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EA Part 2 study materials
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EA Part 2 practice questions

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Question 1Business Entities and Considerations

A single-member LLC that does not elect corporate treatment is treated for federal tax purposes as which of the following?

  1. A disregarded entity Correct answer.
  2. A partnership
  3. A C corporation
  4. An S corporation

Explanation

By default a single-member LLC is disregarded as separate from its owner, so the owner reports the business activity on the owner's own return. Corporate or S corporation treatment requires an affirmative election.

Question 2Business Entities and Considerations

A partnership must file its annual information return on which form?

  1. Form 1120-S
  2. Form 1041
  3. Form 1120
  4. Form 1065 Correct answer.

Explanation

Form 1065 is the U.S. Return of Partnership Income, an information return that reports partnership income and each partner's distributive share on Schedule K-1. The partnership itself generally pays no entity-level income tax.

Question 3Business Entities and Considerations

Which of the following is a characteristic of an S corporation?

  1. It is subject to the corporate alternative minimum tax
  2. It may have no more than 100 shareholders Correct answer.
  3. It may have partnerships as shareholders
  4. It may have more than one class of stock

Explanation

An S corporation is limited to 100 shareholders, with limited exceptions for certain family members and exempt organizations. Eligible shareholders must generally be individuals, estates, or certain trusts.

Question 4Business Entities and Considerations

A C corporation's taxable income is subject to which rate structure under current law?

  1. The same graduated rates that apply to individuals
  2. A flat 21 percent rate Correct answer.
  3. A flat 15 percent rate
  4. A graduated rate schedule topping out at 35 percent

Explanation

The Tax Cuts and Jobs Act replaced the graduated corporate rate schedule with a flat 21 percent rate on corporate taxable income. This rate applies regardless of the size of the corporation's income.

Question 5Business Entities and Considerations

Which of the following business forms is generally not subject to federal income tax at the entity level?

  1. A publicly traded corporation
  2. A C corporation
  3. A corporation that has not made an S election
  4. A general partnership Correct answer.

Explanation

A partnership is a pass-through entity, so its income is taxed to the partners rather than to the partnership. C corporations are separate taxable entities that pay tax on their own income.

Question 6Business Entities and Considerations

Which form is used to make an S corporation election?

  1. Form 2553 Correct answer.
  2. Form 7004
  3. Form 1120-S
  4. Form 8832

Explanation

Election by a Small Business Corporation is made on Form 2553. The election must generally be filed no later than two months and 15 days after the beginning of the tax year for which it is to take effect.

Question 7Business Entities and Considerations

Which of the following is a defining feature of a limited partnership?

  1. It may have no general partner
  2. All partners have unlimited personal liability
  3. It has at least one general partner and at least one limited partner Correct answer.
  4. It is taxed as a C corporation by default

Explanation

A limited partnership requires at least one general partner, who manages and bears unlimited liability, and at least one limited partner, whose liability is generally limited to the partner's investment. It is taxed as a partnership by default.

Question 8Business Entities and Considerations

A business owner wants limited liability but wishes to avoid an entity-level income tax and is the sole owner. Which structure best fits that goal?

  1. A single-member LLC Correct answer.
  2. A general partnership
  3. A C corporation
  4. A sole proprietorship

Explanation

A single-member LLC provides limited liability while being disregarded for federal income tax purposes, so the owner reports the income directly and no entity-level tax applies. A C corporation would impose an entity-level tax.

Question 9Business Entities and Considerations

A partnership's ordinary business income is reported to each partner on which schedule?

  1. Schedule K-1 (Form 1065) Correct answer.
  2. Schedule C (Form 1040)
  3. Schedule D (Form 1040)
  4. Schedule M-3 (Form 1120)

Explanation

Schedule K-1 (Form 1065) reports each partner's distributive share of income, deductions, and credits. The partner then reports those items on the partner's own return.

Question 10Business Entities and Considerations

An S corporation shareholder's basis is increased by which of the following items?

