EA Exam Lite
Part 2
Businesses – I
1
Topic 1
Business Income:
Special Income
Inclusion Rules
2
1A Farmers – Inventory
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Livestock Raised for Resale – On Sch. F, deduct
cost of livestock, but no expenses (already
deducted on the cash basis)
Accrual Basis - Capitalize feed & breeding fees
Crop Method – Defer costs until year income is
realized (CCC Loan may report in year received)
Ag Assistance Payments – Sch. F (& SE)
Inventories – By either (1) cost, (2) LCM, (3)
farm-price (mkt. – disposition costs), or (4) unit
live-stock (standard unit price by type and age)
Question 1
3
1B Farm Disaster and WeatherRelated Payments
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Crop Insurance and Disaster Pay – income when
received, but may elect to postpone to later year
if income normally reported then
Weather-related sales - Report forced excess
livestock/ poultry sales due to drought/flood/
other weather sales in later year when normally
sold (must be cash-basis, location eligible for
federal government assistance, detailed return
attachment)
Questions 2 and 3
4
1C Cash Basis Income
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Cash Basis – Income when received, expenses
when paid (subject to cash equivalent,
constructive receipt, and claim of right)
Normal Accounts Receivable – If unsecured,
defer income until actually collected
Deposits – No income if obligation to repay
(e.g., damage deposits)
5
1D Accrual Basis Income
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Accrual Method – Income when earned,
not when received (but subject to claim of
right, constructive receipt, etc.)
Condition Precedent – Usually delays
reporting of income (such as lawsuit)
Condition Subsequent – Does not delay
recognition (such as money-back offer)
6
1E Advance Payment Rules
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Advance Payments – Taxed immediately
Exceptions to General Rule – If accrual method:
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Prepaid Membership Dues (Sec. 456)
Prepaid Subscription Income (Sec. 455)
Prepaid Services (Rev. Proc. 2004-34 – defer into next
year max if also used for financial accounting)
Advances for Goods (Reg. Sec. 1.451-1 – defer
income until delivery, with 2-year maximum rule)
Question 4
7
1F Miscellaneous Inclusion –
Debt Forgiveness
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Debt Cancellation – If personal, may be gift
Business Debt – Generally income (except if
cash basis and not deducted) unless (1)
insolvent, (2) bankrupt, (3) farming (>50% farm
receipt for 3 yrs), or (4) qualified business realty
held by a non-corporate taxpayer
Price for exclusion – Surrender favorable tax
attributes (credits, losses) and/or basis reduction
Corp debt forgiven – Dividend to S/H
S/H Debt Forgiven – Add’l capital cont. by S/H
8
Topic 2
MACRS Cost
Recovery
Deductions
9
2A MACRS in General
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Cost Recovery – Only for (1) limited life (2)
business or production of income, and only
when “ready to use” (placed in service)
Converted Personal Property – Initial basis is
lesser of cost basis or FMV at conversion
Failure to Deduct Depreciation – Still reduces
basis (use straight-line if none deducted in
past); amended return allowed (also possible to
recoup with auto. change of acct’g. method)
MACRS – Based on method, recovery pd., &
convention
10
2B Class Life and Acquisition
Year Assumptions
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Depreciable cost – includes installation
Depr. Methods – MACRS, MACRS SL, ADS, AMT
Recovery Table – 200% DB, 150% DB , SL
Acquisition Year Assumption – Either:
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Mid-Year (Half-Year) – Most personalty
Mid-Quarter – If >40% personalty in last quarter
Mid-Month – All realty
Question 5
11
2C Basic MACRS Computations
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Regular MACRS – Apply table factor to cost;
table factor based on MACRS class & convention
Table Factors - 1st year, half-year conv. MACRS
personalty factor is (1/MACRS life x 2.00 x .50);
for mid-qtr, Yr. 1, Qtr. 1 factor is (1/MACRS life x
2.00 x 10.5/12)
Like-kind Exchange Property – Depreciate old
basis over remaining life of old asset, but any
“boot given” is separate “new” depreciable asset
Figure 1
12
2D Sec. 179 Deduction
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Election – Expense up to $125,000 of bus.
personalty placed in service during year (bus.
percentage use only)
Phaseout - $1 for $1 put in service > $500,000
Taxable Income Limit - Unused adds to next yr.
