Page 1 of 11 Gleim CPA Review Updates to Regulation 2016 Edition, 1st Printing November 2016 NOTE: Text that should be deleted is displayed with a line through it. New text is shown with a blue background. If you are still studying for the CPA 2016 testing window that closes December 10, these updates do not apply to you. These edits update topics as they will be covered on the 2017 Q1 version of the CPA exam, for example, edits due to the PATH Act and The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015. We have included edits in this 2017 Q1 update for the following: Study Unit 1 Ethics and Professional Responsibilities Study Unit 2 CPAs and the Law Study Unit 3 Individual Taxation and Gross Income Study Unit 4 Self-Employment, Farming, and Adjustments Study Unit 5 Deductions from AGI, Credits, AMT, and Limitations Study Unit 6 Property Transactions Study Unit 7 Corporate Taxable Income Study Unit 9 Corporate Tax Special Topics Study Unit 10 S Corporations Study Unit 12 Estates, Trusts, and Wealth Transfer Taxes Study Unit 13 Federal Tax Legislation, Procedures, Planning, and Accounting Study Unit 16 Agency and Regulation These topic updates do not apply for candidates taking the exam prior to January 1, 2017. Changes for the 2017 Q2 version of the exam will be in our upcoming 2017 edition materials. Study Unit 1 Ethics and Professional Responsibilities Page 13, Subunit 1.1, item 3.d.3): 3) Practitioner. A practitioner, properly authorized by the taxpayer, who (a) signed a return as a preparer or (b) prepares a return but is not required (by the instructions to the return or regulations) to sign the return may represent the taxpayer with respect to tax liability for the period covered by the return. 4 3) Others. An individual may be authorized by the Commissioner of the IRS to represent others in a particular matter. Page 21, Subunit 1.3, item 4.d.: d. If the understatement was caused by the preparer s willful or reckless conduct, the penalty is the greater of $5,000 or 50% 75% of the income to be derived.
Page 2 of 11 Page 34, Subunit 1.3, Question 28: 28. Which of the following acts, if any, constitute grounds for a tax preparer penalty? I. Without the taxpayer s consent, the tax preparer disclosed taxpayer income tax return information under an order from a state court. II. At the taxpayer s suggestion, the tax preparer deducted the expenses of the taxpayer s personal domestic help as a business expense on the taxpayer s individual tax return. Answer (B) is correct. REQUIRED: The acts, if any, that constitute grounds for a tax preparer penalty. DISCUSSION: A penalty equal to the greater of $1,000 $5,000 or 50% 75% of the income derived is imposed on a tax return preparer if any part of an understatement of tax liability resulted from a willful attempt to understate the liability or from an intentional disregard of rules or regulations. A penalty will not be imposed if client information is disclosed under a court order. A. I only. B. II only. C. Both I and II. D. Neither I nor II. Study Unit 2 CPAs and the Law Page 47, Subunit 2.1, item 8.b.: b. Regulation A permits certain issuers to offer up to $5 million of securities in any 12-month period without full filing a formal registration statement and prospectus. It imposes no limitations on the number and nature of investors, and resale is not restricted. However, neither an issuer subject to the reporting requirements of the 1934 act immediately before the offering nor investment companies are eligible for the exemption General solicitation and advertising are allowed, and resale is not restricted. However, investment companies and issuers subject to the reporting requirements of the 1934 act immediately before the offering are not eligible for the exemption. 1) The Jumpstart our Business Startups (JOBS) Act of 2012 provides for an exemption of up to $50 million within second tier of Regulation A offerings. In this tier, the amount sold in a 12-month period must not exceed $50 million, the securities may be offered and sold publicly, and the issuer must file audited financial statements annually and other disclosures required by the SEC. The SEC s new rules under the 1933 act Regulation A+ establish criteria for Tier 1 (maximum of $20 million) and Tier 2 (maximum of $50 million) offerings. 2) The SEC integrates all registrations and exempted offerings. For example, three registrations of $2 million each would not qualify for exemption under Regulation A if issued within one 12-month period. The SEC does not integrate an offering unless it is made within 6 months before or after another offering. 3) Regulation A filings are less detailed, time consuming, and costly than full registration statements. a) A formal registration statement and prospectus are not required. Offerings and sales still may be made by general solicitation and advertising, and the securities continue to be unrestricted. But all issuers must file financial statements for the last 2 complete fiscal years. i) Bad actors, persons who are convicted or subject to sanctions for securities fraud or other offenses involving transactions in security on SEC filings, cannot use the exemption.
