CPA TCP: Tax Compliance and Planning Practice Test

Use this page when you are preparing for the Certified Public Accountant Tax Compliance and Planning section and want a direct practice route. The public preview gives you sample questions and a full-length MCQ diagnostic; the web app adds mixed sets, topic drills, timed mocks, progress tracking, and full practice.

Mastery Exam Prep is independent exam-prep software. These are original practice questions, not official CPA Exam questions from AICPA, NASBA, or any state board.

What this CPA TCP page gives you

• a direct web route into Certified Public Accountant Tax Compliance and Planning practice
• 24 public sample questions with detailed explanations before you subscribe
• a free 68-question multiple-choice question (MCQ) diagnostic across the TCP blueprint areas
• focused topic pages for each major blueprint area
• timed mixed practice for pacing, review discipline, and exam-day readiness
• explanations written to show why the reasoning is right, not just which answer is marked correct

CPA TCP exam snapshot

Abbreviation guide for this page

Topic coverage for CPA TCP practice

What CPA TCP is really testing

CPA TCP rewards candidates who can connect tax facts to compliance, planning, entity, owner-level, and property-transaction consequences. Strong answers consider both the immediate tax result and the planning trade-off created by the facts.

CPA TCP versus other CPA sections

High-yield CPA TCP traps

• computing a tax amount before deciding taxpayer, entity, owner, or property character
• missing basis, at-risk, passive-loss, holding-period, or related-party limitations
• choosing a planning move without considering timing, cash flow, or compliance constraints
• confusing core REG treatment with the deeper planning emphasis of TCP

Simulation-style skills to pair with MCQs

Use multiple-choice practice to test tax consequences, then pair it with client-fact and planning-document review. For CPA TCP, that means reading taxpayer objectives, ownership facts, entity documents, asset-disposition details, retirement or estate facts, and timing constraints before choosing a compliant planning move. When you miss an MCQ, identify whether the gap was tax consequence, planning objective, cash-flow effect, entity-owner split, limitation, or compliance constraint.

How to use CPA TCP practice efficiently

1. Start with focused topic drills until you can explain the rule, objective, or calculation setup behind each answer.
2. Use the free 68-question diagnostic once as a baseline rather than as a memorization set.
3. Review misses by weakness type and return to the matching topic page before another timed set.
4. Move into timed mixed practice when topic-level accuracy is stable and you need pacing discipline.
5. If several unseen timed attempts are above roughly 75%, schedule or proceed instead of trying to memorize the full bank.

Miss pattern to next drill

CPA section routes

• CPA AUD : Auditing and Attestation
• CPA FAR : Financial Accounting and Reporting
• CPA REG : Taxation and Regulation
• CPA BAR : Business Analysis and Reporting
• CPA ISC : Information Systems and Controls
• CPA TCP: Tax Compliance and Planning

Free review resources

Need concept review before timed practice? Read the CPA TCP guide on CPAExamsMastery.com, then return here for sample questions, topic drills, timed mocks, and the full practice route.

Focused sample questions

Use these child pages when you want focused Mastery Exam Prep practice before returning to mixed sets and timed mocks.

• Free CPA TCP Full-Length Practice Exam
• CPA TCP: Individual and Personal Tax Planning
• CPA TCP: Entity Tax Compliance
• CPA TCP: Entity Tax Planning
• CPA TCP: Property Transactions

Free samples and full practice

• Live now: CPA TCP practice is available on web.
• On-page sample set: this page includes 24 public sample questions for the TCP route.
• Full practice: open the web route for mixed sets, topic drills, timed mocks, progress tracking, and detailed explanations.

24 CPA TCP sample questions with detailed explanations

These are original Mastery Exam Prep practice questions aligned to the live CPA TCP route and the main blueprint areas shown above. Use them to test readiness here, then continue in Mastery Exam Prep with mixed sets, topic drills, and timed mocks.

Question 1

Topic: Tax Compliance and Planning for Individuals and Personal Financial Planning

Alex, a single taxpayer, asks his CPA for a current-year tax projection and advice on whether to increase wage withholding before year-end. He has provided this preliminary summary, but the CPA has not yet reviewed source documents:

• Alex exercised 1,000 nonqualified stock options from his employer. The exercise price was $18 per share, and the fair value on the exercise date was $30 per share. He kept all of the shares.
• Alex’s brokerage account received $2,400 of qualified dividends and $1,100 of bank interest.
• Alex made an interest-free demand loan of $200,000 to his adult son on January 1. The son used the funds to buy mutual funds. Alex’s organizer states that AFR-based forgone interest for the year was $8,000.
• Alex elected to defer $18,000 of salary into his employer’s 401(k), and the employer paid $9,000 for Alex’s coverage under its group health plan.

What should the CPA do next before recommending a withholding adjustment?

• A. Obtain and review the option, brokerage, payroll, and loan records, then classify each item as compensation, investment income, imputed interest, or excluded/deferred income before projecting Alex’s tax.
• B. Recommend that Alex sell some employer stock now to raise cash for the expected tax on the option exercise and the loan arrangement.
• C. Analyze first whether the deemed gift element of the below-market loan uses any annual exclusion before determining Alex’s year-end withholding.
• D. Compute the employer’s deductions related to the option exercise and group health coverage before finalizing Alex’s individual projection.

Best answer: A

Explanation: Before changing withholding, the CPA should first classify each nonroutine item from the supporting documents. Here, the nonqualified option spread is compensation, the dividends and bank interest are investment income, the forgone interest on the family loan is imputed interest income, and the 401(k) deferral and employer health coverage are deferred or excluded from current gross income. In a nonroutine gross-income planning case, the proper next step is classification based on source data, not an immediate planning recommendation. Alex’s exercise of nonqualified stock options creates current compensation income equal to the spread at exercise, even though he did not sell the shares. The qualified dividends and bank interest are investment income. Because Alex made a $200,000 interest-free demand loan to his son and the forgone interest is given as $8,000, Alex must account for imputed interest income under the below-market loan rules. By contrast, salary deferred into a traditional 401(k) is generally deferred from current federal income tax, and employer-paid group health coverage is generally excluded from gross income. Once those categories are identified correctly, the CPA can build a reliable projection and then decide whether withholding should change.

