs when income is credited to a taxpayer's account or made available without substantial restriction, even if not physically received.
Question 7: Under agency law, which of the following would create an apparent authority for an agent?
- The principal gives the agent explicit written instructions
- The principal's conduct leads third parties to reasonably believe the agent has authority (Correct answer)
- The agent acts beyond the scope of their actual authority without the principal's knowledge
- The agent ratifies a prior unauthorized act
Correct answer: The principal's conduct leads third parties to reasonably believe the agent has authority
Apparent authority arises when the principal's conduct or representations cause a third party to reasonably believe the agent has authority to act.
Certified Public Accountant (CPA) Regulation 4
Which of the following describes the 'economic substance doctrine' in tax law?