CPA Regulation Reg Quiz: Apply Formation And Termination Rules

What this quiz covers

This quiz focuses on Apply Formation And Termination Rules, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA Regulation Reg.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

Question 1

1. $0, because the transfer qualifies under Section 351.
2. $60,000, the full realized gain.
3. $10,000, the amount of boot received. (correct answer)
4. $50,000, the difference between the stock received and the adjusted basis.

Explanation: Under Section 351(b), when a transferor receives boot (cash or property other than stock) in addition to stock, gain is recognized to the extent of the lesser of (1) realized gain or (2) boot received. Petra's realized gain = $100,000 FMV -$40,000 basis = $60,000. Boot received =$10,000 cash. Recognized gain = lesser of $60,000 or$10,000 = $10,000. Answer A is incorrect because receipt of boot triggers partial gain recognition. Answer B ($60,000) would be the recognized gain only if boot received equaled or exceeded the full realized gain. Answer D ($50,000) has no valid basis in the Section 351(b) computation.

Question 2

1. $0, because Section 721 provides nonrecognition for contributions to a partnership. (correct answer)
2. $50,000, the full amount of built-in gain.
3. $20,000, representing 25% of the total built-in gain allocated to the contributing partner.
4. $12,500, representing the fair market value of the interest received times the gain percentage.

Explanation: Section 721 provides that no gain or loss is recognized by a partner upon contribution of property to a partnership in exchange for a partnership interest, except in certain limited circumstances such as disguised sales or contribution of services. The contributing partner's basis in the partnership interest equals the adjusted basis of the contributed property ($30,000) under Section 722, and the partnership takes a carryover basis in the property under Section 723. Answer B is incorrect because the built-in gain is deferred, not recognized, on formation. Answer C is incorrect because Section 721 nonrecognition is not limited to a percentage; no gain is recognized. Answer D is incorrect for the same reason; the entire built-in gain is deferred under Section 721.

Question 3

1. The $200,000 is treated as ordinary income in full.
2. The $120,000 gain is treated as a dividend to the extent of corporate earnings and profits.
3. The $120,000 gain is treated as capital gain from the sale or exchange of the stock. (correct answer)
4. No gain is recognized because liquidating distributions are tax-free returns of capital.

Explanation: Under Section 331, amounts received by a shareholder in a complete liquidation of a corporation are treated as full payment in exchange for the shareholder's stock. The shareholder recognizes gain or loss equal to the difference between the fair market value of property received and the adjusted basis of the stock. Here, the $120,000 gain ($200,000 - $80,000) is capital gain. Answer A is incorrect because Section 331 provides sale-or-exchange treatment, resulting in capital gain rather than ordinary income. Answer B is incorrect because the dividend rules apply to non-liquidating distributions; Section 331 expressly overrides the dividend rules for complete liquidations. Answer D is incorrect because gain is recognized to the extent proceeds exceed stock basis; only the return of basis portion ($80,000) is tax-free.

Question 4

1. $150,000
2. $110,000 (correct answer)
3. $90,000
4. $60,000

Explanation: Under Section 331, the shareholder treats the liquidating distribution as proceeds from the sale of stock. The amount realized equals the fair market value of the property received ($150,000). Gain =$150,000 - $40,000 stock basis =$110,000. Answer B is correct. Answer A ($150,000) ignores the shareholder's stock basis entirely. Answer C ($90,000) has no valid basis in the computation. Answer D ($60,000) is the corporate-level adjusted basis in the distributed property, which is irrelevant to the shareholder's Section 331 gain calculation.

Question 5

1. $70,000 (correct answer)
2. $85,000
3. $50,000
4. $35,000

Explanation: Under Section 722, the basis of a partner's interest acquired by contribution equals the sum of money contributed plus the adjusted basis of any property contributed. Cash contribution = $50,000; property basis =$20,000; total basis = $70,000. The fair market value of the contributed property is irrelevant to the partner's outside basis calculation. Answer B ($85,000) incorrectly substitutes the FMV of the property ($35,000) for its adjusted basis. Answer C ($50,000) counts only the cash and ignores the property contribution entirely. Answer D ($35,000) uses only the property's FMV and ignores the cash contribution.