Question 2

Topic: Entity Tax Compliance

Stone Corp., a domestic C corporation, is reviewing whether it must report a current-year inclusion from Nova Ltd., a foreign corporation, even though Nova paid no dividend. The tax manager wrote: “If Nova is a controlled foreign corporation and Stone is a 10%-or-more U.S. shareholder, Nova’s passive earnings may increase Stone’s U.S. taxable income.”

Which file item best supports the tax manager’s conclusion?

• A. Nova’s local-country income statement showing $600,000 of passive royalty income and no dividend paid for the year.
• B. An ownership and income summary showing that, for the entire tax year, Stone owned 8% of Nova’s vote and value, two other unrelated domestic corporations owned 27% each, foreign persons owned 38%, and Nova earned $600,000 of passive royalty income.
• C. An ownership and income summary showing that, for the entire tax year, Stone owned 18% of Nova’s vote and value, two other unrelated domestic corporations owned 22% each, foreign persons owned 38%, and Nova earned $600,000 of passive royalty income.
• D. An ownership and income summary showing that, for the entire tax year, Stone owned 18% of Nova’s vote and value, one unrelated domestic corporation owned 22%, foreign persons owned 60%, and Nova earned $600,000 of passive royalty income.

Best answer: C

Explanation: The best support is the ownership and income summary showing Stone owns at least 10% and qualifying U.S. shareholders collectively own more than 50% of Nova. Adding passive royalty income supports the conclusion that Stone may have a current U.S. taxable income inclusion even without a dividend. A foreign corporation is generally a controlled foreign corporation when U.S. shareholders that each own at least 10% of vote or value collectively own more than 50% of the corporation’s vote or value. If a domestic corporation is one of those 10%-or-more U.S. shareholders, certain CFC income can affect its current U.S. taxable income even when no cash distribution is made. Passive royalty income is a classic fact pattern for that concern. The strongest evidence therefore must show three things at once: Nova is foreign, Stone is at least a 10% U.S. shareholder, and the total ownership of qualifying U.S. shareholders exceeds 50%. The summary with Stone at 18%, two other domestic corporations at 22% each, and passive royalty income does exactly that.

Question 3

Topic: Entity Tax Planning

Alta Machines, Inc., a calendar-year C corporation, may schedule a $400,000 maintenance project in either December 20X5 or January 20X6. The cost is fixed and fully deductible in the year performed, and the project has no business effect other than tax timing.

The controller prepared this planning schedule:

Additional notes:

• Both years have sufficient taxable income to fully use the deduction.
• Ignore the federal tax effect of deducting state income taxes.
• If combined tax rates are otherwise equal, Alta prefers the earlier deduction.
• Schedule recommendation: perform the maintenance in 20X6.

Which missing assumption is most critical because, if it proves false, the recommendation is most likely to change?

• A. Alta’s 20X6 activities will actually create State B income tax exposure and support the projected 40% State B apportionment.
• B. Alta’s GAAP expense recognition for the maintenance will occur in the same year as the tax deduction.
• C. Alta will have enough 20X6 taxable income to use the full maintenance deduction immediately.
• D. Alta’s shareholders prefer higher reported 20X5 earnings to lower current taxes.

Best answer: A

Explanation: The recommendation to delay the deduction to 20X6 is driven by a higher projected combined tax rate next year. That rate increase depends on Alta actually becoming taxable in State B at the projected apportionment; if that assumption fails, Alta’s stated preference for an earlier deduction could make 20X5 the better choice. For C corporation timing decisions, the key comparison is the value of taking income or deductions in one year versus another, using the expected marginal tax rate in each year and whether the tax effect is usable immediately. Here, both years can fully absorb the deduction, and the federal rate is the same in both years. That means the schedule’s recommendation to wait until 20X6 rests mainly on the projected higher state tax burden after expansion into State B. If Alta does not actually have State B income tax exposure, or if the expected 40% apportionment there does not occur, the projected 20X6 tax-rate advantage largely disappears. Once that happens, Alta’s stated preference for the earlier deduction would likely favor performing the maintenance in 20X5 instead.

Question 4

Topic: Property Transactions (Disposition of Assets)

Pine C Corp made a $200,000 demand loan on January 1, Year 1, to Lee, its 80% individual shareholder. The note bears stated annual interest of 2%, paid on December 31, Year 1. The applicable federal rate for Year 1 is 6%. Pine has sufficient current and accumulated earnings and profits, and no below-market loan exception applies.

How should the Year 1 foregone interest be characterized for federal income tax purposes?

• A. $8,000 return of capital to the shareholder and $8,000 interest income to Pine
• B. $12,000 deemed dividend to the shareholder and $12,000 interest income to Pine
• C. $8,000 deemed dividend to the shareholder and $8,000 interest income to Pine
• D. $8,000 additional loan principal and no current deemed dividend or interest income

Best answer: C

Explanation: For a below-market demand loan, foregone interest equals the AFR interest minus the stated interest actually charged. Here, that amount is $8,000. Because the borrower is a shareholder and the corporation has sufficient earnings and profits, the deemed transfer is a dividend, with a matching deemed interest payment back to the corporation. A below-market demand loan creates imputed interest each year. Compute the foregone interest by multiplying the loan balance by the difference between the applicable federal rate and the stated rate. Pine loaned $200,000 at 2% when the AFR was 6%, so the foregone interest is $8,000. In a corporation-shareholder loan, the tax law treats that amount as a two-step deemed transaction: first, the corporation transfers the foregone interest amount to the shareholder; second, the shareholder is deemed to pay the same amount back to the corporation as interest. Because Pine has sufficient current and accumulated earnings and profits, the deemed transfer is characterized as a dividend rather than return of capital. Thus, the correct characterization is an $8,000 deemed dividend to Lee and $8,000 of interest income to Pine.

Question 5

Topic: Tax Compliance and Planning for Individuals and Personal Financial Planning

On December 20, 2026, Maya, a cash-basis sole proprietor, asks her CPA for a year-end tax-planning recommendation. Her projections, after enacted federal rate changes, are:

• A)40,000 customer payment can be received on December 29, 2026, or January 4, 2027, at Maya’s direction, with no constructive receipt issue.