  1. The shareholder's share of ordinary business income Correct answer.
  2. Distributions received from the corporation
  3. The shareholder's share of non-deductible expenses
  4. The shareholder's share of tax-exempt income only

Explanation

A shareholder's stock basis increases with income items passed through, including ordinary business income, and decreases with losses and distributions. Non-deductible expenses reduce basis, and tax-exempt income also increases basis but is not the only item that does.

Question 11Business Entities and Considerations

A partner contributes property to a partnership in exchange for a partnership interest. What is the general rule for gain recognition?

  1. The partner recognizes gain equal to the property's fair market value
  2. The partner recognizes gain only if the property is inventory
  3. No gain or loss is recognized on the contribution Correct answer.
  4. The partner recognizes gain equal to the property's adjusted basis

Explanation

Under the general rule, a partner recognizes no gain or loss when contributing property to a partnership in exchange for a partnership interest. Exceptions apply for contributions that are in substance sales or that involve disguised payments.

Question 12Business Entities and Considerations

Which of the following is required for a trust to be an eligible S corporation shareholder?

  1. It must be a business trust taxed as a corporation
  2. It must be a foreign trust
  3. It must have more than 100 beneficiaries
  4. It must be an eligible trust type, such as a grantor trust or a qualified subchapter S trust Correct answer.

Explanation

Only certain trusts may hold S corporation stock, including grantor trusts, qualified subchapter S trusts, and certain testamentary trusts. Foreign trusts and trusts taxed as corporations are not eligible shareholders.

Question 13Business Entities and Considerations

A C corporation distributes a cash dividend to its shareholder. How is the distribution treated?

  1. It is a dividend taxable to the shareholder to the extent of corporate earnings and profits Correct answer.
  2. It is a tax-free return of capital in all cases
  3. It is deductible by the corporation
  4. It is taxed only when the shareholder sells the stock

Explanation

Corporate distributions are dividends to the extent of earnings and profits and are taxable to the shareholder. They are not deductible by the corporation, which creates the double taxation characteristic of C corporations.

Question 14Business Entities and Considerations

A shareholder owns stock in an S corporation with a basis of $10,000. The corporation passes through a $14,000 ordinary loss. What amount of loss may the shareholder deduct currently, assuming no other basis adjustments?

  1. $0
  2. $10,000 Correct answer.
  3. $4,000
  4. $14,000

Explanation

A shareholder may deduct pass-through losses only to the extent of stock basis plus any debt basis. The loss is limited to the $10,000 basis, and the excess $4,000 is suspended and carried forward.

Question 15Business Entities and Considerations

Which item is separately stated on a partnership's Schedule K rather than included in ordinary business income?

  1. Salaries paid to employees
  2. Gross receipts from sales
  3. Charitable contributions Correct answer.
  4. Cost of goods sold

Explanation

Items that may affect partners differently, such as charitable contributions, capital gains, and investment income, are separately stated. Operating items like sales, cost of goods sold, and wages are combined into ordinary business income.

Question 16Business Entities and Considerations

A corporation makes a valid S election effective for the current year. What is the general consequence for the corporation's federal income tax?

  1. The corporation must liquidate within one year
  2. The corporation continues to pay tax on all of its income
  3. The corporation becomes exempt from filing any return
  4. The corporation generally ceases to pay entity-level federal income tax and passes items through to shareholders Correct answer.

Explanation

An S corporation is generally not subject to entity-level federal income tax; income, deductions, and credits pass through to shareholders. It still files an annual information return on Form 1120-S.

Question 17Business Entities and Considerations

Which of the following best describes a partner's outside basis in a partnership interest?

  1. The partner's basis in the partnership interest itself Correct answer.
  2. The fair market value of the partner's capital account
  3. The partner's share of partnership liabilities only
  4. The partnership's basis in its own assets

Explanation

Outside basis is the partner's basis in the partnership interest, which is used to measure gain or loss on disposition and to limit deductible losses. Inside basis refers to the partnership's basis in its assets.

Question 18Business Entities and Considerations

A limited liability company with two members has made no elections. How is it taxed by default?

