CPA Exam — REG (Regulation) flashcards

Specific types of debts that cannot be eliminated in a Chapter 7 bankruptcy and remain obligations of the debtor.

• Include certain taxes, student loans (absent undue hardship), domestic support obligations (alimony, child support), and debts incurred by fraud.
• The purpose is to prevent abuse of the bankruptcy system and protect certain creditors.
• Debtors remain liable for these debts even after the bankruptcy discharge.

Memory trick: FATS DUCKS are Not Discharged.

A clear and unequivocal indication by one party to a contract, before performance is due, that they will not perform their contractual obligations.

• Allows the non-breaching party to immediately sue for breach.
• Must be a clear and definite statement or action.
• Can be retracted if the non-breaching party has not yet acted upon it.

Memory trick: Anticipate the Repudiation, then React to the Breach.

A shipping term under the UCC where the risk of loss passes from the seller to the buyer when the goods are delivered to the carrier.

• Seller pays to get goods to the carrier.
• Buyer pays freight from shipping point to destination.
• Buyer bears risk of loss during transit.

Memory trick: FOB: Follow Our Business to know where risk shifts.

Authority explicitly granted to an agent by the principal, either orally or in writing, to perform specific acts.

• Clearly defined and stated.
• Limits the agent's power to only the specified actions.
• Often found in agency agreements or power of attorney documents.

Memory trick: Express is Explicit, Implied is Necessary, Apparent is Perceived.

The power of a partner to bind the partnership to a third party when the third party reasonably believes the partner has authority to act on behalf of the partnership, based on the partnership's representations or past conduct, even if the partner lacks actual authority.

• Depends on the reasonable belief of the third party.
• Created by the partnership's actions or inactions, not the partner's representations alone.
• Can bind the partnership even if the act is not in the ordinary course of business, if the third party's belief is reasonable.

Memory trick: Actual is Agreed, Apparent is Perceived, Implied is Necessary.

An implied warranty under UCC Article 2, applicable to merchants, that goods are fit for the ordinary purposes for which such goods are used, are of fair average quality, and conform to any promises or affirmations of fact made on the container or label.

• Applies only when the seller is a merchant with respect to goods of that kind.
• Goods must be fit for their ordinary purpose.
• Can be disclaimed, but specific requirements apply.

Memory trick: Merchantability for Ordinary, Fitness for Specific.

A contract defense where an unforeseen event makes performance extremely difficult, expensive, or burdensome, though not literally impossible, excusing performance.

• Event must be unforeseeable at the time of contract formation.
• Performance must be rendered commercially unreasonable, not just less profitable.
• The party seeking to be excused must not have assumed the risk of the event.

Memory trick: I-F-M-A: Impracticability, Frustration, Mistake, Alteration.

A legal doctrine holding an employer (or principal) liable for the wrongful acts of an employee (or agent) committed within the scope of their employment or agency.

• Means 'let the master answer'.
• Applies to torts committed by an employee during the course of employment.
• The employer is vicariously liable, even if not directly negligent.

Memory trick: Vicarious: One's Actions, Another's Blame.

The legal principle under UCC Article 9 that determines the order in which multiple creditors with security interests in the same collateral will be paid upon debtor's default.

• General rule: 'first to file or perfect' takes priority.
• Perfection can occur by filing, possession, or control.
• Special rules apply for purchase money security interests (PMSIs).

Memory trick: F-I-P-S: First In Perfection, Secures.

A provision in a security agreement that grants a security interest in collateral the debtor obtains after the agreement is made.

• Commonly used for inventory and accounts receivable.
• Security interest attaches when debtor acquires the property.
• Perfection generally relates back to the original filing date for future advances and after-acquired property.

Memory trick: A-A-P: Always Automatically Perfected (if filed early).

A comprehensive quarterly financial report submitted by public companies to the U.S. Securities and Exchange Commission (SEC).