• $18,000 of ordinary and necessary business expenses have already been incurred and are deductible when paid; Maya can pay them on December 30, 2026, or January 5, 2027. \nAssume no AMT, QBI deduction, phaseouts, or other limitations apply. \nWhat should the CPA recommend next to best minimize Maya’s combined 2026-2027 federal income tax liability?

• A. Receive the $40,000 customer payment in December 2026 and pay the $18,000 expenses in January 2027.

• B. Receive the $40,000 customer payment in January 2027 and pay the $18,000 expenses in January 2027.

• C. Receive the $40,000 customer payment in December 2026 and pay the $18,000 expenses in December 2026.

• D. Receive the $40,000 customer payment in January 2027 and pay the $18,000 expenses in December 2026.

Best answer: D

Explanation: Maya is in a higher marginal bracket in 2026 than in 2027, so the tax-efficient move is to shift income into 2027 and pull deductions into 2026. That uses the lower rate on income and the higher rate on deductions. For a cash-basis individual, income is generally taxed when received and expenses are generally deducted when paid. When the taxpayer’s current-year marginal rate is higher than the following year’s rate, the usual year-end planning goal is to defer income into the lower-rate year and accelerate deductions into the higher-rate year. Here, moving the $40,000 payment from 2026 to 2027 shifts that income from a 35% year to a 24% year, reducing tax by about $4,400. Paying the $18,000 deductible expenses in 2026 instead of 2027 places the deduction against 35% income rather than 24% income, increasing its value by about $1,980. That combined timing strategy produces the lowest two-year federal tax.

Question 6

Topic: Entity Tax Compliance

Pine, Inc. is a calendar-year C corporation. Its Year 1 records show the following:

Based on these facts, which is the best interpretation of the Year 1 federal income tax consequences?

• A. Pine recognizes $12,000 of imputed interest income, and Nora is treated as making a $12,000 capital contribution to Pine and paying an additional $12,000 of interest.
• B. Pine recognizes $12,000 of imputed interest income in addition to the $3,000 stated interest, and Nora is treated as receiving a $12,000 dividend and paying an additional $12,000 of personal interest.
• C. Pine recognizes no imputed interest because the note is bona fide and Nora paid the 1% stated interest required by the note.
• D. Pine recognizes $12,000 of imputed interest income, and Nora is treated as receiving a $15,000 dividend because the full AFR amount is deemed distributed.

Best answer: B

Explanation: The loan is below market because Pine charged 1% when the AFR is 5%, so the forgone interest for Year 1 is $12,000. Since Pine lent to its nonemployee shareholder and has sufficient E&P, that forgone interest is treated as a dividend to Nora and as additional interest income to Pine. For a below-market shareholder loan, first compute the forgone interest using the loan balance and the difference between the AFR and the stated rate. Here, \(300,000 × 4% =\)12,000. Because the lender is the C corporation and the borrower is its shareholder, the forgone interest is treated as a deemed transfer from Pine to Nora. With sufficient earnings and profits, that deemed transfer is a dividend, not a capital contribution. Nora is then deemed to pay the same $12,000 back to Pine as interest, so Pine has $12,000 of additional interest income beyond the $3,000 actually received. Since Nora used the borrowed funds entirely for personal purposes, the deemed interest is personal interest rather than business-interest or investment-interest treatment.

Question 7

Topic: Entity Tax Planning

On July 1, Year 5, Liam sells his entire 25% interest in Oak Partnership to Nora for $150,000 cash. Immediately before the sale:

• Liam’s adjusted outside basis is $110,000, including his $20,000 share of partnership liabilities.
• Liam is relieved of that $20,000 liability share because of the sale, and Nora is allocated that same $20,000 share immediately afterward.
• Liam’s share of Oak’s inside basis in partnership assets is $105,000.
• $12,000 of Liam’s total gain is attributable to unrealized receivables and inventory under §751.
• Oak has a valid §754 election in effect.
• Assume all partnership income and loss items through the sale date have already been allocated.

Which result is correct?

• A. Liam recognizes $60,000 gain, consisting of $12,000 ordinary income and $48,000 capital gain; Oak recognizes no entity-level gain or loss and makes a $65,000 §743(b) basis increase for Nora.
• B. Liam recognizes $50,000 gain, consisting of $12,000 ordinary income and $38,000 capital gain; Oak recognizes a $15,000 entity-level gain and makes a $50,000 basis increase for Nora.
• C. Liam recognizes $40,000 capital gain; Oak recognizes no entity-level gain or loss and makes no basis adjustment.
• D. Liam recognizes $60,000 capital gain; Oak recognizes no entity-level gain or loss and makes a $45,000 §743(b) basis increase for Nora.

Best answer: A

Explanation: Liam’s amount realized is $170,000, made up of $150,000 cash plus $20,000 liability relief. Subtracting his $110,000 outside basis gives a $60,000 gain; $12,000 is ordinary under §751 and the remaining $48,000 is capital, while Oak has no entity-level gain and makes a $65,000 §743(b) adjustment for Nora. In a sale of a partnership interest, the selling partner’s amount realized includes both cash received and relief of the partner’s share of partnership liabilities. Here, Liam’s amount realized is $170,000 ($150,000 cash + $20,000 liability relief). Subtracting his $110,000 outside basis produces a $60,000 gain. The problem states that $12,000 of the gain is attributable to unrealized receivables and inventory, so that portion is ordinary income under §751; the remaining $48,000 is capital gain. Oak generally does not recognize gain or loss when one partner sells an interest to another person. Because Oak has a §754 election in effect, it makes a §743(b) adjustment for Nora equal to her outside basis of $170,000 minus her $105,000 share of inside basis, for a $65,000 step-up that applies only to Nora.

Question 8

Topic: Property Transactions (Disposition of Assets)

A CPA is reviewing a client’s Year 1 disposition schedule. On December 15, Year 1, Maya sold investment land for $500,000. Her adjusted basis was $320,000. She received $80,000 cash at closing and a non-readily tradable note for $420,000 payable in three equal principal installments in Years 2 through 4, with adequate stated interest. There is no depreciation recapture, no selling expense, and Maya did not elect out of installment reporting. What is the correct federal income tax treatment for Year 1?