  1. As a partnership Correct answer.
  2. As an S corporation
  3. As a disregarded entity
  4. As a C corporation

Explanation

A multi-member LLC with no election is taxed as a partnership by default. Disregarded entity treatment applies only to single-member LLCs.

Question 19Business Entities and Considerations

Which of the following is a disadvantage of operating as a general partnership?

  1. It must file Form 1120
  2. It must pay federal income tax at the entity level
  3. Each general partner may be personally liable for partnership obligations Correct answer.
  4. It is limited to 100 partners

Explanation

General partners have unlimited personal liability for partnership debts and obligations. A general partnership is nonetheless a pass-through entity that files Form 1065 rather than paying entity-level tax.

Question 20Business Entities and Considerations

A shareholder sells S corporation stock at a loss. Which factor most directly limits the deductible loss?

  1. The corporation's gross receipts
  2. The shareholder's adjusted basis in the stock Correct answer.
  3. The number of shareholders
  4. The corporation's earnings and profits

Explanation

Gain or loss on the sale of stock is measured against the shareholder's adjusted basis. Basis is increased by passed-through income and reduced by distributions and losses.

Question 21Business Entities and Considerations

A partnership allocates depreciation deductions disproportionately to one partner under the partnership agreement. Which requirement governs whether the allocation will be respected?

  1. The allocation must have substantial economic effect Correct answer.
  2. The allocation must be approved by the IRS in advance
  3. The allocation must be reflected in the partnership's gross receipts
  4. The allocation must be pro rata by capital contribution

Explanation

Special allocations are respected only if they have substantial economic effect, meaning they affect the partners' capital accounts and liquidation proceeds and are not merely tax-motivated. Otherwise the allocation is reallocated according to the partners' interests in the partnership.

Question 22Business Entities and Considerations

A C corporation has a net operating loss for the current year. How may the loss generally be used?

  1. It may be carried back two years and forward twenty years without limit
  2. It may not be carried forward at all
  3. It must be carried back five years
  4. It may be carried forward indefinitely, subject to an 80 percent taxable income limitation Correct answer.

Explanation

Post-2017 net operating losses generally may not be carried back and may be carried forward indefinitely, offsetting no more than 80 percent of taxable income in the carryforward year. Different rules apply to farming losses and certain small businesses.

Question 23Business Entities and Considerations

A corporation that made an S election and holds appreciated assets from its C corporation years should be concerned with which tax?

  1. The corporate alternative minimum tax
  2. The built-in gains tax Correct answer.
  3. The accumulated earnings tax
  4. The personal holding company tax

Explanation

The built-in gains tax applies when an S corporation disposes of appreciated assets that it held when it was a C corporation, within the recognition period. The tax prevents conversion of corporate appreciation into pass-through gain without entity-level tax.

Question 24Business Entities and Considerations

A single-member LLC elects to be taxed as an S corporation. Which statement best describes the owner's treatment?

  1. The LLC becomes subject to the corporate alternative minimum tax
  2. The owner's entire distributive share is treated as wages
  3. The owner is treated as an employee-shareholder and must take reasonable compensation for services Correct answer.
  4. The owner may not receive any salary from the LLC

Explanation

When a single-member LLC elects S corporation status, the owner is treated as an employee-shareholder. The owner must receive reasonable compensation for services, which is subject to employment taxes, and remaining profit is reported as a distributive share.

Question 25Business Entities and Considerations

A partnership distributes appreciated property to a partner in a non-liquidating distribution. What is the general effect on the partner's basis in the distributed property?

  1. The partner takes a carryover basis equal to the partnership's basis, limited by the partner's outside basis Correct answer.
  2. The partner takes a basis equal to fair market value
  3. The partner takes a zero basis in the property
  4. The partner recognizes gain equal to the appreciation

Explanation

In a non-liquidating distribution, the partner generally takes a carryover basis in the distributed property equal to the partnership's adjusted basis, and the partner's outside basis is reduced by that amount. Gain is generally not recognized unless cash distributed exceeds outside basis.

Question 26Business Entities and Considerations

A married couple owns a rental property as equal co-owners, sharing profits and losses, with no entity election filed. How is the rental activity generally reported for federal income tax purposes?

