Tax Law and Accounting Fundamentals
Tax Law and Accounting Fundamentals
This domain tests substantive Title 26 tax law plus the accounting mechanics an agent uses to compute a correct tax figure. Expect questions on income recognition, deductions and capitalization, basis, accounting methods, employment-tax liability, and information reporting - and on how book results diverge from taxable income when a return understates receipts.
Core rules
- Income is broad (§61). Assignment of income fails (Lucas v. Earl); income is taxed to the earner. Constructive receipt and claim of right (North American Oil) fix timing.
- Deductions must be ordinary and necessary (§162). Capital expenditures are recovered through basis (§1012, §1001) or depreciation, not expensed.
- Accounting method must clearly reflect income (§446); §448 restricts cash-method eligibility. Consistent use alone does not satisfy §446.
- Trust fund recovery penalty (§6672) imposes personal liability for willful failure to collect or pay withheld tax.
- Reporting: Form 8300 for cash over $10,000 received in a trade or business; FinCEN 114 (FBAR) for foreign accounts above $10,000 aggregate.
Worked example
A sole proprietor deposits $420,000 into a business account and reports $300,000 of gross receipts. The agent documents $60,000 of loan proceeds (signed note, repayment schedule) and $15,000 of transfers from the owner's personal account. Adjusted receipts: $420,000 − $60,000 − $15,000 = $345,000, an understatement of $45,000. Reasoning: loan proceeds are not income because there is no accession to wealth, but only a documented, genuine obligation supports the exclusion; inter-account transfers are counted once, not twice.
Traps that cost marks
- Treating every deposit as income without identifying nontaxable sources.
- Confusing basis with fair market value, or omitting basis reductions for depreciation.
- Assuming consistency of method satisfies §446.
- Accepting a related-party "loan" with no repayment terms.