• A. Recognize the full $180,000 gain in Year 1 because the sale closed and the buyer’s note fixed the total sales price.
• B. Recognize $80,000 of Year 1 gain because the entire cash down payment is taxable when received.
• C. Recognize no Year 1 gain because gain is deferred until total principal collections exceed Maya’s $320,000 basis.
• D. Use the installment method; recognize $28,800 of Year 1 gain from the $80,000 principal received, and treat any stated interest separately.

Best answer: D

Explanation: Because Maya sold investment land and received only a down payment plus a non-readily tradable note, the installment method applies unless she elects out. Her gross profit percentage is $180,000 ÷ \(500,000 = 36%, so Year 1 gain is 36% of the\)80,000 principal collected, or $28,800. An installment sale generally lets a taxpayer recognize gain as principal payments are received rather than recognizing the entire gain in the year of sale. Here, Maya’s total gain is $180,000 ($500,000 selling price less $320,000 basis). Because the note is not readily tradable and she did not elect out, she uses the installment method. The gross profit percentage is 36% ($180,000 ÷ $500,000), and that percentage is applied to principal collected. Since Maya received only $80,000 of principal in Year 1, she recognizes $28,800 of gain in Year 1. The rest of the principal-related gain is recognized as later principal payments are collected. Any stated interest is reported separately as interest income and is not part of the installment-sale gain computation.

Question 9

Topic: Tax Compliance and Planning for Individuals and Personal Financial Planning

Leslie wants to transfer (60,000 of value to her adult daughter within 30 days for a home down payment. Leslie’s stated goals are to reduce Leslie’s taxable estate, minimize the family’s current-year income tax, and avoid using Leslie’s existing cash reserves if possible. Ignore annual exclusion and gift tax return filing effects.

Which action is most supported by the exhibit?

• A. Gift $60,000 cash from Leslie’s existing reserves to the daughter.
• B. Sell the vacant land first and gift the $60,000 cash proceeds to the daughter.
• C. Gift the publicly traded stock directly to the daughter.
• D. Gift the vacant land directly to the daughter.

Best answer: B

Explanation: The best choice is to sell the vacant land first and then gift the cash proceeds. That approach preserves Leslie’s built-in capital loss for current-year tax benefit, still removes $60,000 from her estate, and avoids dipping into her existing cash reserves. When property with a built-in loss is gifted, the donor’s loss generally is not transferred to the donee. For loss purposes, the donee’s basis is the fair market value at the date of the gift, so if Leslie gifts the land worth $60,000 with a $95,000 basis and the daughter immediately sells it for $60,000, no loss is recognized. By contrast, if Leslie sells the land first to the ready third-party buyer, Leslie recognizes the $35,000 capital loss and can use it against her own expected capital gains this year. She can then gift the $60,000 sale proceeds to her daughter, achieving the estate-reduction goal and meeting the daughter’s cash need without using Leslie’s existing cash reserves. Gifting the appreciated stock would shift a large built-in gain to an immediate sale and would not minimize the family’s current-year income tax.

Question 10

Topic: Entity Tax Compliance

A CPA is preparing the 2026 fiduciary accounting schedule for the Lane Family Trust. The trust instrument requires current distribution of trust income to the sole income beneficiary and is silent on capital gains. During the year, the trust received $6,000 of bond interest, $4,000 of cash dividends, and $30,000 from selling stock held as a trust investment. Assume applicable law follows the usual fiduciary accounting rule that gains from the sale of principal assets are allocated to principal.

Which classification is correct?

• A. Bond interest is corpus; cash dividends and stock sale proceeds are trust income.
• B. Stock sale proceeds are corpus; bond interest and cash dividends are trust income.
• C. Cash dividends are corpus; bond interest and stock sale proceeds are trust income.
• D. Bond interest, cash dividends, and stock sale proceeds are all trust income.

Best answer: B

Explanation: Corpus means the trust principal, including property already in the trust and amounts received from disposing of that property. Trust income is the current return produced by corpus, such as interest and ordinary cash dividends, so the stock sale proceeds are corpus while the interest and dividends are trust income. In fiduciary accounting, corpus (or principal) is the underlying trust property preserved for remainder interests, while trust income is the yield generated by that property for the income beneficiary. Under the usual rule, receipts like bond interest and ordinary cash dividends are allocated to trust income because they are current returns on invested assets. By contrast, when the trust sells a principal asset such as stock, the receipt is a principal transaction, so the sale proceeds and related gain are allocated to corpus unless the governing instrument or applicable law provides otherwise. That means the income beneficiary is generally entitled to the interest and dividends, not the stock sale proceeds, for trust accounting purposes.

Question 11

Topic: Entity Tax Planning

A CPA is comparing three liquidation transactions:

• C Corp, a single-shareholder C corporation, will distribute land with adjusted basis $40,000 and FMV $100,000 to its sole shareholder in complete liquidation. The shareholder’s stock basis is $50,000.
• S Corp, a single-shareholder S corporation, will distribute identical land to its sole shareholder in complete liquidation. The shareholder’s stock basis is $50,000. Ignore any built-in gains tax.
• PS, a partnership, will distribute identical land to Partner A in liquidation of A’s entire partnership interest. A’s outside basis is $50,000. The distribution is proportionate, PS has no unrealized receivables or substantially appreciated inventory, and there are no liabilities.

Which tax characterization is correct?

• A. The partnership liquidation produces immediate capital gain to Partner A because the land’s fair market value exceeds A’s outside basis.
• B. The C corporation shareholder treats the liquidating land distribution as a dividend to the extent of the corporation’s earnings and profits.
• C. The S corporation liquidation produces a $60,000 pass-through gain and a $10,000 capital loss on the shareholder’s stock.
• D. The C corporation liquidation produces only shareholder-level capital gain because the corporation does not recognize gain on liquidating distributions.