Question 6

1. The general partner dies and no successor is named within 90 days.
2. The partnership files for Chapter 11 bankruptcy reorganization.
3. A partner's interest is reduced below 10% due to admission of new partners.
4. No part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners. (correct answer)

Explanation: Under Section 708(b)(1)(A), a partnership is terminated when no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership. This is the cessation-of-business termination, distinct from the now-repealed technical termination. Answer A is incorrect because the death of a general partner does not automatically terminate the partnership for tax purposes; state law governs dissolution, but the tax partnership may continue if it is not wound up. Answer B is incorrect because a bankruptcy filing does not terminate the tax partnership. Answer C is incorrect because dilution of a partner's interest through admission of new partners does not cause a termination under Section 708.

Question 7

1. $350,000
2. $270,000 (correct answer)
3. $150,000
4. $430,000

Explanation: Under Section 331, the shareholder's amount realized equals the fair market value of property received minus any liabilities assumed by the shareholder. When encumbered property is distributed, the shareholder takes the property subject to the existing mortgage. Amount realized = $350,000 -$80,000 = $270,000. The shareholder then computes gain by comparing$270,000 to the stock basis. Answer B is correct. Answer A ($350,000) ignores the mortgage reduction to amount realized. Answer C ($150,000) would result from subtracting the corporate basis ($200,000) from FMV ($350,000), which is not the correct computation. Answer D ($430,000) incorrectly adds the mortgage rather than subtracting it.

Question 8

1. $95,000
2. $25,000
3. $85,500
4. $70,000 (correct answer)

Explanation: Under Section 358(a), the transferor's basis in stock received in a Section 351 exchange equals the adjusted basis of the property transferred, decreased by any money received or liabilities assumed, and increased by any gain recognized. Since no boot was received and no gain was recognized, Dunmore's basis in the Newco stock = $70,000 (the adjusted basis of the property transferred). Answer A ($95,000) is the FMV of the stock received and would apply only if gain were fully recognized. Answer B ($25,000) represents the unrealized appreciation, not the stock basis. Answer C ($85,500) represents 90% of the FMV, which has no basis in Section 358.

Question 9

1. When the S corporation fails to file a timely tax return for two consecutive years.
2. When a majority of the S corporation's shareholders consent to revoke the election. (correct answer)
3. When the S corporation has a net operating loss for the current year.
4. When fewer than 50% of shareholders vote to revoke the election at the annual meeting.

Explanation: Under Section 1362(d)(1), an S election may be revoked voluntarily if shareholders holding a majority of shares (more than 50%) consent to the revocation. The revocation may be effective immediately, prospectively, or at the beginning of the following tax year, depending on when it is filed. Answer A is incorrect because failure to file returns does not constitute a voluntary revocation; it may cause other penalties but not an automatic election termination. Answer C is incorrect because net operating losses have no effect on S election status. Answer D is incorrect because revocation requires the consent of shareholders holding more than 50% of shares, not fewer than 50%.

Question 10

1. Vesper must have no more than 150 shareholders at the time of election.
2. Vesper must distribute all accumulated earnings and profits before the S election is effective.
3. Vesper must convert to a calendar tax year ending December 31 before the election is effective.
4. Vesper must obtain consent of all shareholders who held stock at any time during the portion of the year before the election. (correct answer)

Explanation: Under Section 1362, an S election must be consented to by all persons who are shareholders on the date the election is made. If the election is to be effective for the entire current tax year, it must also be consented to by all shareholders who held stock during the portion of the taxable year before the election date. Answer D is correct. Answer A is incorrect because the S corporation shareholder limit is 100, not 150. Answer B is incorrect because accumulated C corporation E&P does not have to be distributed before the S election; it remains as C corporation E&P and is subject to built-in gains and passive income rules after conversion. Answer C is incorrect because an S corporation must use a permitted tax year, but conversion to a calendar year is not a prerequisite for the election itself.

Question 11

1. Renata recognizes $30,000 of ordinary income to the extent of her share of unrealized receivables and inventory items, with any remainder as capital gain.
2. Renata recognizes $30,000 of capital gain on the sale of her partnership interest. (correct answer)
3. Renata's gain is tax-free because she contributed the original capital.
4. Renata recognizes $80,000 of ordinary income because the sale of a partnership interest is always ordinary.