Page 3 of 11 b) An offering statement containing a notification and an offering circular must be filed with the SEC s regional office, and the 20-day waiting period must be observed. The offering circular also must be provided to offerees and purchasers of the underlying securities. Sales may by made after the SEC has approved the filing with certain disclosures must be filed on EDGAR and approved by the SEC. Also, each offeree and purchaser must receive an offering circular with concise narrative disclosures. c) The issuer may test the waters by use of using broadcast or written advertisements. But no oral communications with buyers are allowed until the SEC receives the advertisements. No sales are allowed until the offering statement is approved by the SEC. d) Under Tier 1, the number and nature of investors are not limited, and no ongoing reporting requirements apply. e) Under Tier 2, a nonaccredited investor in unlisted securities cannot purchase an amount exceeding 10% of the greater of the investor s net worth or annual income. Furthermore, (1) annual, semiannual, and current events filings must be made; (2) audited statements must be included in the offering statement; and (3) issuers are exempt from registration and qualification under state securities (blue-sky) laws. Page 49, Subunit 2.1, item 8., table: Exempt Transactions by Issuers Exemption Maximum Price Investors Method of Offer Resale Rule 147 (intrastate offerings) Regulation A (excludes issuers that report under 1934 act) Regulation A+ Tier 1 (excludes issuers reporting under the 1934 act, investment companies, and bad actors Regulation A+ Tier 2 (excludes issuers filing under the 1934 act, investment companies, and bad actors) Regulation D -- Rule 504 (excludes most issuers that report under 1934 act) No maximum $5 million in 12-month period $20 million in 12month period $50 million in 12-month period $1 million in 12-month period -- Rule 505 $5 million in 12-month period Purchasers and offerees must be state residents No limit No limit Noncredited investors limited to 10% of the greater of annual income or net worth if securities unlisted No limit No more than 35 purchasers who are not accredited -- Rule 506 No maximum No more than 35 purchasers who are not accredited. Must have the knowledge and experience to evaluate the risks and merits. Rule 4(6) $5 million Only accredited but number unlimited Crowdfunding $1 million No limit but amount limited by income and net worth General solicitation and advertising, but interstate distribution not permitted Testing the waters; sales after approval of offering statement Testing the waters, offering circular, approval of filed offering statements, general solicitation and advertising, 2 years of financial statements Same as Tier 1 plus audited statements in offering statement; annual, semiannual, current events filings; exemption from blue-sky laws General solicitation allowed if compliant with state law No general solicitation or advertising No general solicitation and advertising unless all sales are to accredited investors No general solicitation or advertising Funding portals on Internet No resales to nonresidents for at least 9 months Not restricted Not restricted Not restricted Not restricted if compliant with state law Restricted Restricted Restricted Restricted
Page 60, Subunit 2.3, item 13.a.2)a): Page 4 of 11 a) However, a corporate issuer with a market capitalization of less than $75 million is exempt from the required audit of management s assertions about control and procedures for financial reporting (Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010). Pages 61-62, Subunit 2.3, item 14.: 14. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 a. This comprehensive legislation was enacted after the economic crisis in 2008. The act extends to, among other things, (1) the financial services industry, (2) consumer protection, (3) financial markets, (4) securities laws, (5) financial reporting and governance, and (6) broker-dealer audits. b. The act enlarges the scope of the SEC s authority to prosecute those who aid and abet securities law violations. 1) Moreover, the legal standard for those involved is now knowing or reckless instead of merely knowing. c. Auditors of broker-dealers are subject to inspection by the PCAOB and possible sanctions. 1) All broker-dealers must be audited by registered auditors. d. The Financial Stability Oversight Council has been established to (1) identify, in advance, financial system risks; (2) comment to the SEC about accounting issues; and (3) report annually to Congress about financial market and regulatory matters. e. Investment advisors with $25 million to $100 million of assets under management must register with state regulators. 1) But an advisor required to register with at least 15 states may register with the SEC. f. Shareholders have the right to a nonbinding vote on compensation for specified corporate officers at least once every 3 years. 1) The act also requires independent compensation committee members and disclosure of independent compensation committee advisors and related fees or conflicts of interest. 2) A public company must have a clawback policy defining how to recover performance-based executive compensation after a financial restatement. 3) The SEC now has the power to give shareholders with at least 3% of the voting interests access to the corporation s proxy procedures. g. The SEC may compensate whistleblowers who provide information other than that from an audit or investigation. 1) Whistleblowers may sue retaliating employers. 2) Under SOX, (a) whistleblower claims may be asserted for up to 180 days, (b) trial by jury is allowed, and (c) whistleblower rights and remedies may not be waived. h. Credit rating agencies are to be examined annually by the SEC. These agencies (1) must disclose their methods, (2) are subject to investor suits, and (3) must consent to use of their ratings in registration statements.
