Tax Law Practice Exam Questions

1. 1.Salary ($150,000): Gross income under IRC Section 61. Fully taxable as compensation for services.
2. 2.Book advance ($20,000): Taxable in the year received under the claim of right doctrine (cash method). Even though the book is unwritten, the professor has an unrestricted claim to the payment.
3. 3.Personal injury settlement ($10,000): Excluded from gross income under IRC Section 104(a)(2) because it compensates for physical injuries. If any portion compensates for emotional distress not attributable to physical injury, that portion is taxable.
4. 4.Bitcoin gift ($5,000): Gifts are excluded from the recipient's gross income under IRC Section 102. However, if the Bitcoin is a tip or payment for services (even if labeled a gift), it is taxable as compensation.
5. 5.Parking space ($3,000): Qualified transportation fringe benefit under IRC Section 132(f). Excludable up to the statutory limit ($315/month in 2024). If the $3,000/year ($250/month) is under the limit, it is fully excludable.

1. 1.C corporation: Entity-level tax at 21% ($63,000). Distributions taxed again as qualified dividends (20% + 3.8% NIIT for high earners). Double taxation results in effective rate of approximately 39.8% on distributed income.
2. 2.S corporation: Pass-through entity. Income taxed only at the individual level. Owners who work in the business must pay themselves reasonable compensation (subject to payroll taxes). Remaining distributions avoid self-employment tax. Potential 20% Section 199A deduction.
3. 3.Partnership/LLC: Pass-through entity. All income subject to self-employment tax for active partners (15.3% on first $168,600, 2.9% + 0.9% above). Section 199A deduction available for qualified business income.
4. 4.Recommendation: For $300,000 in income, the S corporation likely provides the best balance -- avoiding double taxation while reducing self-employment tax through the salary/distribution split. The Section 199A deduction further reduces the effective rate.

Correct Answer: B

Under IRC Section 104(a)(2), damages received on account of personal physical injuries are excluded from gross income. The $20,000 for physical injuries is excluded. However, the $30,000 for lost wages is taxable as it compensates for income that would have been taxable if earned. Lost wages are included in gross income even when received through a lawsuit.

Correct Answer: B

When a taxpayer donates long-term capital gain property (held more than one year) to a qualified public charity, the deduction is the fair market value of the property ($10,000). The taxpayer does not recognize the $8,000 in unrealized capital gain. This is one of the significant tax benefits of donating appreciated property -- the taxpayer gets a deduction for the full FMV while avoiding capital gains tax.

Correct Answer: B

Under the constructive receipt doctrine (Treas. Reg. Section 1.451-2), income is taxable when it is made available to the taxpayer without substantial limitations or restrictions, even if not actually reduced to possession. Receiving a check constitutes constructive receipt because the taxpayer had the ability to deposit or cash the check. The delay in depositing does not defer the income to the following year.