Best answer: C

Explanation: The correct characterization is the S corporation result. The corporation recognizes gain on the appreciated land as if it were sold, that gain passes through and increases stock basis, and only then does the shareholder compute gain or loss on the liquidating exchange of stock. Liquidating distributions are compared differently across entity types. A C corporation generally recognizes gain or loss when it distributes property in complete liquidation as if the property were sold at fair market value, and the shareholder separately recognizes capital gain or loss on the stock exchange, creating potential double taxation. An S corporation also recognizes gain on appreciated property distributed in liquidation, but that gain passes through to the shareholder and adjusts stock basis before the shareholder measures gain or loss on the stock. Here, the land gain is $60,000 ($100,000 FMV less $40,000 basis). The S shareholder’s basis rises from $50,000 to $110,000, so receiving property worth $100,000 results in a $10,000 capital loss on the stock. By contrast, a proportionate partnership liquidating distribution of property generally does not trigger immediate gain merely because the property’s FMV exceeds the partner’s outside basis.

Question 12

Topic: Property Transactions (Disposition of Assets)

During a review of an asset disposition schedule, a CPA notes the following item:

Assume the equipment is Section 1245 property and there are no other asset dispositions. How should the issue on the schedule be characterized?

• A. No error, because gain on business equipment held more than 1 year is always Section 1231 gain.
• B. Character classification error, because the $40,000 gain should be ordinary income under Section 1245 recapture, not Section 1231 gain.
• C. Calculation error, because the recognized gain should be $50,000, not $40,000.
• D. Character classification error, because the $40,000 gain should be long-term capital gain.

Best answer: B

Explanation: The schedule’s $40,000 gain is mathematically correct: $120,000 selling price minus $10,000 selling expenses equals $110,000 amount realized, and $110,000 minus $70,000 adjusted basis equals $40,000 gain. The problem is character, because Section 1245 requires ordinary income recapture up to prior depreciation. When reviewing an asset disposition schedule, first verify the amount, then verify the character. Here, the adjusted basis is $70,000 ($180,000 cost minus $110,000 depreciation). The amount realized is $110,000 ($120,000 gross selling price minus $10,000 selling expenses). That produces a correctly calculated $40,000 gain.

However, the asset is Section 1245 property. On the sale of Section 1245 property, gain is recharacterized as ordinary income to the extent of prior depreciation deductions. Because prior depreciation was $110,000 and the total gain is only $40,000, the entire $40,000 is ordinary income recapture. So this is not a math error; it is a character classification error on the schedule.

Question 13

Topic: Tax Compliance and Planning for Individuals and Personal Financial Planning

Mila materially participates in an LLC taxed as a partnership. Relevant current-year facts are:

• Beginning amount at risk: $30,000 from prior cash contributions
• Additional contribution: $20,000 cash funded by Mila’s personal full-recourse bank borrowing
• Mila’s allocated share of the LLC’s nonrecourse borrowing: $25,000
• Mila’s allocated ordinary loss: $70,000

Assume Mila has sufficient outside basis, is not protected against loss, and no passive activity limitation applies.

How should Mila’s current-year LLC loss be characterized under the at-risk rules?

• A. $70,000 ordinary loss currently deductible because basis is sufficient
• B. $30,000 ordinary loss currently deductible and $40,000 suspended under the at-risk rules
• C. Entire $70,000 loss suspended under the at-risk rules because partnership debt is nonrecourse
• D. $50,000 ordinary loss currently deductible and $20,000 suspended under the at-risk rules

Best answer: D

Explanation: Mila may deduct loss only to the extent she is at risk in the activity. Her at-risk amount is $50,000: $30,000 from prior cash contributions plus $20,000 from personally borrowed full-recourse funds contributed to the LLC; the allocated nonrecourse debt does not increase her at-risk amount. Under the at-risk rules, an individual generally may deduct pass-through losses only up to the amount economically at risk in the activity. Cash contributions increase the at-risk amount, and funds the owner personally borrows on a full-recourse basis and puts into the activity also increase it because the owner bears personal liability. By contrast, an allocated share of entity-level nonrecourse debt generally does not increase the owner’s at-risk amount. Here, Mila’s at-risk amount before the current-year loss is $50,000 ($30,000 + $20,000). Because her allocated ordinary loss is $70,000, she may currently deduct $50,000 and must suspend the remaining $20,000 under the at-risk limitation. The stem removes basis and passive loss issues, so only the at-risk limit controls.

Question 14

Topic: Entity Tax Compliance

The Reed Trust requires annual distribution of fiduciary accounting income to the income beneficiary. The trust instrument is silent on how corporate distributions are allocated, and the governing state follows the Uniform Principal and Income Act. During the year, the trust received a pro rata 10% stock dividend from a corporation whose shares it already held, and no cash election was offered. For fiduciary accounting purposes, how should the stock dividend be classified?

• A. Between income and corpus based on fair value
• B. Deferred from allocation until the shares are sold
• C. Entirely to income
• D. Entirely to corpus

Best answer: D

Explanation: Because the trust instrument is silent, the default principal-and-income rules control. Under those rules, a pro rata stock dividend with no cash election is allocated to corpus rather than fiduciary accounting income. Trust accounting first follows the governing instrument, and if the instrument is silent, state principal-and-income law applies. Under Uniform Principal and Income Act style rules, ordinary cash dividends are generally income, but a pro rata stock dividend of additional shares is a principal receipt. The distribution increases the trust’s ownership interest without delivering cash to the income beneficiary, so it is added to corpus for the remaindermen’s benefit. This is a fiduciary accounting classification issue, not a DNI or taxable-income determination.

Question 15

Topic: Entity Tax Planning

Atlas Supply, Inc., formerly a C corporation, made a valid S election effective January 1, 2024. In October 2026, while still within the built-in gains recognition period, Atlas plans to sell one asset to raise cash. Assume Atlas had a positive net unrealized built-in gain on the S-election date, the taxable income limitation will not reduce the built-in gains amount, and each asset below was owned on January 1, 2024.

Which asset should Atlas sell if it wants the smallest amount of gain subject to the S corporation built-in gains tax?

• A. Sell the Ridge tract; $90,000 of gain would be subject to built-in gains tax.
• B. Sell the Lake tract; $30,000 of gain would be subject to built-in gains tax.
• C. Sell the Downtown lot; $35,000 of gain would be subject to built-in gains tax.
• D. Sell the stock portfolio; $0 of gain would be subject to built-in gains tax.