• Required under the Securities Exchange Act of 1934.
• Provides a continuing view of the company's financial position.
• Due 40 or 45 days after the end of the first three fiscal quarters (depending on company size).

Memory trick: K-Q-8: Know Your Quarterly and Event Filings.

An annual report required by the SEC for publicly traded companies, providing a comprehensive summary of the company's financial performance and business activities.

• Filed annually, usually within 60-90 days of fiscal year-end.
• Contains audited financial statements, management's discussion and analysis (MD&A), and business description.
• More detailed than the annual report sent to shareholders.

Memory trick: 10-K for the Year, 10-Q for the Quarter, 8-K for the Key Event.

The statutory order in which proceeds from the liquidation of a debtor's estate are distributed to various claimants in a Chapter 7 bankruptcy.

• Secured creditors are paid first from their collateral.
• Administrative expenses have highest priority among unsecured claims.
• Priority claims (e.g., certain taxes, wages) are paid before general unsecured claims.
• General unsecured creditors are paid last, typically pro rata if funds are insufficient.

Memory trick: S-A-P-G: Secured, Admin, Priority, General.

Occurs when a party performs nearly all of their contractual obligations, but with minor defects. The performing party is entitled to the contract price minus damages for the defects.

• Applies when the breach is not material.
• Allows the non-breaching party to recover damages for the minor defect.
• Prevents forfeiture of payment for significant work completed.

Memory trick: Performance is like baking: mostly done, just missing a sprinkle.

Debts that are legally released by a bankruptcy court, freeing the debtor from personal liability.

• Most unsecured debts (e.g., credit cards, medical bills) are dischargeable.
• Certain debts (e.g., student loans, most taxes, child support) are generally non-dischargeable.
• The purpose is to give the debtor a 'fresh start' by eliminating obligations.

Memory trick: 7 Deadly Non-Dischargeables, but most others are free!

Rules governing how a secured party must sell or otherwise dispose of collateral after a debtor's default to satisfy the outstanding debt.

• Must be conducted in a 'commercially reasonable manner'.
• Debtor must generally receive notice of the disposition.
• Proceeds are applied to expenses, then the debt, with any surplus to the debtor.

Memory trick: Default leads to Dispose Reasonably, Notice to Debtor.

A shipping term under the Uniform Commercial Code (UCC) where the seller retains the risk of loss until the goods are delivered to the buyer's specified destination.

• Seller pays shipping costs.
• Risk of loss passes to buyer upon tender of delivery at destination.
• Often used when the seller wants to ensure safe arrival.

Memory trick: F.O.B. is like a relay race: who holds the baton? That's who bears the risk.

The general rule for determining which secured party has priority over collateral when there are multiple perfected security interests is 'first to file or perfect'.

• Applies when there are conflicting perfected security interests.
• Date of filing a financing statement or perfection, whichever is earlier, governs.
• Exceptions exist, such as for Purchase Money Security Interests (PMSIs).

Memory trick: First in line, First in right: Perfection wins.

The authority explicitly granted by a principal to an agent, either orally or in writing, to perform specific acts on the principal's behalf.

• Directly communicated from principal to agent.
• Can be oral or written.
• Clearly defines the agent's powers.

Memory trick: Agents get their power in different ways, like a secret handshake or a loud command.

A defense to breach of contract where unforeseen circumstances make performance objectively impossible, excusing the performing party.

• Event must be unforeseen and unpreventable.
• Performance must be objectively impossible, not just difficult or expensive.
• Excuses both parties from further performance.

Memory trick: Defend your contract with solid grounds, like an impossible feat.

Rules under the Uniform Commercial Code (UCC) governing how sellers can disclaim or modify implied warranties, such as the warranty of merchantability or fitness for a particular purpose.

• For merchantability, disclaimer must mention 'merchantability' and be conspicuous (if written).
• For fitness for a particular purpose, disclaimer must be in writing and conspicuous.
• Can also be disclaimed by 'as is,' 'with all faults,' or by buyer's examination of goods.

