16 Regulation (REG) Practice Questions & Answers

1. 1. How does a tax credit differ from a tax deduction in reducing a taxpayer's federal income tax liability?

   • A.A credit reduces taxable income, while a deduction reduces the tax owed dollar-for-dollar
   • B.Both reduce the tax owed dollar-for-dollar, but only credits are refundable
   • C.A credit reduces the tax owed dollar-for-dollar, while a deduction reduces taxable income✓ Answer
   • D.Both reduce taxable income, but a credit does so at a higher rate

   A deduction lowers the amount of income subject to tax, so its benefit equals the deduction multiplied by the taxpayer's marginal rate. A credit is applied directly against the computed tax, reducing it dollar-for-dollar, which generally makes a credit more valuable than a deduction of the same amount.

   Source: IRC concepts; AICPA REG Blueprint, Area II (federal taxation of individuals)Report a problem with this question

2. 2. For federal income tax purposes, which characteristic distinguishes a capital gain from ordinary income?

   • A.Capital gain includes interest and dividends earned during the year
   • B.Ordinary income is exempt from tax while capital gain is fully taxable
   • C.Capital gain arises from the sale or exchange of a capital asset, whereas ordinary income arises from routine sources such as wages and business operations✓ Answer
   • D.Capital gain is always taxed at a higher rate than ordinary income

   A capital gain results from the sale or exchange of a capital asset, while ordinary income comes from everyday sources like compensation and business profits. This character distinction matters because long-term capital gains are generally taxed at preferential rates lower than those on ordinary income, not higher.

   Source: IRC §1221 (capital asset definition); §1(h) (preferential rates)Report a problem with this question

3. 3. What does a taxpayer's 'basis' in property generally represent for federal income tax purposes?

   • A.The total rental income the property has generated
   • B.The property's insured replacement cost
   • C.The taxpayer's investment in the property used to measure gain or loss on disposition✓ Answer
   • D.The property's current fair market value on the last day of the tax year

   Basis is generally the taxpayer's investment in property (often original cost), adjusted over time for items such as improvements and depreciation. It is the reference point subtracted from the amount realized to compute gain or loss when the property is sold or otherwise disposed of.

   Source: IRC §1011–1012 (adjusted basis / cost basis)Report a problem with this question

4. 4. Which statement best describes the key difference between the taxation of a C corporation and a pass-through entity such as an S corporation or partnership?

   • A.A pass-through entity pays entity-level income tax, and its owners pay again on distributions
   • B.Both C corporations and pass-through entities are exempt from all federal income tax
   • C.A C corporation's income is taxed only once at the shareholder level
   • D.A C corporation's income is taxed at the entity level and again when distributed as dividends, while pass-through income is generally taxed only once at the owner level✓ Answer

   A C corporation is a separate taxable entity: it pays corporate income tax, and shareholders are taxed again when earnings are distributed as dividends, producing 'double taxation.' A pass-through entity generally pays no entity-level income tax; its income flows through to owners and is taxed once on their returns.

   Source: Subchapter C vs. Subchapter K/S; IRC §11, §701, §1363Report a problem with this question

5. 5. Filing status for a U.S. individual income tax return is generally determined as of what point in time?

   • A.The taxpayer's marital status on the last day of the tax year✓ Answer
   • B.The average of the taxpayer's status across all twelve months
   • C.The taxpayer's marital status on the first day of the tax year
   • D.The date the return is actually filed

   Marital status for filing purposes is generally determined on the last day of the tax year; a taxpayer married on December 31 is treated as married for the entire year. A special rule treats a taxpayer whose spouse died during the year as married for that year.

   Source: IRC §7703(a) (determination of marital status)Report a problem with this question

6. 6. Under general contract law, which set of elements is required to form a valid, enforceable contract?

   • A.Only an offer and the intent of one party
   • B.A written document and a notary seal in all cases
   • C.Payment of money by both parties
   • D.Offer, acceptance, and consideration, with mutual assent and capacity✓ Answer

   A contract requires an offer, acceptance of that offer, and consideration (a bargained-for exchange of value), together with mutual assent and the legal capacity of the parties. A writing is required only for certain contracts under the Statute of Frauds, not for every enforceable contract.