Explanation: Renata's outside basis = $50,000 (original cash contribution, adjusted for her share of income, losses, and distributions over two years, but assuming basis remains at$50,000 for this problem). Gain on sale = $80,000 -$50,000 = $30,000. Under Section 741, the gain on sale of a partnership interest is generally treated as capital gain. However, under Section 751 (hot assets), gain attributable to unrealized receivables and substantially appreciated inventory is recharacterized as ordinary income. Answer A correctly identifies the Section 751 hot asset rule, but the question stem does not specify that hot assets exist, so Answer B (pure capital gain) is the default treatment absent hot assets. Answer C is incorrect because gain is recognized on the sale. Answer D is incorrect because partnership interest sales are generally capital, not ordinary.

Question 12

1. $0
2. $20,000 (correct answer)
3. $50,000
4. $90,000

Explanation: Under Section 731(a), a partner recognizes gain on a liquidating distribution only to the extent that money distributed exceeds the partner's outside basis. Partner A receives $90,000 cash and has an outside basis of$70,000. Gain recognized = $90,000 -$70,000 = $20,000, typically characterized as capital gain. Answer B is correct. Answer A ($0) would apply only if cash did not exceed outside basis. Answer C ($50,000) has no valid basis in the Section 731 computation. Answer D ($90,000) ignores the outside basis offset entirely.

Question 13

1. The subsidiary recognizes gain but not loss on appreciated property distributed.
2. The subsidiary recognizes gain and loss on all property distributed, as in an arm's-length sale.
3. The subsidiary recognizes neither gain nor loss on distributions to the parent in a qualifying Section 332 liquidation. (correct answer)
4. The subsidiary recognizes gain only on property distributed to minority shareholders.

Explanation: Under Section 337(a), no gain or loss is recognized by a subsidiary on the distribution of property to its 80%-or-more parent in a liquidation qualifying under Section 332. The subsidiary distributes to the parent without triggering gain or loss at the corporate level. Answer C is correct. Answer A is incorrect because the subsidiary recognizes no gain on distributions to the parent - not gain-but-not-loss. Answer B is incorrect; distributions to the parent do not produce arm's-length gain recognition. Answer D partially describes the overall Section 337 framework - the subsidiary does recognize gain on distributions to minority shareholders - but the stem asks specifically about distributions to the parent, for which no gain or loss is recognized.

Question 14

1. $120,000, the fair market value of the stock.
2. $85,000, the average of basis and fair market value.
3. $70,000, the amount of deferred gain.
4. $50,000, the adjusted basis of the property transferred. (correct answer)

Explanation: Under Section 358, when a shareholder transfers property in a qualifying Section 351 exchange, the shareholder's basis in the stock received equals the adjusted basis of the property transferred, decreased by any boot received and increased by any gain recognized. Since no boot was received and no gain was recognized, Marlow's stock basis = $50,000 (the adjusted basis of the property transferred). Answer D is correct. Answer A ($120,000) is the FMV of the stock received and would apply only if gain had been fully recognized. Answer B ($85,000) has no basis in the Section 358 formula. Answer C ($70,000) represents the deferred gain, not the stock basis.

Question 15

1. The parent recognizes no gain or loss on the receipt of the liquidating distribution from the subsidiary. (correct answer)
2. The parent recognizes gain equal to the fair market value of assets received in excess of its basis in the subsidiary stock.
3. The parent recognizes a loss if the fair market value of assets received is less than its basis in the subsidiary stock.
4. The parent treats the liquidating distribution as a dividend to the extent of the subsidiary's earnings and profits.

Explanation: Section 332 provides that no gain or loss is recognized by a parent corporation when it receives property in complete liquidation of a subsidiary, provided the parent owns at least 80% of the subsidiary's voting stock and total share value throughout the liquidation period. The parent takes a carryover basis in the subsidiary's assets under Section 334(b). Answer B is incorrect because Section 332 specifically provides nonrecognition of gain to the parent. Answer C is incorrect because Section 332 also disallows recognition of loss by the parent; losses on subsidiary liquidations are deferred or permanently disallowed. Answer D is incorrect because Section 332 liquidations are not treated as dividend distributions; they receive special nonrecognition treatment.

Question 16

1. The stock received for services is excluded from gross income if the transferor also contributes property in the same exchange.
2. The stock received for services is treated as boot and is taxable as capital gain.
3. The stock received for services is excluded from the Section 351 exchange but the property contributors may still qualify if they meet the control requirement without counting the service contributor. (correct answer)
4. The stock received for services is nontaxable if the corporation is newly formed and the service contributor becomes a majority shareholder.

