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REG CPA Practice Questions: Taxation of Income from Disregarded Entities
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May 3, 2024
In this video, we walk through 5 REG CPA exam practice questions on how to calculate the income reported in the year of death for a decedent. 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-taxation-of-income-from-disregarded-entities/ See the other REG walkthrough videos here: https://www.superfastcpa.com/free-reg-cpa-practice-question-walkthroughs/ 0:00 Intro 00:51 Question 1: Business Income from a Disregarded Entity 04:08 Question 2: Items Not Included in Business Income of a Disregarded Entity 07:09 Question 3: Additional Items Not Included in Business Income of a Disregarded Entity 09:19 Question 4: Business Loss from a Disregarded Entity 11:25 Question 5: Rental Income from a Disregarded Entity 14:15 Pillar Topics
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0:00
Welcome to another reg walkthrough video
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I'm Logan, and in today's video, we're going to be going over reporting income from a disregarded entity on an individual's tax return
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And we're going to be doing that, the Super Fast CPA way, by diving straight into questions to learn the material
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If you don't know much about our strategies, or if this is the first thing you're seeing from us, make sure you go to superfast CPA.com to watch our free one-hour webinar training, where we go over the six key ingredients to passing the CPA exam
0:26
The link will be in the description. Make sure you go check that out. Again, it's only one hour long, it's free, and it will save you months and months of struggling
0:34
with your process. The link will be in the description. Also, if you like the idea of going through questions as your main learning material
0:41
be sure to check out our Superfast CPA app where we have five question mini quizzes that
0:45
you can access easily on your phone to continually practice throughout your day. With all that said, let's dive straight into some questions
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All right, here's the first question. John Doe owns a single member LLC that is treated as a disregarded entity for tax purposes
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The LLC operates a small retail store. For the tax year, the LLC had gross receipts of $200,000
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The expenses incurred by the business were as follows. Cost of goods sold, $80,000, rent for the store, $24,000, employee salaries, $50,000, utilities, $6,000, insurance, $4,000
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John is preparing his individual tax return and needs to report the income from his LLC
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Using the Schedule C, how should John report the ordinary business income
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or loss from his LLC. All right, if you don't know what a disregarded entity is, that's okay
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We're going to be learning about that here in just a second. Before we go to the answer, make sure
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you pause the video, read through the question to make sure you understand what it's asking and you understand what the different options are. And when you're ready, come back and we'll
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go over the answer to start learning about disregarded entities. All right, here is the answer
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So he would report $36,000 as net profit on his Schedule C, which would be added to his total
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income on his 1040. Okay. To find the ordinary business income, subtract the total expenses from the
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gross receipts. The total expenses include the cost of goods sold, for $80,000, the rent for the
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store for $24,000, the employee salaries for $50,000, the utilities for $6,000, and the insurance for
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$4,000, which sums up to $164,000. Subtracking this from the gross receipts of $200,000
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gives a net profit of $36,000, which would then be added to his $1040 as income
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Now let's learn about disregarded entities. A disregarded entity such as a single-member LLC or even a sole proprietorship does not file
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its own tax return for federal income tax purposes. Instead, its income and losses are reported on the tax return of the owner
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In this case, John reports the financial activities of his LLC on Schedule C, which is attached
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to his personal tax return, the Form 1040. This Schedule C reports the profit or loss from the business, and this figure is used to calculate
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the owner's total income tax liability. The key rule for disregarded entities is that while they
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are separate for legal purposes, for tax purposes, the entity's income is treated as directly
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earned by the owner. This simplifies tax filing and ties the financial fate of the business
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directly to the personal tax obligations of the owner. So essentially, disregarded entities are
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entities like single member LLCs or sole proprietorships, those are the more common ones
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where for tax purposes, all the business is technically run by the individual, not necessarily
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the business that they're running. So it's all taxed to them. And that's why you have to use a
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Schedule C, which is a part of the 1040 instead of a 1065 for a partnership or an 1120 for a corporation
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or an 1120s for an S corporation. So essentially, you just figure out what the business income
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or loss was on the Schedule C, and then you put that on the individual's 1040. It's pretty simple
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and you would treat it pretty much like a normal business. Whatever the income is, and then whatever
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the expenses are you net those together to get the income or loss and then you put that on the taxpayers 1040 Let go ahead and do some more questions to learn more about how this works
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Here's question two. Samantha Green operates Green Gardens, a sole proprietorship that specializes in landscape design
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During the tax year, Green Gardens had the following financial results. Gross service revenue of $420,000, salary to the employees, $120,000, office rent $30,000, utilities, $6,000, vehicles
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$8,000, business loan interest, $7,000, depreciation, $9,000, estimated quarterly tax payments for
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Samantha, $25,000, Samantha's personal health insurance premiums, $14,000, and contribution to Samantha's
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personal IRA for $6,000. Given this information and assuming all reported expenses are ordinary and
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necessary for the business, what amount should Samantha report as net profit from Green Gardens on her
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Schedule C. All right, take a look at this. See if you can figure out what counts on the