Listed Property Recapture – Includes any 179
Like-kind Exch. – Boot given qualifies for 179
Figure 2
Question 6
13
2E S/L MACRS and ADS
Elections
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S/L MACRS – S/L over MACRS life
(consistency requirement for the year)
Alternative Depreciation System (ADS) –
Also elected irrevocably – S/L over class
life, except computers & autos (5 yrs), no
class life (12 yrs), & realty (40 yrs)
Sec. 179 & Conventions – Still apply
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Question 7
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14
2F Listed Property Rules
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“Listed” Property Rules – Applicable to
autos, computers, video, cell phones, and
other entertainment equipment
Limitation – Use ADS S/L if business use
alone does not exceed 50% of total usage
Recapture – Applies in a later year if bus.
use drops to 50% or below; additional
income is (prior deduction – correct ADS)
15
2G Luxury Auto Limitations
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Luxury Auto Limitations – Applicable to vehicles
(passenger) < 6,000 lbs., cost < $15,300
Maximum Depreciation - set at $3,060 (Yr. 1),
$4,900 (Yr. 2), $2,850 (Yr. 3), and $1,775 each
succeeding year (not for vehicle for hire); higher
limits for luxury trucks/vans/SUVs & electric cars
Less Than 100% Business Use – Limit decrease
same %; 80% bus. use would be $3,060 x .80
Question 8
16
2H Cost Recovery for AMT
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AMT Cost Required Cost Recovery:
 Personalty - 150% DB over MACRS life (class
life if placed in service prior to 1999)
 Realty - Straight-line recovery over MACRS life
(40 years if placed in service prior to 1999)
Difference – Between MACRS and AMT
deductions is a + or - adjustment for AMT
AMT Recovery – May be used for regular tax as
well to eliminate AMT adjustment
17
Topic 3
Business Bad
Debt
Deductions
18
3A Business vs. Non-business
Bad Debt Determinations
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Bad Debt – Must be bona fide and possess
characteristics of outside loan- family gift?
Cash-Basis Lender – No deduction for bad debts
(no basis, since no income reported), but any
out-of-pocket expenses are deductible
Business Bad Debts – Must have business
relationship; investor status does not qualify
(unless taxpayer is also an employee who made
loan to protect livelihood)
19
3B Reporting Bad Debts
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Business Bad Debt – Must use direct
write-off method (evidence debt is bad);
an ordinary deduction, and any evidence
of partial worthlessness justifies deduction
Nonbusiness Bad Debt – Deductible only
when final determination is made, and is
deducted as a short-term capital loss
Question 9
20
3C Recoveries of Bad Debts
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Tax Benefit Rule – Applies to recoveries (“other
income” if tax benefit from earlier deduction)
Installment Note – If recovered, full amount of
note is reported as income
Tax Benefit – Includes any NOL carryover
benefit (used or still unexpired) generated by
original deduction
Question 10
21
Topic 4
Tax-Deferred
Exchanges
22
4A Qualifying Like-Kind
Exchanges (Sec. 1031)
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Qualifying Property – Either (1) used in a trade
or bus. or (2) held for production of income
Swaps – Across categories are allowed
Personalty – Must be “like class” (general asset
classification) or “like kind” (facts/circumstance)
Intangibles – Qualify if similar (but not goodwill)
Nonqualifying Transactions – Personalty for
realty, inventory, personal assets, stocks &
securities, partnership interests
23
4B Deferred Like-Kind
Exchanges
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Delayed Exchanges – Possible within limits
Requirements for a Delayed Exchange –
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45 Days – Identify replacement property
180 Days – Deliver replacement (return due date, if