Explanation: Under Section 351 and its regulations, a person who transfers only services to a corporation does not qualify for nonrecognition - the stock received for services is taxable as ordinary compensation income. For purposes of the 80% control test, service-only contributors are excluded from the Section 351 group; property contributors must independently satisfy the control requirement without counting the service contributor. Answer C is correct. Answer A is incorrect because stock received for services is still taxable as ordinary income even when the contributor also transfers property in the same exchange. Answer B is incorrect because service income is ordinary income, not capital gain. Answer D is incorrect; neither new formation nor majority-shareholder status exempts the service contributor from ordinary income recognition.

Question 17

1. The S corporation reports a net operating loss for three consecutive years.
2. A majority shareholder transfers shares to the shareholder's U.S. citizen spouse pursuant to a divorce proceeding.
3. The S corporation has passive investment income exceeding 25% of gross receipts for three consecutive years while it has accumulated C corporation earnings and profits. (correct answer)
4. The S corporation fails to make a timely payroll tax deposit for one quarter.

Explanation: Under Section 1362(d)(3), an S corporation's election is terminated if it has accumulated earnings and profits from C corporation years and has passive investment income exceeding 25% of gross receipts for three consecutive tax years. The termination is effective at the start of the tax year following the third consecutive year. Answer C is correct. Answer A is incorrect because net operating losses do not cause S election termination. Answer B is incorrect because a transfer to an eligible individual shareholder - such as a U.S. citizen spouse - does not trigger S election termination; the spouse is an eligible shareholder under Section 1361. Answer D is incorrect because payroll tax compliance issues do not affect S election status.

Question 18

1. $55,000 (correct answer)
2. $100,000
3. $40,000
4. $120,000

Explanation: When a partner contributes property subject to a liability, the partner's outside basis is computed as follows: start with the adjusted basis of contributed property ($100,000), decrease by the liability transferred to the partnership ($60,000), and increase by the partner's share of the assumed liability ($15,000). Outside basis =$100,000 - $60,000 +$15,000 = $55,000. Answer B ($100,000) ignores the liability entirely. Answer C ($40,000) would result from$100,000 - $60,000 with no addback for the partner's share. Answer D ($120,000) incorrectly adds both the FMV and some adjustment rather than working from adjusted basis and liability adjustments.

Question 19

1. The transferring shareholders must receive only common stock in the exchange.
2. The property transferred must have a fair market value greater than its adjusted basis.
3. Immediately after the exchange, the transferring shareholders must be in control of the corporation, defined as owning at least 80% of total combined voting power and 80% of total shares of each class of nonvoting stock. (correct answer)
4. The corporation must be newly formed at the time of the transfer.

Explanation: Section 351 nonrecognition applies when property is transferred to a corporation solely in exchange for stock, and immediately after the exchange, the transferring shareholders are in control of the corporation. Control means owning at least 80% of total combined voting power of all classes of voting stock and at least 80% of total shares of each class of nonvoting stock. Answer A is incorrect because shareholders may receive preferred stock as well as common stock and still qualify, as long as no boot is received. Answer B is incorrect because Section 351 applies regardless of whether the property has a built-in gain or loss. Answer D is incorrect because Section 351 applies to transfers to both new and existing corporations, provided the control requirement is met immediately after the exchange.

Question 20

1. A grantor trust whose sole grantor is a U.S. citizen.
2. A nonresident alien individual. (correct answer)
3. An estate of a deceased U.S. citizen shareholder.
4. A qualified Subchapter S trust (QSST) that has made a valid QSST election.

Explanation: Under Section 1361(b)(1), an S corporation may not have a nonresident alien as a shareholder. If a nonresident alien acquires stock in an S corporation, the S election is immediately terminated. Answer A is incorrect because a grantor trust whose grantor is a U.S. citizen is an eligible S corporation shareholder under Section 1361(c)(2). Answer C is incorrect because the estate of a deceased U.S. shareholder is an eligible shareholder and may hold S corporation stock during the administration of the estate. Answer D is incorrect because a QSST that has filed a valid election under Section 1361(d) is an eligible S corporation shareholder.