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Schedule C and what doesn't based off of what we learned from the previous question. And when you're
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ready, come back and we will look at the answer to continue to learn how to calculate the income on
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the Schedule C. Okay, here's the answer. $240,000. To arrive at the net profit for Green Gardens
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we subtract all ordinary and necessary business expenses from the gross service revenue
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personal expenses such as Samantha's personal health insurance premiums, her estimated tax payments
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and IRA contributions are not deductible on Schedule C for the business. They may be deductible else in her personal income tax return, but not from the disregarded entity
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And then obviously here's the calculation. You subtract all of these from the gross service revenue, and that gives you the $240,000
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of income from the business, and that would go on her $1040 to be taxable in her insurance
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income. Samantha's estimated tax payments, personal health insurance, and IRA contributions are not
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subtracted from the gross income on Schedule C because they are personal expenses or payments, not business
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income. So that's one thing that can be a little bit confusing and you have to pay attention
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And if you've ever worked in taxes or anything like this, a lot of people get confused with this
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when they're running their own business because in their mind, everything is business because they
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are the business. So with sole proprietorships and really any disregarded entity
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This is something to watch for to make sure that personal expenses are not included in the business expenses
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And let's read a little bit more about it here. In a sole proprietorship, only expenses directly related to the operation of the business are deductible on Schedule C
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It's important to distinguish between business and personal expenses as personal expenses are not deductible on Schedule C
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This distinction is essential for proper tax reporting and adherence to IRS rules and regulations
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And we already went over all of that. Again, not too much to it. You just have to know how to net income and expenses for a business
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And basically anything that is an expense for operating the business and any income from the business
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you just net those two together on the Schedule C. And that goes through to the taxpayer's income
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The only thing to watch for is personal expenses. Let's go to the next question
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All right. Question three. Alex Martin is a graphic designer who runs a sole proprietorship named Martin visuals
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For the tax year, in question, Martin visuals had the following financial data
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Total income from design projects, $320,000. REND, $25,000, salary to the assistant designer, $40,000, payments for freelance consultants, $30,000, purchase of new design software, $5,000, marketing and advertising expenses, $18,000, office expenses, $3,000, payment for business internet and phone, $4,800
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equipment depreciation, $10,000, Alex's personal draw or an owner's draw, $70,000. That's basically Alex's salary
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Personal car payment, car not used for the business. $6,000, contribution to a personal retirement plan, $5,500
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Alex's life insurance premiums $1,200. Assuming all expenses are ordinary and necessary were applicable and Alex does not claim personal expenses as business deductions what is the net profit that should be reported on Schedule C for Martin visuals So basically assuming Alex does this correctly
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what is going to be his net profit from his business? All right, you've already learned a lot from
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the first two questions. I bet you could figure out what goes on the Schedule C and what is personal
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so it shouldn't be on the Schedule C. So go ahead, pause the video. Do the question and when you're
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ready, come back and we will look at the answer. All right, the answer is $184,200. To calculate the
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net profit for Martin visuals, we'll subtract the allowable business expenses from the total income
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We will not deduct Alex's personal draw, personal car payment, personal retirement plan contribution
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or life insurance premiums as they are personal expenditures. So one note I want to make there
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personal draws from a sole proprietorship. That's basically Alex just giving himself a salary
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And that is not a business deduction for a sole proprietor that cannot be deducted for him
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in his schedule C. So that is not counted as an expense
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And then obviously we have the computation here. You add all these expenses up and then subtract them from the net profit and then subtract them
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from the income and that's what you get is the net profit right there. Again, fairly simple, pretty straightforward
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Let's go to the next couple of questions to learn a few more things and then we'll be done
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Here's question four. Jacob is a freelance IT consultant who operates as a sole proprietor
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This year, Jacob's business income and expenses were as follows. He had gross income from his IT consulting services of $50,000
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He had rent for $10,000, business insurance, $2,000, equipment purchases, $8,000, advertising, $5,000, utilities, $3,000, travel, $4,000, depreciation, $3,500, and salary paid to an assistant, $20,000
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Jacob also had a salary from a teaching at a local college amounting to $30,000 for the year
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How should Jacob treat the net income or loss from his IT consulting business on a business
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his personal tax return. Okay, we're four questions in. Take a second, pause the video, see if you
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can calculate what his business income would be from his IT consulting services and figure out how
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that is going to affect his individual tax return. When you're ready, come back and we will look at
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the answer. Okay, here's the answer. So he would report a net business loss of $5,500, which can be
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used to offset his teaching salary. Okay, so he had a loss. So you add up all of his expenses