earlier)
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Multiple Properties – May be used
Qualified Intermediaries – May be used, as long
as constructive receipt by either party not
possible (otherwise, treated as sale)
24
4C Like-Kind Gain or Loss
Computation
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Solely Like-Kind – No gain/loss, c/o of basis
Monetary Boot Given – No gain or loss
Nonmonetary Boot Given – Gain or loss on boot
given only (as if boot was first sold for FMV)
Any Boot Received – No loss, gain is lesser of (1)
realized (acct) gain or (2) boot received (exp. offset)
Expenses of Sale – May offset boot rec’d first
Liabilities – If assumed by TP, boot given; if assumed by
other party, boot received (net if both directions)
Holding Period – Of old property tacks to new
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Question 11
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25
4D Basis of Like-Kind Property
Received – Method 1
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Method 1 – Work with Basis of Old:
Adjusted Basis – Old Like-kind Property
+ Gain Recognized
+ Boot Given
- Loss Recognized (e.g., nonmonetary boot)
- Boot Received
= Basis of New Like-kind Property
26
4E Basis of Like-Kind Property
Received – Method 2
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Method 2 – Work with FMV of New Like-kind
property received:
FMV of New Property
+ Loss not Recognized (Deferred/Postponed*)
- Gain Not Recognized (Deferred/Postponed*)
= Adjusted Basis – New Like-kind Property
*Deferred Gain/Loss – Acct’g – Taxable
Figure 3
Question 12
27
4F Like-Kind Exchanges –
Special Rules
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Related Party Exchanges – If either party sells
property w/i 2 years, original exchange taxable
Corporate Reorganizations – Stock for stock, or
bonds for bonds nontaxable; taxable if (1) boot
received (non-stock, non-security) or (2) bonds
received exceed bonds surrendered
Marital Transfers – Nontaxable between spouses
Reinvestments in Qualified Small Bus. Stock –
Gain from sale of publicly-held securities limited
to amount not reinvested in QSBICs
28
4G Involuntary Conversions –
Gain or Loss
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Sec. 1033 – Election to defer gain only (loss is
usually deductible)
Involuntary Conversion – Casualty, theft,
destruction, condemnation (or threat thereof)
Qualified Replacement Property – Functional use
test if owner/user, only other income-producing
property if owner/lessor
Qualified Replacement Period – Up to 2 years
after end of year gain first recognized
29
4H Involuntary Conversions –
Sec. 1033 Gain or Loss
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If Qualified – Taxable gain limited to
insurance proceeds NOT reinvested in
qualified replacement
Condemned Business or Investment Realty
– Replacement property need only be
“like-kind”, extended replacement pd.
Holding Period – Of old property tacks to
new property
30
4I Involuntary Conversions –
Basis of Replacement Property
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Basis of Replacement – Essentially uses
Method 2 for like-kind exchanges
Basis = FMV new – Gain not recognized
Gain Not Recognized = Acct’g. Gain –
Taxable Gain
Figure 4
31
Topic 5
Sec. 1231 Gains &
Losses
32
5A Sec. 1231 Properties
Defined
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Definition – Gains (losses) from the sale or
exchange of property used in a business and
held on long-term basis; also includes any
involuntary conversion of business properties
Extended Definition - Includes cutting of timber,
mining of coal and iron ore, livestock used
productively in business, crops sold with land
Note – Sec. 1231 property is never a capital
asset, and if held one year or less, result is
ordinary income or loss
Question 13
33
5B Netting Sec. 1231 Gains &
Losses
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“Best” Netting – At the end of the year, all Sec.