   Source: Restatement (Second) of Contracts §17, §71; AICPA REG Blueprint, Area I (business law)Report a problem with this question

7. 7. In an agency relationship, when does a principal become bound by a contract that the agent enters with a third party?

   • A.Never, because agents cannot bind principals
   • B.Only if the principal personally signs the contract
   • C.Only when the third party is also an agent of the principal
   • D.When the agent acts within the scope of actual or apparent authority✓ Answer

   A principal is bound when the agent acts within actual authority (expressly or impliedly granted) or apparent authority (created by the principal's conduct leading the third party to reasonably believe authority exists). The whole purpose of agency is that an authorized agent's acts bind the principal, so the principal need not sign personally.

   Source: Restatement (Third) of Agency §2.01–2.03 (actual and apparent authority)Report a problem with this question

8. 8. Which characteristic most clearly distinguishes a general partnership from a corporation with respect to owner liability?

   • A.Both general partners and shareholders are always jointly liable for entity debts
   • B.General partners are personally liable for partnership obligations, while corporate shareholders generally have liability limited to their investment✓ Answer
   • C.General partners have limited liability, while corporate shareholders are personally liable for all debts
   • D.Neither general partners nor shareholders have any liability for entity debts

   In a general partnership, partners are personally liable for the partnership's obligations, so creditors can reach their personal assets. A corporation is a separate legal entity that shields shareholders, whose loss is generally limited to the amount they invested.

   Source: Uniform Partnership Act §306; Model Business Corporation Act §6.22 (limited shareholder liability)Report a problem with this question

9. 9. Circular 230 governs practice before the Internal Revenue Service. Who is subject to its rules?

   • A.Only taxpayers who owe a balance to the IRS
   • B.Practitioners such as CPAs, attorneys, and enrolled agents who practice before the IRS✓ Answer
   • C.Only attorneys who have never practiced tax law
   • D.Only foreign accountants preparing U.S. returns

   Circular 230 sets the standards of practice for those authorized to represent taxpayers before the IRS, including CPAs, attorneys, enrolled agents, and enrolled actuaries. It establishes duties and prohibited conduct, and violations can lead to censure, suspension, or disbarment from practice before the IRS.

   Source: Treasury Department Circular No. 230, §10.0 (scope) / §10.3 (who may practice)Report a problem with this question

10. 10. Under Circular 230, what is a tax practitioner's obligation upon learning that a client has not complied with the tax laws or made an error on a return?

    • A.Promptly advise the client of the noncompliance, error, or omission and its potential consequences✓ Answer
    • B.Ignore the error because the client is responsible for the return
    • C.Immediately notify the IRS of the client's error without telling the client
    • D.Correct the return and file it without informing the client

    Circular 230 requires a practitioner who knows a client has not complied or has made an error or omission to promptly advise the client of it and of the consequences of that noncompliance. The practitioner is not required to notify the IRS and must respect client confidentiality, so the duty is to inform the client.

    Source: Treasury Department Circular No. 230, §10.21 (knowledge of client's omission)Report a problem with this question

11. 11. Which of the following is a hallmark of a limited liability company (LLC) as a business entity?

    • A.Its members are always personally liable for all company debts
    • B.It is automatically taxed as a C corporation with no other option
    • C.It can never have more than one owner
    • D.It combines limited liability for its members with flexibility in how it is taxed✓ Answer

    An LLC gives its members limited liability similar to a corporation while allowing flexible federal tax treatment: under the check-the-box rules an LLC can be taxed as a disregarded entity, a partnership, or a corporation. This blend of liability protection and tax flexibility is its defining feature.

    Source: State LLC statutes; Treas. Reg. §301.7701-3 (check-the-box classification)Report a problem with this question

12. 12. How is a taxpayer's gain or loss on the sale of property calculated for federal income tax purposes?

