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REG CPA Practice Questions: Partnership Ordinary Income and Separately Stated Items
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May 3, 2024
In this video, we walk through 5 REG CPA exam practice questions teaching how to calculate Partnership ordinary business income and separately stated items. Important Links Link to the free study training webinar mentioned in the video: https://www.superfastcpa.com/strategic-study See the full post for this video: https://www.superfastcpa.com/reg-cpa-practice-questions-explained-how-to-calculate-partnership-ordinary-business-income-and-separately-stated-items/ See the other REG walkthrough videos here: https://www.superfastcpa.com/free-reg-cpa-practice-question-walkthroughs/ 00:00 Intro 00:51 Question 1: Calculating Partnership Ordinary Income 03:02 Question 2: Determining Separately Stated Items 05:05 Question 3: Guaranteed Payments 06:51 Question 4: What Is Considered a Guaranteed Payment 08:09 Question 5: Putting It All Together 09:52 Pillar Topics
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Welcome to another reg walkthrough video. I'm Logan, and in today's video, we're going to be going over partnership, ordinary income, and separately stated items
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And we're going to be doing that, the Superfast CPA way, which is diving straight into questions to learn the material
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If you don't know much about our strategies, make sure you go to superfast CPA.com and check out our free one-hour training webinar
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We go over the key ingredients to passing the CPA exam. Again, it's one hour, it is free, and it will save you so much time struggling with your study process
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It's definitely worth checking out. Make sure you go do that. The link will be in the description of this video
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Also, if you like the idea of going through questions to learn the material, make sure you
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check out our super fast CPA app where we not only have audio notes and review notes and
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follow-along notes, but we also have five-question mini quizzes that you can easily access
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on your phone all throughout your day to continue practicing. With that said, let's dive straight into the questions
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All right, here is question one. In the current fiscal year, a partnership has reported the following items
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fees earned of $700,000, salary expense, $150,000, rent expense $50,000, charitable contributions, $12,000
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dividend income $5,000, short-term capital gain, $3,000, and office supplies of $2,000
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We need to calculate the partnership's ordinary income for the year. Which of the following options is correct
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All right, if you don't really know what ordinary income is for a partnership, or also if you haven't seen the video on S-corporation ordinary income, that's okay
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let's go ahead and go straight into the answer to learn how this works. Okay, and the answer is $498,000
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The partnership's ordinary income is primarily calculated by subtracting the allowable expenses from the business earnings
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excluding items like charitable contributions and capital gains, which are separately stated and not included in ordinary income calculations
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Here's how it's done. So we would take the fees earned, less the salary expense, less the rent expense
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less the office supplies, and that would give you an ordinary income of $498,000
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Ordinary income for a partnership encompasses all revenue generated through the ordinary business activities of the partnership, minus any allowable business expenses
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This typically includes earnings such as fees from services rendered, sales revenue, and income from routine business operations
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From these revenues, allowable expenses like salaries, rent, utilities, and office supplies are deducted
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However, certain items such as capital gains, dividends, and charitable contributions do not count towards ordinary income
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They are treated separately on tax returns due to their distinct tax implications and are reported in different sections of the partnership's financial disclosures
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This distinction ensures that each partner's share of the income and expenses is correctly reflected for tax purposes, taking into account their potential differences in tax liabilities and benefits
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Essentially ordinary business income is most of the stuff that you would think of when you think of business income you know normal revenue salaries normal expenses things like that But there are separately stated items that we will get into here in a second that are not included in the calculation of ordinary business income
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All right, let's go ahead and go to the next question. All right, here is question two. For the fiscal year ending, a partnership has reported the following items on its financial statements
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Net profit from operations of $600,000, interest income of $10,000, long-term capital gain of $20,000
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charitable contributions of $15,000 and Section 179 deduction of $25,000. We need to determine which of the following statements best explains how these items should
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be treated on the partnership's tax return. Okay, take a second, pause the video, read through those different options, and see which
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you would think would be correct. And when you're ready, come back and we will look at the answer together
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Okay, and the answer is interest income, long-term capital gain, charitable contributions
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and Section 179 deduction should be separately stated and not. included in the ordinary income calculation. All right, so let's read the explanation
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In a partnership, separately stated items are specific types of income, deductions, and credits
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that are not included in the partnership's ordinary income, but are reported separately on the
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partnership's tax return. This distinction is crucial because these items can affect each
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partner's tax situation differently. Examples include, like we already went over, interest
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income, capital gains and losses, charitable contributions, and certain deductions like the
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Section 179 expense deduction. Just a reminder, the Section 179 expense deduction
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basically a tax provision that allows a company to, in the current year for tax purposes
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deduct the full depreciation expense of a property instead of depreciating it over time
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Each of these items has unique tax rules and implications. By reporting these items separately
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the partnership allows individual partners to apply them according to their personal tax circumstances
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such as different income levels, tax rates, or eligibility for deductions, thereby ensuring the most accurate and beneficial tax treatment for each partner
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So basically, there's ordinary income that is distributed to the partners based off of their percentage ownership, but then there's separately stated items that have to be passed through to them and listed individually so that the partner knows how to treat each of those items
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All right, we've learned about ordinary business income and separately stated items. Let's go ahead and do a few more questions just to learn a little bit more
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Okay, and here is question three. A partnership agreement stipulates that one of the partners is to receive a guaranteed payment of $100,000
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annually for services rendered, regardless of the partnership's income for the year
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The partnership's total net income before considering the guaranteed payment was $500,000 for the year
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How should this guaranteed payment be treated for tax purposes on the partnership's return
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Okay, so this is something new if you haven't seen it before, guaranteed payment
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How is this treated on the partnership level? I have already made a video about pass-through entity and how that works for individuals