1231 property gains and losses are netted, with
the net result receiving the “best of both tax
worlds” treatment:
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Net gain – treated as a long-term capital gain
Net loss – each treated as ordinary income or loss
Note – If net gain for individuals, gains must be
separated into 15%, 25% and 28% categories
Figures 5 and 6
34
5C Sec. 1231 Lookback
Recapture
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Recapture Rule – Designed to prevent taxpayers
from loading all gains in one year and all losses
in a different year (for best of both worlds each)
If Current-Year Result is Net Gain – Gain is
ordinary income to extent of any unrecaptured
net Sec. 1231 losses in past 5 years
Remaining Gain – Is Sec. 1231 gain
35
Topic 6
Depreciation
Recaptures
36
6A Sec. 1245 Property Defined
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Definition – Three characteristics:
 Depreciable personalty
 Held on a long-term basis
 Sold at a gain
Included Assets – Ballplayer contracts,
autos, room air conditioners, greenhouses
Excluded Assets – Elevators & escalators
37
6B Sec. 1245 Computations
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Tax Result – Gain on sale ordinary income to
extent of depreciation taken on property
Gain Exceeding Depr – Sec. 1231 gain
If Sold at a Loss – Sec. 1231 loss
Sec. 179 Deduction – Treated as depreciation
1245 Rule – Also applies to limited realty (ACRS
realty with accelerated recovery – see next)
Figure 7
Question 14
38
6C Sec. 1250 Property Defined
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Definition – Four characteristics:
 Depreciable personalty
 Held on a long-term basis
 Sold at a gain
 Property on which “excess depreciation” exists
Excess Depr – Total taken exceeding SL
MACRS Realty – Not subject to Sec. 1250, since
only SL recovery is allowed
39
6D Sec. 1250 Computations
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General Rule – 100% of “excess depreciation”
recaptured as ordinary income
Exceptions to General Rule –
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ACRS Nonresidential – 100% of total depreciation
MACRS Realty – None (no excess depreciation)
25% Rate for Individuals – Possible for
“unrecaptured Sec. 1250 gain (see slide 6F)
Figure 8
Question 15
40
6E Special Recapture Rules
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Installment Sale – All recapture in year of sale
Nontaxable Exchange – Gain due to boot rec’d
ordinary if recapture on a sale at FMV would be
Charitable Contribution – Ordinary income
property; reduce deduction by recapture
Carryover of Recapture Potential – With gifts
(statement required), like-kind exchange, or
involuntary conversion
Question 16
41
6F Sec. 291 Recapture (Corp)
& 25% Rate Gain (Individual)
Gain assuming 1245
Actual 1250 gain
25% Gain (IND)
$100,000
( 20,000)
$ 80,000 *
x .20
Sec. 291 Gain (CORP) $ 16,000
====
* Termed “Unrecaptured Sec. 1250 Gain”
42
Topic 7
Self-employed
Taxes, Estimated
Taxes, and Special
Tax Computations
43
7A Self-Employment Earnings
Defined
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SE Earnings – Income on Sch. C, income share
+ guaranteed payments for unlimited partner;
Board of Director fees, clergy, newspaper, real
estate agents, agricultural assistance payments
SE Tax – SE inc. $400, church employee $100
Independent Contractor – Not subject to SE tax;
controls what will be done & how it will be done
Statutory employees – Driver, employee (Sch C)
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Question 17
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44
7B Determining Self-Employed
Earnings
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SE Tax - SS = 12.4% of first $97,500 wages (or
SE income x .9235, if less)
SE TAX – MC = 2.9% x SE inc. x .9235
Partner Death – Allocate income to death
Optional Method – If SE income < $1,600 and <
2/3’s non-farm income, report the 2/3’s nonfarm up to $1,600 as SE income
Farmers – Similar method, but use $2,400
Required for Opt. - $400 SE income prior 2 yrs.
Question 18
45
7C Federal Unemployment
Taxes & Other Payroll Taxes
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FICA Taxes – Employer match - 6.2% on first
$97,500 (SS), 1.45% on all wages (MC)
EI Number – Require only with employees
FUTA Tax – 6.2% on first $7,000 wages (credit)
Wages to Spouse – All taxes but FUTA
Wages to Children – FUTA if <21, none if <18
Farmers – Pay FUTA if (1) $20,000 or more
wages in a qtr, or (2) 10 workers for at least 1
day for 20 weeks
46
7D Estimated Taxes and
Farm/Fishing Income
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Basic Rules – Special rules if 2/3s income from
farm or fishing
Avoid Penalty – If each qtr. pay = (1) 66 2/3s of
current year tax or (2) 100% of prior year tax
Alternative Exemption From Penalty – Either (1)
make one estimated payment by 1/15 & file by
4/15, or (2) file return & pay all tax due by 3/1
Farm Income – Sch. F, Sch. E farm rents, gains
for sale
Question 19
47
7E Income Averaging for
Farmers & Fishermen
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Averaging – Only for Sch. F profit by individuals,
partners, and S shareholders
Election – Timely-filed return (Schedule J),
unless IRS allows to amend earlier return
Elective Farm & Fishing Income – Elect to
remove any amount from current income, add
1/3 to each 3 prior years’ incomes, then add
marginal taxes to current-year tax
48
Topic 8
Partnerships: Tax
Issues at Formation
Under Sec. 721
49
8A Partnerships – Legal
Formalities
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Definition – Unincorporated group of two or
more persons carrying on a business for profit
Co-ownership Sharing Expenses – Not a p’ship,
unless significant services provided
Not a P’ship – Corp under state law, ins. co.,
certain banks, tax-exempt, REIT, trust
Inv. Orgs – All members may opt out p/s
Electronic Return – If partners >100
Conversion to LLC – Not a liquidation of old
50
8B Partnerships – Family
Members as Partners
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Family Members – May be partners if:
 Capital is material income-producing factor,
and interest acquired in bona fide transaction,
or
 Family members join together in good faith,
each provides capital or service to p’ship
Capital Interest – Is an interest in assets
Gift Interest (Including Related Sale) – Any
compensation allocated before income
51
8C Partnerships – The
Partnership Agreement
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Partnership Agreement – Need not be in
writing
Modifications – May be made up to due
date of return (ignoring extensions)
Local Law – Governs if agreement silent
Flexibility – In allocating profits/losses, as
long as “substantial economic effect”
52
8D Contributions to P’ship – No
Liabilities Involved
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Sec. 721 – No gain/loss if solely for p’ship int.