    • A.Fair market value plus the property's adjusted basis
    • B.Adjusted basis minus the original purchase price
    • C.Selling price multiplied by the taxpayer's marginal rate
    • D.Amount realized minus the property's adjusted basis✓ Answer

    Realized gain or loss equals the amount realized (cash plus the fair market value of other property received, net of selling costs) minus the property's adjusted basis. A positive result is a gain and a negative result is a loss, and this realized amount is then subject to recognition rules.

    Source: IRC §1001(a) (computation of gain or loss)Report a problem with this question

13. 13. A CPA preparing a tax return signs it as the paid preparer. Under professional standards, what does this signature affirm?

    • A.That the CPA personally guarantees the IRS will accept every position
    • B.That the return was prepared with due diligence and the preparer has a reasonable basis for the positions taken✓ Answer
    • C.That the CPA will pay any tax the client owes
    • D.That the client, not the preparer, is solely responsible for the return's accuracy

    By signing as paid preparer, a CPA attests that the return was prepared with due diligence and that positions taken meet the applicable reporting standards, generally requiring at least a reasonable basis (with disclosure) or substantial authority. The signature does not guarantee IRS acceptance nor make the CPA liable for the client's tax.

    Source: IRC §6694 (preparer standards); Circular 230 §10.34; AICPA SSTS No. 1Report a problem with this question

14. 14. A father gifts stock to his daughter. At the date of the gift, the donor's adjusted basis is $10,000 and the fair market value (FMV) is $7,000. The daughter later sells the stock. Which basis does she use to compute her result?

    • A.FMV at date of gift for a gain; donor's basis for a loss
    • B.Always the FMV of $7,000 at the date of the gift
    • C.Always the donor's carryover basis of $10,000
    • D.Donor's basis for a gain; FMV at date of gift for a loss✓ Answer

    When gifted property's FMV is below the donor's adjusted basis, a dual-basis rule applies: gain is figured using the donor's carryover basis, while loss is figured using the lower FMV at the date of the gift. This prevents the donee from claiming a built-in loss that economically belonged to the donor, and it can produce a sale price (between $7,000 and $10,000) yielding neither gain nor loss.

    Source: IRC §1015(a); IRS Publication 551 (Basis of Property), gifted property dual-basis ruleReport a problem with this question

15. 15. Under current federal law following the Tax Cuts and Jobs Act, which of the following can still qualify for tax-deferred like-kind exchange treatment under IRC §1031?

    • A.A fleet of delivery trucks exchanged for newer trucks
    • B.Machinery and equipment used in a factory exchanged for similar equipment
    • C.Real property held for investment exchanged for other real property held for productive use in a business✓ Answer
    • D.Corporate stock exchanged for stock in another company

    The Tax Cuts and Jobs Act limited §1031 like-kind exchange treatment to real property held for productive use in a trade or business or for investment. Personal property (trucks, machinery, equipment) and intangibles no longer qualify, and stocks and securities were always statutorily excluded from §1031.

    Source: IRC §1031(a), as amended by the Tax Cuts and Jobs Act (real property only); §1031(a)(2) excludes stock and securitiesReport a problem with this question

16. 16. Under UCC Article 9, a security interest in collateral is enforceable against the debtor (i.e., it attaches) only when all three of which conditions are met?

    • A.The debtor is solvent, the loan is recorded with the state, and a guarantor co-signs
    • B.The collateral is appraised, insured, and physically delivered to the secured party
    • C.A financing statement is filed, notice is published, and the debtor signs a promissory note
    • D.Value is given, the debtor has rights in the collateral, and there is an authenticated security agreement (or the secured party has possession/control)✓ Answer

    Attachment under UCC §9-203 requires three concurrent elements: (1) value has been given by the secured party, (2) the debtor has rights in the collateral, and (3) the debtor has authenticated a security agreement describing the collateral (unless the secured party has possession or control). Attachment makes the interest enforceable between the parties; filing a financing statement instead governs perfection against third parties.

    Source: UCC §9-203(b) (attachment requirements: value, rights in collateral, authenticated security agreement)Report a problem with this question

Concept-focused practice questions based on the AICPA CPA Exam Blueprints. Not affiliated with the AICPA or NASBA, and not accounting, tax, or legal advice. Specific dollar thresholds change yearly — confirm current figures with authoritative sources. About the CPA Exam →