  1. On a corporate return, because co-ownership creates a separate taxable entity
  2. On a partnership return, with each spouse receiving a Schedule K-1
  3. On separate individual returns only if they elect out of partnership status annually
  4. On their joint return as a qualified joint venture, splitting income by ownership share Correct answer.

Explanation

When the only owners are a married couple filing jointly and the business is unincorporated, the activity may be treated as a qualified joint venture reported directly on the joint return with each spouse's share of income and expenses. No partnership return is required if the election is made.

Question 27Business Entities and Considerations

Which characteristic distinguishes a limited liability partnership from a general partnership?

  1. The LLP cannot make an S corporation election under any circumstances
  2. Partners in an LLP generally are shielded from liability for other partners' malpractice claims Correct answer.
  3. The LLP must have at least one general partner with unlimited liability
  4. The LLP is taxed at the entity level before distributions

Explanation

An LLP provides each partner protection against liabilities arising from the negligence or misconduct of other partners, while a general partnership exposes partners to joint and several liability. The LLP remains a pass-through entity.

Question 28Business Entities and Considerations

A C corporation earns $200,000 of taxable income and distributes all after-tax earnings to its sole shareholder, who is in the 37% bracket. Which tax consequence results from the corporate form?

  1. Only the shareholder pays tax, at capital gains rates
  2. Both the corporation and the shareholder pay tax on the same earnings Correct answer.
  3. Only the corporation pays tax, and the distribution is tax-free
  4. Neither party pays tax if the distribution is labeled a return of capital

Explanation

C corporation earnings are taxed first at the corporate level, and dividends paid from those earnings are taxed again to the shareholder, producing double taxation. The distribution is not tax-free merely because the corporation already paid tax.

Question 29Business Entities and Considerations

A partner receives a guaranteed payment of $30,000 for services rendered to the partnership, which had $90,000 of ordinary income before the payment. How is the guaranteed payment characterized to the partner?

  1. A separately stated capital gain
  2. Ordinary income reported on the partner's return, not as a distribution Correct answer.
  3. A distribution of partnership property
  4. A tax-free return of capital reducing outside basis

Explanation

A guaranteed payment for services is ordinary income to the partner and is deductible by the partnership in computing ordinary business income. It is not a distribution of partnership property.

Question 30Business Entities and Considerations

An S corporation has 95 shareholders, one of whom is a nonresident alien. What is the effect on the corporation's S election?

  1. The election remains valid because fewer than 100 shareholders exist
  2. The election is unaffected if the alien shareholder holds nonvoting stock
  3. The election is terminated because a nonresident alien cannot be a shareholder Correct answer.
  4. The election is suspended until the alien shareholder sells the stock

Explanation

An S corporation may have no more than 100 shareholders, and all shareholders must be eligible individuals, estates, or certain trusts. A nonresident alien is an ineligible shareholder, which terminates the S election.

Question 31Business Entities and Considerations

A partnership agreement allocates 90% of all income to the managing partner and 10% to the limited partner, who contributed 90% of the capital. Which standard governs whether the allocation will be respected?

  1. The allocation must be approved by the IRS in advance
  2. The allocation must favor the partner with the greatest liability exposure
  3. The allocation must have substantial economic effect Correct answer.
  4. The allocation must match capital contributions exactly

Explanation

Partnership allocations are respected only if they have substantial economic effect, meaning they affect the partners' capital accounts and liquidation proceeds and are not merely tax-motivated. Allocations need not track capital contributions.

Question 32Business Entities and Considerations

A trust holds S corporation stock and qualifies as a grantor trust. How is the trust's share of S corporation income reported?

  1. The deemed owner reports the income directly on the individual return Correct answer.
  2. The income is exempt because grantor trusts are tax-exempt entities
  3. The income is taxed to the corporation and not passed through
  4. The trust reports the income on its own fiduciary return at trust rates

Explanation

A grantor trust is an eligible S corporation shareholder, and the trust's items of income and deduction are reported by the deemed owner on the owner's individual return. The trust itself generally does not pay tax on that income.