Best answer: D

Explanation: The amount subject to built-in gains tax for an asset sold during the recognition period is generally the lesser of the actual gain recognized or the asset’s built-in gain on the S-election date. Because the stock portfolio had a built-in loss, not a built-in gain, on January 1, 2024, none of its later gain is subject to the built-in gains tax. For an asset held when a C corporation becomes an S corporation, recognized built-in gain is measured asset by asset. During the recognition period, the amount potentially subject to the built-in gains tax is the lesser of: the gain recognized on sale, or the asset’s built-in gain on the S-election date (FMV minus basis, if positive). If the asset had no built-in gain on that date, later appreciation is not recognized built-in gain.

Here, Ridge tract: gain $110,000, built-in gain $90,000, so $90,000 is subject. Lake tract: gain $30,000, built-in gain $60,000, so $30,000 is subject. Downtown lot: gain $35,000, built-in gain $40,000, so $35,000 is subject. Stock portfolio: basis $250,000 and FMV $220,000 on the S-election date, so it had no built-in gain; therefore its later $30,000 gain is not subject to the built-in gains tax.

Question 16

Topic: Property Transactions (Disposition of Assets)

Marin, an individual, sold investment land on January 2, Year 1 for $500,000. The land had an adjusted basis of $350,000. There were no selling expenses, no debt on the property, and no depreciation recapture. The buyer paid $100,000 cash at closing and signed a note for the remaining $400,000, payable in four equal $100,000 principal installments. Before December 31, Year 1, Marin received one $100,000 principal installment and $4,000 of stated interest.

Marin’s preparer drafted this Year 1 installment sale schedule:

Which interpretation is most appropriate?

• A. The schedule is incorrect because only the $200,000 of principal received in Year 1 is multiplied by 30%, so Year 1 recognized gain should be $60,000.
• B. The schedule is correct because the gross profit percentage applies to all cash received in Year 1, including stated interest.
• C. The schedule is incorrect because the gross profit percentage should be computed using only the $400,000 note balance, so Year 1 recognized gain should be $75,000.
• D. The schedule is incorrect because only the $100,000 down payment is recognized in Year 1, so Year 1 recognized gain should be $30,000.

Best answer: A

Explanation: The preparer’s schedule overstates Year 1 gain by including stated interest in the installment payment base. Under the installment method, recognized gain equals the gross profit percentage multiplied by principal collected, so Marin recognizes $60,000 on $200,000 of principal receipts. For an installment sale, current-year recognized gain is computed by multiplying the gross profit percentage by the principal payments received during the year. Separately stated interest is not part of the installment sale payment for gain recognition; it is reported as interest income. Here, gross profit is $150,000 on a $500,000 sale, so the 30% gross profit percentage is correct. In Year 1, Marin received $100,000 down at closing plus one additional $100,000 principal installment, for total principal collections of $200,000. The $4,000 interest does not increase installment gain. Therefore, the correct Year 1 recognized gain is $60,000 ($200,000 × 30%), and the preparer’s $61,200 amount is too high.

Question 17

Topic: Tax Compliance and Planning for Individuals and Personal Financial Planning

Jordan, a single taxpayer, can fund only one investment and expects to sell it after a 13-month holding period. Jordan’s federal marginal tax rates are 32% on ordinary income and 15% on qualified dividends and long-term capital gains. Municipal bond interest is federally tax-exempt. Ignore state taxes, NIIT, and AMT. Assume advisory fees are not deductible and no Sec. 199A deduction applies to any REIT distributions.

Based on the exhibit, which investment gives Jordan the highest projected after-tax ROI over the holding period?

• A. The municipal bond fund should be selected for the highest projected after-tax ROI.
• B. The corporate bond fund should be selected for the highest projected after-tax ROI.
• C. The REIT fund should be selected for the highest projected after-tax ROI.
• D. The dividend stock fund should be selected for the highest projected after-tax ROI.

Best answer: D

Explanation: Compute after-tax net return for each option as after-tax yield plus after-tax appreciation minus the nondeductible fee, then divide by initial cost. The dividend stock fund is highest at about 8.17%, so it provides the best tax-adjusted ROI. Tax-adjusted ROI compares net after-tax profit to the amount invested. Here, ordinary income is taxed at 32%, while qualified dividends and long-term capital gains are taxed at 15%, and municipal bond interest is tax-exempt. Using those rules: corporate bond fund = (($2,600 × 68%) + ($400 × 85%) - \(100) /\)40,000 = 5.02%; municipal bond fund = ($1,950 + ($100 × 85%) - \(75) /\)38,000 = 5.16%; dividend stock fund = (($2,100 × 85%) + ($2,400 × 85%) - \(150) /\)45,000 = 8.17%; REIT fund = (($2,850 × 68%) + ($900 × 85%) - \(100) /\)42,000 = 6.20%. Because the dividend stock fund has the highest after-tax percentage return, it is the best choice.

Question 18

Topic: Entity Tax Compliance

Birch Corp, a C corporation, received land from its sole shareholder in exchange for Birch Corp stock and cash.

Assume the transfer otherwise qualifies under Sec. 351, the liability assumption is not treated as boot, and the liability does not exceed the shareholder’s basis in the land.

Based on the exhibit, what basis does Birch Corp take in the land immediately after the transfer?

• A. Birch Corp takes a basis of $110,000 in the land.
• B. Birch Corp takes a basis of $40,000 in the land.
• C. Birch Corp takes a basis of $90,000 in the land.
• D. Birch Corp takes a basis of $150,000 in the land.

Best answer: A

Explanation: A C corporation generally takes a carryover basis in property received in a Sec. 351 exchange, increased by any gain the shareholder recognizes. Here, the shareholder’s basis is $90,000 and the $20,000 cash boot causes $20,000 of recognized gain, so Birch Corp’s basis is $110,000. For property contributed to a C corporation in a qualifying Sec. 351 exchange, the corporation’s basis is generally determined under the carryover basis rule. The starting point is the shareholder’s adjusted basis in the transferred property, and that amount is increased by any gain the shareholder recognizes on the transfer. In this case, the land had a $90,000 adjusted basis. The shareholder also received $20,000 of cash boot, which causes recognition of gain up to the amount of boot received, assuming sufficient realized gain exists. Because the assumed liability is not treated as boot and does not exceed the shareholder’s basis, it does not create additional recognized gain here. Therefore, Birch Corp’s basis in the land is $90,000 plus $20,000, or $110,000.