i. Over-the-counter derivatives are regulated by the SEC and the Commodity Futures Trading Commission (CFTC). Page 5 of 11 1) Hedge funds and private equity funds must register with the SEC. 2) If derivatives can be cleared, the act requires that they be centrally cleared and exchange traded. 3) The act prohibits the Federal Reserve and the Federal Deposit Insurance Corporation from assisting most insured depository institutions that participate in swap markets. Page 70, Subunit 2.1, Question 5: 5. An offering made under the provisions of Regulation A+ of the Securities Act of 1933 Tier 1 requires that the issuer A. File an offering circular statement with the SEC. B. Sell only to accredited investors. C. Provide investors with the prior 4 years audited financial statements. D. Provide investors with a proxy registration statement. Answer (A) is correct. REQUIRED: The requirement for a stock offering made under Regulation A+ Tier 1. DISCUSSION: Under Regulation A Tier 1, a small public issue of securities up to $20,000,000 is exempt from full registration with the SEC if certain requirements are met. Regulation A applies to issuances not exceeding $5 million if the issuer files an offering circular with the SEC, provides it to each offeree and purchaser, and observes the 20-day waiting period The issuer must file an offering statement with the SEC on EDGAR, provide it to each offeree and purchaser, and observe the 20-day waiting period. But Regulation A is not available to an issuer that must report under the 1934 act or an investment company that contains specified disclosures. Moreover, each offeree and purchaser must receive an offering circular containing concise narrative disclosures, and the issuer must file 2 years of financial statements. Advantages of a Tier 1 offering are that (1) ongoing reporting requirements do not apply, and (2) the number and nature of investors are unlimited. Answer (B) is incorrect. Regulation A does The rules for Tier 1 do not restrict resale, have an investor sophistication requirement, or limit the number of buyers. Also, no disclosure is necessary if the offering is $100,000 or less. Answer (C) is incorrect. Regulation A+ provides an exemption from the otherwise required filing of a registration statement and prospectus requires the issuer to file financial statements for the last 2 complete fiscal years. Answer (D) is incorrect. Filing proxy statements is required under the 1934 act. Regulation A provides an exemption from filing certain requirements of the 1933 act. Study Unit 3 Individual Taxation and Gross Income Page 92, Subunit 3.1, item 3.d.: d. Since 2013, same-sex couples have qualified for married filing status. The related Supreme Court rulings of 2015 have little effect on federal taxes, other than an expected increase in the volume of married same-sex taxpayers filing joint returns, now that all states are required to license marriages between people of the same sex.
Page 6 of 11 Study Unit 4 Self-Employment, Farming, and Adjustments Page 139, Subunit 4.1, item 25.e.3): 3) Deductions allocable to the trade or business for which the home office is used that are not home office expenses, e.g., employee compensation, minus NOTE: The Schedule C deduction is still only the portion allocated to the business use of the home. The remaining expense is an itemized deduction on Schedule A. Page 158, Subunit 4.5, item 9.b.2)b): This information was previously edited in our June 2016 update. b) Taxpayers with an AGI exceeding $80,000 ($160,000) do not receive any deduction NOTE: The tuition statement (Form 1098) provided to the taxpayer is required to include the name, address, and TIN (Taxpayer Identification Number) of the student. Study Unit 5 Deductions from AGI, Credits, AMT, and Limitations Page 189, Subunit 5.3, item 2.d.3): 3) The Lifetime Learning Credit is available for an unlimited number of years and can be used for both graduate- and undergraduate-level courses. NOTE: The tuition statement (Form 1098) provided to the taxpayer must include the name, address, and TIN (Taxpayer Identification Number) of the student. Page 193, Subunit 5.3, item 3.e.5): 5) The American Opportunity Credit is allowed per student while the Lifetime Learning Credit is calculated per taxpayer, without reference to the number of students. NOTE: The tuition statement (Form 1098) provided to the taxpayer must include the name, address, and TIN (Taxpayer Identification Number) of the student. Study Unit 6 Property Transactions Page 222, Subunit 6.1, item 8.a.: This content was added in our June 2016 update, in which it appears under item 10.a.3). 3) Generally, repairs and maintenance expenses are considered a current-period deduction. However, certain repairs may be classified as an improvement, which must be capitalized. There are multiple safe harbors that allow repairs and maintenance to always be classified as a current-period expense instead of capitalized. a) Repairs under $2,500 are always considered a de minimis expense ( Taxpayers who have elected to use the de minimis expense treatment must expense all repairs up to the de minimis amount (i.e., $2,500, or $5,000 for taxpayers with audited or other approved financial statements).