Basis & Holding Pd. – Carries over from property
to new partnership interests
Contribution of Services – Always taxable, and
amount becomes basis of partnership interest
Boot Received – Fully taxable transaction - later
transfer to partner may be collapsed
Investment Co. – If p’ship has >80% assets as
inv (like corp), gain on contribution is recognized
Question 20
53
8E Contributions to P’ship With
Liabilities Involved
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Liabilities Assumed by P’ship – Not treated
as boot received by partner as long as
shares assumed by other partners < basis
Liabilities Assumed – Affect basis (below)
Excess Liabilities – Gain for excess (above)
Limit on Liability Assumption – FMV prop.
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Question 21
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54
8F Basis of Partnership
Interest
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Adj. Basis – Partnership Interest =
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Adj. basis of property transferred
+ gain recognized (from excess liabilities)
– boot rec’d (liabilities assumed by other
partners)
If Only One Partner Liable – Add the
liability only to that partner’s basis
Question 22
55
8G Basis of Contributed
Property to Partnership
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Partnership Basis in Property = Adjusted basis to
contributing partner + gain recognized due to
excess liabilities
Cost Recovery Method – P’ship continues with
method used by contributing partner
Distribution of Contributed Property – To another
partner within 7 yrs. may create gain
Figure 9
Question 23
56
Topic 9
Reporting
Partnership Income
& Guaranteed
Payments
57
9A Ordinary Partnership
Income vs. Special Allocations
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Partner – Reports guaranteed payments (w/o
regard to profitability) and share of ordinary
income items and “specially allocated items”
Ordinary Income (OI) – Any rev/exp that cannot
vary across partners’ ind. returns, including a
subtraction for guaranteed payments
Specially Allocated Items – Any rev/exp that can
vary across partner’s individual return
Nonguaranteed Payments – Nontaxable Distrib.