Memory trick: Merchantability needs Mention and Conspicuousness.

A form of bankruptcy that involves a reorganization of a debtor's business affairs, debts, and assets. It allows the business to continue operating while repaying creditors over time under a court-approved plan.

• Primarily for businesses (corporations, LLCs, partnerships).
• Debtor typically remains in possession (DIP).
• Goal is reorganization and continued operation.

Memory trick: Bankruptcy chapters are like different paths to financial recovery.

Circular 230 restricts when practitioners can charge contingent fees, generally prohibiting them for preparing original tax returns.

• Generally prohibited for preparing original or amended tax returns.
• Permitted for services in connection with an IRS examination.
• Permitted for claims for refund/credit solely for statutory interest/penalties.
• Permitted for judicial proceedings under the IRC.

Memory trick: Original returns, no contingent earn; audits, yes, the rules you learn.

A tax position with a 'reasonable basis' (realistic possibility of being sustained) but lacking 'substantial authority' requires disclosure on the tax return to avoid preparer penalties.

• Reasonable basis generally means a >20% chance of success.
• Substantial authority generally means >33% but <50% chance of success.
• If only 'reasonable basis' is met, disclosure on Form 8275 is mandatory for preparers to avoid penalties.
• Disclosure alerts the IRS to the position and potential for controversy.

Memory trick: Reasonable basis, disclose with grace, or penalty you'll face.

Taxpayers and preparers can challenge IRS penalty assessments through an administrative appeals process before resorting to litigation.

• First step is usually an administrative appeal with the IRS Office of Appeals.
• Appeals process allows for independent review within the IRS.
• Can result in resolution without litigation or payment.
• If appeal fails, other options include paying and claiming refund, or litigation.

Memory trick: Appeal to the IRS, before legal stress.

Circular 230 outlines the duties and restrictions for tax practitioners when representing taxpayers before the IRS, including exercising due diligence in preparing tax returns.

• Practitioners must exercise due diligence in preparing and filing tax returns.
• They cannot advise a client to take a frivolous position on a tax return.
• They must inform clients of penalties reasonably likely to apply to tax return positions.

Memory trick: Ethics guide the preparer's path, avoiding IRS wrath.

Circular 230 sets standards for advising on tax return positions, primarily 'more likely than not' (MLTN) and 'reasonable basis'.

• MLTN: >50% chance of being sustained on merits; generally no disclosure needed.
• Substantial Authority: >33% but <50% chance; disclosure may be needed to avoid penalties.
• Reasonable Basis: >20% chance; disclosure always needed to avoid preparer penalties for undisclosed positions.
• Frivolous Position: No reasonable basis; cannot advise.

Memory trick: More Likely Than Not, no disclosure sought.

IRC Sec. 6694(b) imposes significant penalties on tax preparers for understatements due to their willful or reckless conduct in preparing a return.

• Applies when preparer willfully attempts to understate tax liability.
• Also applies to reckless or intentional disregard of rules or regulations.
• Penalty is the greater of $5,000 or 50% of preparer's income from the return.
• This is a more severe penalty than for unreasonable positions without willful/reckless conduct.

Memory trick: Willful act, a hefty tax fact.

A written tax opinion that meets specific Circular 230 standards, primarily used by clients to establish reasonable cause and good faith to avoid accuracy-related penalties.

• Must identify and consider all relevant facts.
• Cannot be based on unreasonable factual or legal assumptions.
• Must relate the applicable law to the relevant facts.
• Must clearly state the conclusion as to the likelihood of success (e.g., 'more likely than not').

Memory trick: Facts must be true, assumptions few, for penalty protection's due.

'Practice before the IRS' includes all matters related to a client's rights, privileges, or liabilities under laws administered by the IRS, including representation, preparing documents, and communicating.

• Includes preparing and filing documents with the IRS.
• Includes communicating with the IRS on behalf of a client.
• Includes representing a client at conferences, hearings, or meetings.
• Suspension prohibits all such activities.