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and I put that link in the description but specifically for the partnership how is this guaranteed payment treated Take a second pause the video think through this see if you can get the correct answer and when you ready come back and we will look at the answer together
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Okay, and the answer is that the guaranteed payment should be treated as a reduction from the partnership's ordinary income, resulting in a net ordinary income of $400,000
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Okay, let's read the explanation. Guaranteed payments are considered a distributive share or a withdrawal of the partnership's income and are deducted from the partnership's ordinary income
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income. They are treated like a business expense, but are allocated specifically to the partner
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receiving them, ensuring they are taxed as ordinary income to that partner. Therefore, after
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accounting for the guaranteed payment, the partnership's net ordinary income would be $400,000
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So essentially, guaranteed payments, you know, it's in the name. They are payments that will be
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made to the partner, regardless of how the partnership does. It's a little bit like a salary
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and it's for the part on the partnership level, it is treated like a salary, basically. You just
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deduct it from your ordinary income because you're essentially paying a salary to the partner
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That's not necessarily exactly what it means, but that's an easy way to think of it
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All right, we've learned about guaranteed payments now. Let's go ahead and go to the next question
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Okay, here is question four. Consider the following descriptions of payments made by a partnership to its partners
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Payment made to a partner for management services provided to the partnership, set at a fixed amount annually
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irrespective of the partnership's income, distribution of profits to partners according to their
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ownership interest at the end of the fiscal year, a fixed monthly rental payment to a partner
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for using his property as the partnership's office space, an annual bonus to a partner calculated
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as 10% of the partnership's profits if the profits exceed $500,000. So which of these would be
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considered a guaranteed payment? We just learned about guaranteed payments. This is trying to
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give us a little bit more context. Go ahead and pause the video and try to see if you can figure out
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which ones would be guaranteed payments. And when you're ready, come back and we will look at
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the answer together. Okay, and the answer is one and three. So the payment for management services and the fixed monthly rental payment
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Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income
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These are typically for services or for the use of capital. So payment one is a guaranteed payment as it is a fixed amount for management services provided regardless of the partnership's profitability
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And payment three is also a guaranteed payment as it is a fixed rental cost paid regardless of the partnership's earnings and it is for the use of a partner's property
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All right. We learned a little bit more about guaranteed payments there. Let's go ahead and do one more question to kind of tie this all together
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Okay, here is question five. For the fiscal year, a partnership report the following financial information
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I'm not going to read through all that because I think that you should pause the video
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read through this whole question, and see if you can get the correct answer. You just need to calculate the partnership's ordinary income or loss for the year
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We've learned how ordinary income works, how separately stated items work, and how guaranteed payments work
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So again take a second pause the video do this calculation and when you ready come back and we will look at the answer Okay and the answer is Did you get that Let go ahead and read the explanation
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So first, you would calculate the ordinary income by focusing only on the operational transactions and adjusting for guaranteed payments
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So we would take the service fees earned, subtract the salary expense, subtract the depreciation expense
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subtract the guaranteed payment. Again, guaranteed payment is subtracted from ordinary income, and that would leave you with $350,000
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The ordinary income should be $350,000 after correctly applying all deductions related to the
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partnerships operations and not including separately stated items such as the rent income
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And I guess I should say if rent income is the whole purpose of the partnership, then that
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might be ordinary income. But in this question, it did say that the rental income was passive or basically just a passive
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rental income. So since it was passive, that would be a separately stated item
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And then, of course, interest income, charitable contribution. and long-term capital gains
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These items should be reported separately due to their specific tax treatment. Okay, very similar to S-Corporation, ordinary income, and separately stated items
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In fact, the major difference is guaranteed payments. S-corporations don't have guaranteed payments, partnerships do
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All right, now let's go ahead and finish the video by doing one more part of the Superfast
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CPA strategy, which is something called Pillar Topics. Now, if you don't know what Pillar Topics is, essentially, as you're going through the
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questions to learn the material, there will be things that will pop out over the course
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of you doing the questions that are obviously important. These are the things that are
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popping up in multiple questions and you keep seeing this topic and you know it's
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important according to your review course for the CPA exam. So let's go ahead and
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look at the pillar topics for this video. Okay and here are the pillar topics for
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this video. Partnerships just like S corporations pass through income and losses
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to the partners. Partnership ordinary income is basically just normal business operations like revenue expenses depreciation etc. However just like with S
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corporations, certain items are considered separately stated items and so are not included in the calculation of ordinary income or loss
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These would include things like interest or dividend income, capital gains or losses, charitable contributions, and so on
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Unlike S corporations, partnerships have something called guaranteed payments. These are amounts paid to partners regardless of the income of the partnership
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In the context of the partnership itself, these guaranteed payments are deducted from ordinary income
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All right, that's the end of this video. Thank you so much for watching. Make sure you go check out our free one-hour webinar training on superfastcpa.com
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Again, we teach the key ingredients to passing the CPA exam, and it's one hour, it's free
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You should go check it out. Also, if you'd like to going through the questions as your main learning material
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make sure you check out our Superfast CPA app, where we have five question mini quizzes that you can easily access on your phone all throughout the day
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If you like this video, make sure to like it and leave a comment. I hope this was helpful, and I will see you in the next video
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