Question 24
58
9B Partner Reporting of
Partnership Income
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Profits & Losses – Allocated per partnership
agreement (or interest, if no agreement)
Conduit – Character of each item retained
Passive Loss – Retains character, combine
Sec. 179 – Combine with TP’s other 179 items
Schedule E – Used to report income/GPs
Acct’g Methods – Some determined at partner
level if item is treated differently
Question 25
59
9C Character of Partnership
Income or Loss
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Capital Assets and Inventory – In hands of
contributing partner, retain that character
for five years in the partnership’s hands
Limit on Capital Loss – Limited to excess
of contributing partner’s basis over FMV of
property at contribution
60
9D Determining Partnership
Guaranteed Payment
Deduction
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Guaranteed Payment (GP) – Determined w/o
reference to profits, deductible by partnership,
and allocated directly to partner receiving the GP
(subject to SE tax)
Regular Ordinary Income – Allocated to partners
after deduction for any guaranteed payments
Minimum GP – If income share is < GP,
deficiency is a GP (if not, no GP is needed)
Question 26
61
9E Timing of Guaranteed
Payment Income/Deduction
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Partner Income Share – Report for the
partnership year ending within the
partner’s individual tax year
Guaranteed Payments – Same reporting
Beware – Changes in GPs during calendar
year that are not relevant to question
Question 27
62
Topic 10
Partnership
Distributions and
Sales of Partnership
Interest
63
10A Nonliquidating P’ship
Distribution – General Rules
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Gain – Gain recognized only if money
(cash or marketable securities) alone
exceeds partner’s basis of interest
(reason: no basis left to assign)
Loss – Never recognized with a
nonliquidating distribution
64
10B Nonliquidating P’ship
Distributions – Basis Issues
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General Rule – Partnership basis in distributed
assets carries over to partner
If P’ship Basis Exceeds Partner’s Basis – Basis of
property received will be basis of partner’s
interest (after any cash rec’d is subtracted)
Several Properties Received – If total basis
exceeds partner’s basis, allocate remaining
partner’s basis by relative FMVs
Question 28
65
10C Pre-contribution Gain
Taxed to Contributing Partner
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Partner Contributing Appreciated Property
– Must recognize gain on any distribution
of that property by partnership to any
partner within 7 years of the contribution
Gain Recognized – The lesser of:
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FMV property received > Adj. basis of interest
Net “precontribution” gain on original transfer
Question 29
66
10D – Liquidating P’ship
Distributions – General Rules
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Liquidating Distribution – Terminates interest
Entire P’ship Liquidated – Gain only if money
(cash + mkt. sec.) exceeds basis; Loss only if
(1) partner’s basis > distrib., (2) entire interest
liquidated, (3) distribution only in money,
unrealized receivables (below), or inventory
Retiring or Deceased Partner – Allocate:
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Payments for Interest – Capital gain (loss)
Other – Excess payments (GP or inc. share - ordinary)
Question 30
67
10E Liquidating Distribution –
Effect on Partnership
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No gain or loss – Recognized by p’ship
with a liquidating distribution
Retiring or Deceased Partner – Tax
treatment of payment by the partnership:
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Payments for Interest – Nondeductible distrib.
Other – Payments for unrealized receivables
or goodwill are deductible as other payments
68
10F Liquidating P’ship
Distributions – Gain (Loss) to
Partner
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Partner Share of Liabilities –Included in
amount realized with a liquidating
distribution (since also in partner’s basis)
Liabilities Share – Treated as cash
Payments in Installments – No tax
consequences until cash rec’d > basis
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10G Liquidating Partnership
Distrib. – Basis of Property
Received
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Property Basis – Usually, basis – money rec’d.
Unrealized Rec. & Inventory – Allocated basis
equal to partnership basis first (“tacking”)
Remaining Basis – Allocated to properties, based
on each prop’s adjusted basis to p’ship
If Excess Basis Remains – Allocate to
appreciated property first, then other @ FMVs
If Not Enough Basis – Subtract from depreciated
properties first, then from other on adj. basis
Question 31
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10H Sale of a Partnership
Interest – General
Consequences
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Gain or Loss – Generally capital unless sale
involves inventory or unrealized receivables
Liabilities Share – Included in both amount
realized and adjusted basis for selling partner
Adjusted Basis – Determined on sale date
Possible – Installment method sale, basis adj.
Not Possible – Like-kind exchange
Abandonment of Interest – Ordinary loss
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10I Sale of P’ship Interest
Without Sec. 751 Properties

Gain or Loss – Must be capital without
Sec. 751 properties; interest is cap. asset
Liabilities Share of Selling Partner – Are
assumed by buying partner; thus, these
must be part of amount realized
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Question 32
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10J Sale of P’ship Interest
With Sec. 751 Properties
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Ordinary Income – Must be reported for any
gain on “Sec. 751 properties”
Sec. 751 Prop - Inventory & unreal receivables
Unrealize Rec. – Right to receive noncapital
asset, acc’t rec. of cash-basis, depr. recap.
Inventory – Not capital or Sec. 1231 gain
Disclosure – Form 8308, details included
Sec. 751 Gain – Determined first (based on FMV
– partner’s % basis), remainder capital gain/loss
Question 33
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Questions?
As Time Permits
Contact:
John Everett
Professor of Accounting
Virginia Commonwealth University
jeverett@vcu.edu
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