Memory trick: Suspended from IRS, no client's stress relief you bless.

If a practitioner discovers an error or omission on a client's previously filed return, they must inform the client and recommend corrective action.

• Applies to errors or omissions on prior returns.
• Practitioner must promptly advise the client.
• Must inform of potential consequences and recommend corrective measures.
• The decision to amend rests with the client.

Memory trick: Find the old mistake, advise the client's sake.

Circular 230 requires practitioners to assess if responsibilities to a former client materially limit their ability to represent a current client, constituting a conflict of interest.

• A conflict arises if representation is materially limited by responsibilities to a former client.
• Must assess if prior adverse outcomes affect the current 'more likely than not' assessment.
• Requires disclosure to the current client and informed written consent.
• Practitioner must reasonably believe they can still provide competent representation.

Memory trick: Past client's plight, affects current advice's light.

A tax preparer may generally rely in good faith on client-provided information without independent verification, unless there is reason to doubt its accuracy.

• Good faith reliance is a defense against preparer penalties.
• No requirement to audit or verify client data independently.
• Must make reasonable inquiries if information appears incorrect, inconsistent, or incomplete.
• This applies to IRC Sec. 6694 penalties for unreasonable positions.

Memory trick: Good faith reliance, avoids penalty appliance.

Practitioners must exercise due diligence in preparing tax returns, which includes ensuring accuracy even when using tax preparation software, and correcting known errors.

• Cannot rely on software if known to produce incorrect results.
• Responsible for the accuracy of the return, regardless of software use.
• Must override or manually adjust for known software errors.
• Failure to do so violates Circular 230 due diligence requirements.

Memory trick: Software's a tool, but your due diligence rules.

Suspension from practice before the IRS prohibits a practitioner from representing clients, communicating with the IRS on behalf of clients, or advising clients regarding communication with the IRS. It broadly restricts activities that involve direct interaction with the IRS on behalf of others.

• Prohibits representation of clients before the IRS.
• Prohibits communication with the IRS on behalf of clients.
• Prohibits advising clients regarding IRS communications.
• Does not necessarily prohibit preparing returns or general tax advice not involving IRS interaction.

Memory trick: When 'IRS Practice Suspended', 'No Direct Client-IRS Contact'.

If a practitioner becomes aware of an error or omission on a client's previously filed return, they must promptly advise the client of the error and its potential consequences.

• Duty to inform client, not the IRS.
• Client decides whether to amend.
• Must inform of potential penalties.

Memory trick: When an 'Old Error' is found, 'Tell the Client' the truth.

The initial step for a tax preparer to challenge an IRS-assessed penalty (e.g., under IRC Sec. 6694) is usually to request an administrative appeal with the IRS Office of Appeals.

• Administrative appeal is generally the first step.
• Allows for independent review within the IRS.
• Judicial remedies typically follow administrative exhaustion.

Memory trick: When 'IRS Penalizes', 'Appeal First', then Litigate.

Tax practitioners must exercise due diligence in preparing returns, including making reasonable inquiries when client-provided information appears questionable or incomplete.

• Do not ignore implications of information furnished.
• Make reasonable inquiries if information appears incorrect or incomplete.
• Do not verify every item, but question red flags.

Memory trick: Diligent preparers 'Question Red Flags' to ensure accuracy.

When specific, verifiable information (e.g., from a Form 1099) is known to exist but is missing, practitioners must advise clients to obtain the correct information from the source.

• Do not ignore implications of information known to exist.
• Make reasonable inquiries to obtain missing information.
• Advise client to seek official documentation.

Memory trick: When data's missing, 'Seek the Source' for truth.

A practitioner generally has a conflict of interest if there is a significant risk that the representation of one client will be materially limited by the practitioner's responsibilities to a former client, especially concerning confidential information. Such conflicts may require declining or withdrawing from the engagement.

• Significant risk of material limitation is the trigger.
• Confidential information from former client is a key factor.
• Informed written consent from all affected parties is required to proceed, if possible.
• Sometimes the conflict is too severe to be waived, requiring withdrawal.