Question 33Business Entities and Considerations

A corporation's S election was terminated because it issued a second class of stock. When does the termination generally take effect?

  1. On the date the corporation files its final S return
  2. On the first day of the following tax year
  3. On the date the terminating event occurred Correct answer.
  4. On the date the IRS issues a notice of termination

Explanation

Termination generally occurs on the date the disqualifying event happens, such as the creation of a second class of stock or an ineligible shareholder. The corporation then becomes a C corporation on that date.

Question 34Business Entities and Considerations

A sole proprietor operates a consulting business as a single-member LLC taxed by default. Which return does the owner file for the business activity?

  1. Form 1120S
  2. Form 1120
  3. Form 1065
  4. Schedule C with the individual return Correct answer.

Explanation

A single-member LLC with no election is a disregarded entity, so the owner reports the business on Schedule C of the individual return. No separate entity return is filed.

Question 35Business Entities and Considerations

A shareholder's S corporation stock basis is $5,000 and the shareholder's share of corporate losses is $9,000. What is the current deductibility of the losses?

  1. $4,000 is deductible and $5,000 is suspended
  2. $5,000 is deductible and $4,000 is suspended Correct answer.
  3. No losses are deductible until the corporation reports a profit
  4. $9,000 is deductible because losses always pass through in full

Explanation

An S corporation shareholder may deduct losses only to the extent of stock basis plus basis in loans to the corporation. Losses exceeding basis are suspended and carried forward until basis is restored.

Question 36Business Entities and Considerations

Two individuals form a multi-member LLC and make no tax election. Which tax classification applies by default?

  1. Partnership Correct answer.
  2. Sole proprietorship
  3. C corporation
  4. S corporation

Explanation

A domestic multi-member LLC with no election is classified as a partnership for federal tax purposes. It must file Form 1065 and issue Schedules K-1.

Question 37Business Entities and Considerations

A partner's outside basis in a partnership is $20,000. The partnership borrows $40,000 on a recourse basis, and the partner's share of the liability is $10,000. What is the partner's basis after the borrowing?

  1. $40,000
  2. $60,000
  3. $30,000 Correct answer.
  4. $20,000

Explanation

A partner's share of partnership liabilities is treated as a contribution of money, which increases outside basis. Adding the $10,000 share to the $20,000 existing basis yields $30,000.

Question 38Business Entities and Considerations

A C corporation has accumulated earnings and profits. It distributes appreciated property to a shareholder as a dividend. How is the corporation treated?

  1. It recognizes gain only if the property is later sold by the shareholder
  2. It reduces earnings and profits by the property's adjusted basis only
  3. It recognizes gain as if it had sold the property at fair market value Correct answer.
  4. It recognizes no gain on the distribution of appreciated property

Explanation

A distributing corporation recognizes gain on the distribution of appreciated property as though it had sold the property at fair market value. The shareholder reports dividend income equal to the property's fair market value.

Question 39Business Entities and Considerations

Which entity type allows profits to pass through to owners while providing all owners with limited liability and central management?

  1. Limited liability company Correct answer.
  2. Sole proprietorship
  3. General partnership
  4. Limited partnership with a general partner

Explanation

An LLC combines pass-through taxation with limited liability for all members and permits centralized management. A general partnership and sole proprietorship expose owners to personal liability.

Question 40Business Entities and Considerations

An S corporation shareholder receives a distribution that exceeds the shareholder's stock basis. How is the excess treated?

  1. As taxable capital gain from the sale of stock Correct answer.
  2. As compensation subject to payroll taxes
  3. As ordinary dividend income to the extent of corporate earnings
  4. As a tax-free return of capital with no further consequence

Explanation

Distributions from an S corporation are tax-free to the extent of stock basis. Any excess is treated as gain from the sale or exchange of the stock, generally capital gain.

Question 41Business Tax Preparation and Taxpayer Filing Requirements

A single-member LLC that has not elected corporate status is treated for federal tax purposes as which of the following by default?