Question 19

Topic: Entity Tax Planning

Willow Creek LLC, taxed as a partnership, is considering a nonliquidating distribution of a parcel of land to Mason, who will remain a 30% partner after the transfer.

Current tax facts:

• Mason’s outside basis immediately before the distribution: $24,000
• Cash to Mason: $10,000
• Land to Mason: FMV $95,000; partnership adjusted basis $40,000
• No liabilities will shift, and no marketable securities are involved
• The engagement partner wants advice on the federal income tax effects to both Mason and Willow Creek before the transaction is approved

What should the CPA do next?

• A. Record partnership gain on the land before the distribution so Willow Creek can distribute the property with a stepped-up tax basis.
• B. Use the land’s $95,000 FMV as Mason’s basis and measure current tax consequences from the built-in appreciation.
• C. Compute Mason’s remaining outside basis after the cash distribution and determine the land’s tax basis to Mason using the partnership’s adjusted basis, while confirming whether Willow Creek recognizes any current gain or loss on the noncash distribution.
• D. Recalculate Mason’s book capital account first, because book capital rather than outside basis controls the tax treatment of a nonliquidating land distribution.

Best answer: C

Explanation: The next step is a basis analysis, not an FMV or book-entry approach. In a nonliquidating distribution, cash reduces the partner’s outside basis first, the distributed land generally takes a carryover tax basis limited by the partner’s remaining outside basis, and the partnership usually does not recognize current gain or loss on distributing land. For a proposed nonliquidating partnership distribution, the CPA should begin by analyzing the distributee partner’s outside basis and the partnership’s inside basis in the property. Cash is applied first; a partner recognizes gain only if cash distributed exceeds outside basis. Here, Mason has $24,000 of outside basis and receives $10,000 cash, so no gain is triggered by the cash. Mason then has $14,000 of remaining outside basis, which limits the tax basis he can take in the distributed land even though the partnership’s basis in the land is $40,000 and its FMV is much higher. The partnership generally does not recognize gain or loss on a noncash nonliquidating distribution of land. Therefore, the proper next step is to compute basis consequences, not use FMV, rely on book capital, or force partnership-level gain recognition.

Question 20

Topic: Property Transactions (Disposition of Assets)

Harper, a calendar-year sole proprietor, had the following 2026 results from dispositions of trade or business property held for more than one year. The amounts below are already calculated after any required recapture.

Harper also has $25,000 of nonrecaptured net Section 1231 losses from the previous five tax years.

After applying the Section 1231 netting and lookback rules, how much of Harper’s 2026 net Section 1231 result is treated as long-term capital gain?

• A. $35,000
• B. $60,000
• C. $45,000
• D. $25,000

Best answer: A

Explanation: First net the Section 1231 amounts: $80,000 - $30,000 + $20,000 - \(10,000 =\)60,000 net gain. Then apply the five-year lookback rule, which recharacterizes $25,000 as ordinary income, so $35,000 remains long-term capital gain. Section 1231 gains and losses from business property held more than one year are netted after any required recapture. If the result is a net Section 1231 loss, it is treated as an ordinary loss. If the result is a net Section 1231 gain, it is generally treated as long-term capital gain, but only after applying the five-year lookback rule.

Here, Harper’s 2026 net Section 1231 result is $60,000: $80,000 + $20,000 - $30,000 - $10,000. Harper also has $25,000 of nonrecaptured net Section 1231 losses from the prior five years. That amount causes $25,000 of the current-year net gain to be recharacterized as ordinary income. The remaining $35,000 keeps Section 1231 capital-gain treatment and is treated as long-term capital gain.

Question 21

Topic: Tax Compliance and Planning for Individuals and Personal Financial Planning

Taylor, a single taxpayer, itemizes deductions and is evaluating two year-end actions for 2026.

Projected 2026 federal tax data before either action:

Possible actions:

• Pay $8,000 of state estimated income tax in December. Assume the full $8,000 is deductible for regular tax purposes and is not deductible in computing AMTI.
• Exercise an incentive stock option with a $15,000 bargain element and hold the shares. Assume the bargain element is not included in regular taxable income in 2026 but is included in AMTI in 2026.

Which interpretation is best supported by these projections?

• A. Neither action changes current federal tax because regular taxable income and AMTI start at the same projected amount.
• B. The ISO exercise increases regular taxable income immediately, while the state tax payment affects only AMTI.
• C. The state estimated tax payment can reduce current federal tax because it lowers regular tax without changing AMTI, but the ISO exercise can create current-year AMT because it increases AMTI without increasing regular taxable income.
• D. The state estimated tax payment reduces both regular taxable income and AMTI, so it provides a current federal tax benefit even if AMT applies.

Best answer: C

Explanation: The best interpretation is that the state tax prepayment helps only on the regular tax side, while the ISO exercise affects only AMTI in the exercise year. Given the projected gap, the deduction still lowers current tax, but the ISO adjustment is large enough to trigger AMT. Total federal tax is effectively the higher of regular tax or tentative minimum tax. Here, Taylor starts with regular tax exceeding tentative minimum tax by $3,000, so there is no AMT before either action. Paying $8,000 of state estimated income tax reduces regular taxable income, saving about $1,920 at the 24% regular rate, but it does not reduce AMTI. Because the $1,920 benefit is smaller than the $3,000 gap, total current federal tax still falls. By contrast, exercising the ISO adds a $15,000 AMT adjustment but no regular taxable income in the exercise year if the shares are held. At a 28% AMT rate, tentative minimum tax rises by about $4,200, which is enough to erase the $3,000 gap and create current-year AMT.