Memory trick: When 'Client Interests Clash', 'Withdraw if Consent Fails'.

When a corporation liquidates, it generally recognizes gain or loss on the distribution of property as if it sold the property at fair market value.

• Corporation recognizes gain/loss on distributed assets.
• Shareholder recognizes gain/loss on receipt of assets.
• Double taxation can occur (corporate level and shareholder level).

Memory trick: Liquidate and Recognize, Like a Sale, Not a Surprise!

Distributions from a C corporation are taxed in a specific order: first as a dividend to the extent of E&P, then as a return of capital to the extent of stock basis, and finally as a capital gain.

• 1. To extent of E&P: Taxable Dividend.
• 2. To extent of stock basis: Tax-free return of capital.
• 3. Excess over stock basis: Capital Gain.

Memory trick: E&P First, Basis Next, Gain Last!

C corporations treat capital losses differently than individuals, allowing carrybacks and carryforwards to offset capital gains.

• Carryback: 3 years (to offset capital gains).
• Carryforward: 5 years (to offset capital gains).
• Capital losses cannot offset ordinary income for C corps.

Memory trick: Three Back, Five Forward: Corporate Capital Losses, A Tax Game Plan!

Partners can deduct their share of partnership losses only up to certain limitations: basis, at-risk amount, and passive activity rules.

• Basis Limit: Losses cannot exceed partner's adjusted basis.
• At-Risk Limit: Losses cannot exceed partner's at-risk amount.
• Passive Activity Limit: Passive losses can only offset passive income.

Memory trick: Basis First, At-Risk Second, Passive Last: The Loss Deduction Gauntlet!

Distributions from an S corporation are generally tax-free to the extent of the Accumulated Adjustments Account (AAA) and then basis, with any excess treated as capital gain or dividend if E&P exists.

• Distributions first from AAA (tax-free).
• Then from accumulated E&P (taxable dividend).
• Then from basis (tax-free return of capital).
• Finally, excess over basis is capital gain.

Memory trick: AAA, E&P, Basis, Gain: The S Corp Distribution Train!

A corporate tax deduction for dividends received from other domestic corporations, designed to prevent triple taxation of corporate earnings.

• Ownership < 20%: 50% DRD
• Ownership 20% to < 80%: 65% DRD
• Ownership >= 80%: 100% DRD

Memory trick: Don't Double-Dip, Deduct Dividends!

A partner's basis in their partnership interest is adjusted annually to reflect their share of partnership income, losses, contributions, and distributions.

• Basis increases by contributions and share of income/gains.
• Basis decreases by distributions and share of losses/expenses.
• Basis cannot go below zero.

Memory trick: Contributions Add, Distributions Subtract, Income Increases, Losses Decrease.

Not-for-profit organizations classify their net assets based on the existence and nature of donor-imposed restrictions.

• Unrestricted: No donor restrictions.
• Temporarily Restricted: Time or purpose restrictions that expire.
• Permanently Restricted: Restrictions that never expire (e.g., endowments, specific assets).

Memory trick: Un-Temp-Perm: Unrestricted, Temporary, Permanent, that's the NFP asset journey!

In a nonliquidating distribution, a partner takes a basis in distributed property equal to the partnership's basis, limited by the partner's pre-distribution outside basis.

• Partner's basis in property = partnership's basis (inside basis).
• Limited to partner's outside basis (before distribution, reduced by cash).
• Partner's outside basis is reduced by the basis taken in the distributed property.

Memory trick: Non-Liquidating Basis: Partnership's Basis, But Don't Go Over Your Own!

A shareholder's basis in an S corporation is adjusted to reflect contributions, income, losses, and distributions, similar to partnership basis.

• Increases by contributions, ordinary income, separately stated income/gain, tax-exempt income.
• Decreases by distributions, ordinary loss, separately stated loss/deduction, non-deductible expenses.