  1. A partnership
  2. A trust
  3. A disregarded entity Correct answer.
  4. A C corporation

Explanation

Under the default classification rules, a domestic entity with a single owner that is not a corporation is disregarded as separate from its owner unless an election is made. The owner reports the business activity on the owner's own return.

Question 42Business Tax Preparation and Taxpayer Filing Requirements

A partnership with three partners must file its annual information return by which date (absent an extension)?

  1. April 15
  2. June 15
  3. March 15 Correct answer.
  4. May 15

Explanation

A partnership files Form 1065 by the 15th day of the third month following the close of its tax year, which is March 15 for a calendar-year partnership. A five-month extension is available on request.

Question 43Business Tax Preparation and Taxpayer Filing Requirements

A C corporation uses a calendar tax year. Its federal income tax return is generally due on which date?

  1. September 15
  2. April 15 Correct answer.
  3. May 15
  4. March 15

Explanation

A calendar-year C corporation files Form 1120 by the 15th day of the fourth month after year-end, which is April 15. An automatic six-month extension is available by filing Form 7004.

Question 44Business Tax Preparation and Taxpayer Filing Requirements

Which business entity is generally not subject to federal income tax at the entity level?

  1. A C corporation
  2. A publicly traded corporation
  3. An S corporation Correct answer.
  4. A limited liability company taxed as a C corporation

Explanation

An S corporation is a pass-through entity; income, deductions, and credits flow through to shareholders, who report them on their own returns. The entity files an information return but generally pays no entity-level income tax.

Question 45Business Tax Preparation and Taxpayer Filing Requirements

Which form is used by an S corporation to report its income and flow-through items to shareholders?

  1. Form 1041
  2. Form 1120
  3. Form 1065
  4. Form 1120-S Correct answer.

Explanation

An S corporation files Form 1120-S, the U.S. Income Tax Return for an S Corporation, and issues Schedule K-1 to each shareholder. The corporation generally pays no entity-level income tax.

Question 46Business Tax Preparation and Taxpayer Filing Requirements

A taxpayer operates a sole proprietorship. On which form does the taxpayer report the business's net profit or loss?

  1. Schedule D
  2. Schedule C Correct answer.
  3. Schedule B
  4. Schedule E

Explanation

A sole proprietor reports business income and expenses on Schedule C, Profit or Loss From Business, which is attached to Form 1040. The resulting net profit or loss is carried to Schedule 1 and then to the Form 1040.

Question 47Business Tax Preparation and Taxpayer Filing Requirements

A partnership must provide each partner with which form reporting the partner's distributive share of income, deductions, and credits?

  1. Schedule K-1 (Form 1065) Correct answer.
  2. Form W-2
  3. Form 1096
  4. Form 1099-MISC

Explanation

Schedule K-1 (Form 1065) reports each partner's distributive share of partnership items. The partnership must furnish it to partners by the same date the partnership return is due.

Question 48Business Tax Preparation and Taxpayer Filing Requirements

An employer must generally furnish Form W-2 to each employee by which date?

  1. January 15
  2. January 31 Correct answer.
  3. February 15
  4. March 31

Explanation

Form W-2, Wage and Tax Statement, must be furnished to employees by January 31 following the close of the calendar year. Copies are also filed with the Social Security Administration.

Question 49Business Tax Preparation and Taxpayer Filing Requirements

A calendar-year C corporation requests an automatic extension of time to file its income tax return. The maximum extended due date is which of the following?

  1. October 15 Correct answer.
  2. September 15
  3. June 15
  4. November 15

Explanation

A calendar-year C corporation may extend its return due date six months, from April 15 to October 15, by filing Form 7004. The extension extends the filing deadline but not the time to pay tax.

Question 50Business Tax Preparation and Taxpayer Filing Requirements

A calendar-year S corporation requests an automatic extension of time to file. Its extended due date is which of the following?

  1. March 15
  2. October 15
  3. September 15 Correct answer.
  4. April 15

Explanation

A calendar-year S corporation files Form 1120-S by March 15 and may extend that date six months to September 15 by filing Form 7004. The original due date is March 15.