Question 22

Topic: Entity Tax Compliance

For this question, treat a U.S. shareholder as a U.S. person that owns at least 10% of a foreign corporation’s vote or value, and treat a foreign corporation as a controlled foreign corporation (CFC) when such U.S. shareholders collectively own more than 50%.

Additional facts: ForeignCo was organized outside the United States, ownership was unchanged all year, ForeignCo earned $300,000 of Subpart F income this year, and ForeignCo paid no dividends.

Based on the exhibit, which conclusion is most supported for U.S. Parent Corp’s current-year U.S. taxable income?

• A. ForeignCo is a CFC, but U.S. Parent Corp reports no current U.S. taxable income because no dividend was paid.
• B. ForeignCo is a CFC, and U.S. Parent Corp must include $120,000 of current U.S. taxable income.
• C. ForeignCo is not a CFC because U.S. Parent Corp alone owns only 40%.
• D. ForeignCo is a CFC, and U.S. Parent Corp must include $165,000 because qualifying U.S. shareholders collectively own 55%.

Best answer: B

Explanation: ForeignCo is a CFC because qualifying U.S. shareholders own 55% in total, which exceeds the 50% control threshold. Since ForeignCo has $300,000 of Subpart F income, U.S. Parent Corp must currently include its 40% share, or $120,000, even though no dividend was paid. A foreign corporation is a CFC when U.S. shareholders that each own at least 10% collectively own more than 50% of its vote or value. In the exhibit, the two domestic corporations each meet the 10% threshold, and together they own 55%, so ForeignCo is a CFC. Once that status applies, certain income such as Subpart F income is taxed currently to the U.S. shareholders on a pro rata basis, even if the foreign corporation makes no cash distribution. U.S. Parent Corp owns 40% of ForeignCo, so it must include 40% of the $300,000 Subpart F income, which is $120,000, in current U.S. taxable income.

Question 23

Topic: Entity Tax Planning

Maple Co. is a calendar-year C corporation. Ava owns 100% of Maple and works full time as its president.

Maple wants to transfer)120,000 of value to Ava this year with the lowest combined current-year federal income tax cost while keeping the tax treatment supportable. Which proposed transaction best meets that goal?

• A. Declare a $120,000 cash dividend to Ava.
• B. Pay Ava a $120,000 year-end cash bonus that is fully reasonable compensation.
• C. Repay $120,000 of principal on Ava’s bona fide shareholder note.
• D. Distribute the land with a $120,000 FMV and a $30,000 basis to Ava.

Best answer: C

Explanation: Repaying principal on a bona fide shareholder loan is generally not taxable to the shareholder and does not create entity-level gain or loss. That makes it more tax-efficient here than a deductible bonus, a nondeductible dividend, or a distribution of appreciated property. For C corporation planning, the best answer is the one with the lowest combined entity-and-shareholder tax cost, not just the lowest shareholder tax. A reasonable bonus helps because Maple deducts it, but Ava still recognizes $120,000 of ordinary income. A cash dividend is worse because Maple gets no deduction and Ava is taxed on the dividend since E&P is sufficient. Distributing appreciated land is usually the least efficient of these choices because Maple must recognize gain as if it sold the land for FMV, and Ava is then taxed on the distribution as well. By contrast, repayment of principal on a bona fide shareholder loan is generally a balance-sheet transaction: Ava is just getting her loan principal back, and Maple does not recognize gain or get a deduction from the repayment itself. Given the valid note, current interest payments, and maturity, loan repayment best satisfies the planning objective.

Question 24

Topic: Property Transactions (Disposition of Assets)

An individual sold delivery equipment (depreciable personal property) used in a Schedule C business. The reviewer is reconciling a staff memo to the tax software output.

Original cost: $90,000
Depreciation allowed or allowable: $54,000
Selling price: $50,000
Selling expenses: $0
Holding period: more than 1 year

Tax software result:
- Adjusted basis: $36,000
- Total gain: $14,000
- Character: $14,000 ordinary income

Staff memo:
- Adjusted basis: $36,000
- Total gain: $14,000
- Character: $14,000 §1231 gain

How should the discrepancy be classified?

• A. A wrong Section 1231 classification issue
• B. A wrong recapture-treatment issue
• C. A wrong adjusted-basis issue
• D. A wrong proceeds issue

Best answer: B

Explanation: The discrepancy is not caused by basis or proceeds because both calculations use the same $36,000 adjusted basis and $50,000 selling price, producing the same $14,000 gain. The problem is the failure to apply depreciation recapture, which makes the gain ordinary rather than §1231 gain. For depreciable personal property used in a trade or business, §1245 recapture applies before any remaining gain can receive §1231 treatment. Here, adjusted basis is $36,000 ($90,000 cost minus $54,000 depreciation), and the sale produces a $14,000 total gain ($50,000 minus $36,000). Because prior depreciation of $54,000 exceeds the entire $14,000 gain, all of the gain is recaptured as ordinary income. That means the software’s character result is correct. Since basis, proceeds, and total gain all agree between the software and the staff memo, the discrepancy is specifically a recapture-treatment problem, not a basis or proceeds problem.

In this section

• CPA TCP: Individual and Personal Tax Planning
  Try 10 focused Certified Public Accountant Tax Compliance and Planning (CPA TCP) questions on individual planning, retirement, investments, estate and gift issues, and client tax trade-offs.
• CPA TCP: Entity Tax Compliance
  Try 10 focused Certified Public Accountant Tax Compliance and Planning (CPA TCP) questions on entity returns, taxable income, basis, distributions, loss limits, and compliance consequences.
• CPA TCP: Entity Tax Planning
  Try 10 focused Certified Public Accountant Tax Compliance and Planning (CPA TCP) questions on entity choice, elections, compensation, distributions, owner tax effects, and planning trade-offs.
• CPA TCP: Property Transactions
  Try 10 focused Certified Public Accountant Tax Compliance and Planning (CPA TCP) questions on asset dispositions, basis recovery, character, depreciation recapture, timing, and planning effects.
• Free CPA TCP Full-Length Practice Exam: 68 Questions
  Try 68 free Certified Public Accountant Tax Compliance and Planning (CPA TCP) questions across the TCP blueprint areas, with answers and explanations, then continue in Mastery Exam Prep.