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and they exceed his business income by $5,500. So he has a net business loss of $5,500
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Now, when it comes to disregarded entities, or basically using the Schedule C
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if this is an active business, which obviously it is because it's a Schedule C
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that loss is then used to offset his other income. And basically to keep it simple
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when it comes to Schedule C, like when it comes to an active business for a disregarded entity
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a loss can be used to offset his other income pretty much as much as needed. However, when it comes to passive activity losses, which is not something
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we're going to cover in this video, there can be limitations on how much of that can be taken
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and how much can affect the income of the individual. But to keep things simple, for the most part
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Schedule C losses can be used to offset income as much as they are able to. And this can be a good thing
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You know, obviously the business had a loss, but it does reduce the taxable income for the individual
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Let's go to one last question for this video to learn something a little bit different
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and then we'll wrap up. Okay, here's question five. Avery, reporting taxes on a cash basis as the sole owner of a disregarded entity LLC
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operates a residential rental property. Over the current tax year, she collected $45,000 in rent
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Before the year's end, a tenant prepaid $12,000 for the upcoming six months
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Avery also received $8,000 from a tenant who decided to terminate their lease agreement prematurely
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In addition, she took in a $1,000 non-refundable pet deposit for cleaning services post-tenancy
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A $3,000 security deposit was also received and held for potential damages
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What amount should Avery report as gross income on Schedule E for her rental activity to then put
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on her 1040? Okay this is a little bit different This is a Schedule E instead of a Schedule C Schedule E is for rental activities where Schedule C is for business activities Take a second pause the video make sure you understand what the question is asking
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and we will go into the answer to learn a little bit more about rental activities
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Here's the answer. $66,000. Avery's gross income on Schedule E for the current year should include the $45,000 in rent collected
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the $12,000 in prepaid rent as it's taxable in the year of state. and the $8,000 lease cancellation payment totaling $65,000
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The $1,000 non-refundable pet deposit is also considered income, since it's kept regardless of property condition upon the lease's end
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bringing the total to $66,000. Since security deposits are not considered income when they are refundable and held for damages
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the $3,000 security deposit is excluded. Okay, so for rent, and I'm sure most of you have dealt with this before
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security deposits are something that you basically put down at the beginning of your lease or your
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rent that they hold on to until the end just in case something happens. Now, that does not count as
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income because it is being held specifically with the purpose of hopefully being refunded
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if there are no damages that need to be fixed by the end of the rent. However, everything else is
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included as rental income, the $12,000 of prepaid rent, the lease cancellation, everything
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everything that's earned in that year is counted as rental income. So the $66,000
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That all goes on to Schedule E, and then that goes from Schedule E to the 1040. We're not going to be
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talking about any loss limitations in this video. Just know that rentals can be considered
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passive activities, and there are some passive activity loss limitations that exist. But in general
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most of the time you're dealing with Schedule C and Schedule E with disregarded entities. And in this
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video we want to focus on how that income is put together and then put onto the 1040 of the individual
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Okay, to finish out this video, we're going to do one more part of the Super Fast CPA strategy
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which is called pillar topics. So to quickly explain pillar topics, pillar topics is essentially you taking the most important things that you learned from doing
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the questions as your main learning material and writing it down in a way that helps you remember
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what is the most important thing I was supposed to learn from doing these questions
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according to my review course. So let's go ahead and write out a few pillar topics to finish this out
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Disregarded entities are typically single-member LLCs or sole proprietorship
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An individual uses a Schedule C to report business income and Schedule E to
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report rental income. The income from the business or rental goes to the individual's income
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on the 1040. Personal expenses of the individual like life insurance, retirement, personal tax payments
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are not deductible on the Schedule C or E. Okay, those are some of the pillar topics
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that we could pull out there. Now, you can make your pillar topics as detailed as you want
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and maybe you thought of some different pillar topics that you could use for yourself. To finish this video, I just want to remind everybody about the free one-hour webinar training
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that we have on superfast CPA.com. We go over the six key ingredients to passing the CPA exam
15:46
and it will save you a ton of time struggling with your study process. Also, if you liked
15:51
the idea of going through the questions first as your main learning material, be sure to check
15:55
out the Superfast CPA app where we have five question mini quizzes that you can access on your phone
15:59
easily throughout the day so you can be continually practicing questions and learning. If you like this
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video, be sure to like it, leave a comment, and especially share with anybody you know who is going
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through the CPA exams as well. Thanks for watching and I'll see you in the next video
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