MODULE 33 TAXES: INDIVIDUAL
chandise is an income producing factor, inventories must be
maintained to clearly reflect income. If merchandise in-
reatories are necessary to clearly determine income, only
the accrual method of tax reporting can be used for pur-
chases and sales.
57. (d) The requirement is to determine the amount of
salary taxable to Burg in 2009. Since Burg is a cash-basis
taxpayer, salary is taxable to Burg when actually or con-
structively received, whichever is earlier. Since the $30,000
of unpaid salary was unqualifiedly available to Burg during
2009, Burg is considered to have constructively received it.
Thus, Burg must report a total of $80,000 of salary for 2009;
the $50,000 actually received plus $30,000 constructively
received.
58. (d) The requirement is to determine the 2009 medi-
cal practice net income for a cash basis physician. Dr. Ber-
ger's income consists of the $200:000 received from patients
and the $30,000 received from third-party reimbursers dur-
ing 2009. His 2009 deductions include the $20,000 of sala-
ries and $24,000 of other expenses paid in 2009. The year-
end bonuses will be deductible for 2010.
59. (c) The requirement is to determine which taxpayer
may use the cash method of accounting for tax purposes.
The cash method generally cannot be used (and the accrual
method must be used to measure sales and cost of goods
sold) if inventories are necessary to clearly determine in-
come. Additionally, the cash method generally cannot gen-
erally be used by (1) a corporation (other than an S corpora-
tion), (2) a partnership with a corporation as a partner, and
(3) a tax shelter. However, this prohibition against the use
of the cash method in the preceding sentence does not apply
to a farming business, a qualified personal service corpora-
tion (e.g., a corporation performing services in health, law,
engineering, architecture, accounting, actuarial science, per-
forming arts, or consulting), and a corporation or partnership
(that is not a tax shelter) that does not have inventories and
whose average annual gross receipts for the most recent
three-year period do not exceed $5 million, ,
I.E. Business Income and Deductions
60. (a) Uniform capitalization rules generally require
that all costs incurred (both direct and indirect) in manufac-
turing or constructing real or personal property, or in pur-
chasing or holding property for sale, must be capitalized as
part of the cost of the property. However, these rules do not
apply to a "small retailer or wholesaler" who acquires per-
sonal property for resale if the retailer's or wholesaler's av-
erage annual gross receipts for the three preceding taxable
years do not exceed $10 million.
61. (a) The requirement is to determine whether the cost
of merchandise, and business expenses other than the cost of
merchandise, can be deducted in calculating Mock's busi-
ness income from a retail business selling illegal narcotic
substances. Generally, business expenses that are incurred
in an illegal activity are deductible if they are ordinary and
necessary, and reasonable in amount. Under a special ex-
ception, no deduction or credit is allowed for any amount
that is paid or incurred in carrying on a trade or business
which consists of trafficking in controlled substances. How-
ever, this limitation that applies to expenditures in connec-
tion with the illegal sale of drugs does not alter the normal
definition of gross income (i.e., sales minus cost of goods
sold). As a result, in arriving at gross income from the busi-
461
ness, Mock may reduce total sales by the cost of goods sold,
and thus is allowed to deduct the cost of merchandise in
calculating business income.
62. (b) The requirement is to determine the percentage
of business meals expense that Banks Corp. can deduct for
2009. Generally, only 50% of business meals and enter-
tainment is deductible. When an employer reimburses its
employees' substantiated qualifying business meal expenses,
the 50% limitation on deductibility applies to the employer.
63. (a) The requirement is to determine which of the
costs is not included in inventory under the Uniform Capi-
talization (UNICAP) rules for goods manufactured by a
taxpayer. UNICAP rules require that specified overhead
items must be included in inventory including factory repairs
and maintenance, factory administration and officers' sala-
ries related to production, taxes (other than income taxes),
the costs of quality control and inspection, current and past
service costs of pension and profit-sharing plans, and service
support such as purchasing, payroll, and warehousing costs.
Nonmanufacturing costs such as selling, advertising, and
research and experimental costs are not required to be in-
cluded in inventory.
64. (d) If no exceptions are met, the uniform capitaliza-
tion rules generally require that all costs incurred in pur-
chasing or holding inventory for resale must be capitalized
as part of the cost of the inventory. Costs that must be capi-
talized with respect to inventory include the ,costs of pur-
chasing, handling, processing, repackaging and assembly,
and off-site storage. An off-site storage facility is one that is
not physically attached to, and an integral part of, a retail
sales facility. Service costs such as marketing, selling, ad-
vertising, and general management are immediately deducti-
ble and need not be capitalized as part of the cost of inven-
tory.
65. (d) The requirement is to determine the correct
statement regarding the deduction for bad debts in the case
of a corporation that is not a financial institution. Except for
certain small banks that can use the experience method of
accounting for bad debts, all taxpayers (including those that
previously used the reserve method) are required to use the
direct charge-off method of accounting for bad debts.
66. (d) The requirement is to determine the amount of
life insurance premium that can be deducted in Ram Corp.'s .
income tax return. Generally, no deduction is allowed for
expenditures that produce tax-exempt income. Here, no
deduction is allowed for the $6,000 life insurance premium
. because Ram is the beneficiary of the policy, and the pro-
ceeds of the policy will be excluded from Ram's income
when the officer dies.
67. (a) The requirement is to determine the amount of
bad debt deduction for a cash-basis taxpayer. Accounts re-
ceivable resulting from services rendered by a cash-basis
taxpayer have a zero tax basis, because the income has not
yet been reported. Thus, failure to collect the receivable
results in a nondeductible loss.
68. (c) The requirement is to determine the loss that
Cook can claim as a result of the worthless note receivable
in 2009. Cook's $1,000 loss will be treated as a nonbusiness
bad debt, deductible as a short-term capital loss. The loss is
not a business bad debt because Cook was not in the busi-