Memory trick: Shareholders' S-Basis: Contributions Up, Income Up, Losses Down, Distributions Down, Exempt Up!

Taxable income is derived by subtracting above-the-line deductions from gross income to reach AGI, and then subtracting the greater of itemized or standard deduction from AGI.

• Gross Income - Above-the-line Deductions = AGI.
• AGI - (Greater of Standard or Itemized Deductions) = Taxable Income.
• Traditional IRA contributions are an above-the-line deduction.

Memory trick: Gross Income starts the journey; deductions pave the way to taxable money.

C corporations can carry back net capital losses 3 years and carry forward 5 years to offset capital gains.

• Offset only capital gains, not ordinary income
• Carryback first, then carryforward
• Losses are treated as short-term capital losses in the carryback/carryforward year

Memory trick: Capital loss: 3 back, 5 forward, only against capital gains, word for word.

Self-employed individuals must pay both the employer and employee portions of Social Security and Medicare taxes (Self-Employment Tax). One-half of this self-employment tax is deductible as an above-the-line deduction.

• Self-employment tax is calculated on 92.35% of net earnings from self-employment.
• The tax rate is 15.3% (12.4% Social Security, 2.9% Medicare).
• There is an annual wage base limit for the Social Security portion.
• One-half of the self-employment tax paid is deductible on Schedule 1 of Form 1040.

Memory trick: Self-employment tax: 92.35% of income, then 15.3% tax, then HALF for the deduction.

The cost basis of property is generally its purchase price plus any expenses incurred to acquire and prepare the property for its intended use.

• Includes purchase price
• Includes acquisition costs (e.g., legal fees, surveying fees)
• Does not include current period operating expenses (e.g., annual property taxes)

Memory trick: Basis is the 'Cost-Plus' to get it Ready.

A portion of Social Security benefits may be included in gross income depending on the taxpayer's 'provisional income' and filing status.

• Provisional income = AGI (excluding SS benefits) + tax-exempt interest + 50% of SS benefits.
• For single filers, thresholds are $25,000 and $34,000.
• Up to 50% or 85% of benefits can be taxable.

Memory trick: Provisional Income is the key to unlock your SS tax.

Net Assets without Donor Restrictions include contributions and other resources that are not subject to donor-imposed stipulations.

• Used for general operations or board-designated purposes
• Formerly called 'Unrestricted Net Assets'
• Reflects resources available for current use without external constraint

Memory trick: NFP's asset pie: no strings, or with strings, for all to see.

Gross income includes all income from whatever source derived, unless specifically excluded by law.

• Unemployment compensation is fully taxable.
• Gambling winnings (including lottery prizes) are fully taxable.
• Capital gains are generally taxable.

Memory trick: Many sources of cash flow into your taxable bucket.

Gross income for federal income tax purposes includes all income from whatever source derived, unless specifically excluded by law.

• Includes wages, salaries, business income, interest, dividends, rents, royalties.
• Excludes certain items like municipal bond interest, gifts, inheritances, and some fringe benefits.
• It is the starting point for calculating taxable income.

Memory trick: Gross Income is your 'total take' before exclusions, like a money funnel.

Qualified medical expenses are deductible only to the extent they exceed 7.5% of the taxpayer's Adjusted Gross Income (AGI).

• Deduction is an itemized deduction.
• Only 'qualified' medical expenses count.
• The AGI threshold is 7.5% for all taxpayers (as of current law).

Memory trick: Medical expenses hurt, but AGI threshold can reduce the tax sting.

A depreciation convention under MACRS that assumes all property placed in service or disposed of during a tax year was placed in service or disposed of at the midpoint of that year, regardless of the actual date.

• Applies to most personal property.
• Results in half of a full year's depreciation in the first and last year.
• Built into MACRS depreciation tables.
• Mid-quarter convention applies if more than 40% of property is placed in service in Q4.

Memory trick: MACRS is 'MA'gical 'C'alculations 'R'educe 'S'ales.