Page 233, Subunit 6.4, item 1.: 1. Limited Tax Avoidance Page 7 of 11 a. These rules limit tax avoidance between related parties. b. Gain recognized on an asset transfer to a related person in whose hands the asset is depreciable is ordinary income. c. Loss realized on sale or exchange of property to a related person is not deductible. The transferee takes a cost basis. There is no adding of holding periods. 1) Gain realized on a subsequent sale to an unrelated party is recognized only to the extent it exceeds the previously disallowed loss. a) If the gain realized on the sale to an unrelated third party is less than the amount of disallowed loss, no gain is recognized. EXAMPLE Taxpayer A sells stock with a basis of $100,000 to a related person, Taxpayer B, for $80,000, creating a $20,000 disallowed loss for Taxpayer A. If Taxpayer B then sells the stock to an unrelated party for $130,000, the realized gain will be $50,000 ($130,000 sale price $80,000 basis) and Taxpayer B will recognize a $30,000 gain ($50,000 realized gain $20,000 disallowed loss from original transaction between A and B). However, if the sale to an unrelated party were for $90,000, the resulting $10,000 gain ($90,000 sale price $80,000 basis) would not be recognized. The $10,000 gain is offset by $10,000 of the $20,000 disallowed loss. Finally, if the unrelated sale had been for $65,000 (creating an additional $15,000 loss), Taxpayer B could only recognize a $15,000 loss, not a $35,000 loss ($20,000 disallowed loss + $15,000 unrelated-sale loss). 2) Loss realized on a subsequent sale to a third party is recognized, but the previously disallowed loss is not added to it. d. For property purchased on or after January 1, 2016, a new rule precludes the above recognition of the disallowed loss when later sold to an unrelated party if the original transferor (e.g., Taxpayer A in the prior example) is a tax-indifferent party. 1) Tax-indifferent parties are those not subject to federal income tax or to whom an item would have no substantial impact on its income tax. Examples of taxindifferent parties include non-u.s. Persons, tax-exempt organizations, and government entities. EXAMPLE If we use the details from the previous example but change Taxpayer A to a tax-indifferent party, the disallowed loss will still be $20,000 when the stock sells for $80,000 to Taxpayer B; however, on the sale from Taxpayer B to an unrelated party for $130,000, the realized and recognized gain is $50,000 ($130,000 $80,000). The $50,000 gain is not offset by the disallowed loss. d e. For purposes of these provisions, related parties generally include 1) Ancestors (parents, grandparents, etc.), descendants (children, grandchildren, etc.), spouses, and siblings 2) Trusts and beneficiaries of trusts 3) Controlled entities (50% ownership) NOTE: Constructive ownership rules between family members apply. e f. Loss on sale or exchange of property between a partnership and a person owning more than 50% of the capital or profit interests in the partnership is not deductible.
Page 8 of 11 Page 258, Subunit 6.8, Unofficial Answers: 1. Basis (9 Gradable Items) 1. $15,000. The basis of property is generally its cost. Cost includes cash paid and any debt that the property is subject to. Basis also includes expenditures for major improvements and costs to acquire title. 2. 24 months. The character of gain on property disposition varies with the holding period. The holding period generally commences when the taxpayer acquires the property of an asset is measured in calendar months, beginning on the day after acquisition. 3. $5,250. The general rule is that the basis of property acquired by gift is the donor s adjusted basis, increased by any gift tax attributable to appreciation. Rich s father had a cost basis in the ring that was unadjusted for depreciation, and no gift tax was imposed on the transfer. Thus, Rich has a transferred basis of $5,250 in the ring. 4. 144 months. The holding period of property generally begins on the date following the date of acquisition. However, if property has the same basis in whole or in part as it had in the hands of a prior holder, the holding period of the prior holder is added (tacked on) to the present owner s holding period. 5. $12,000. Transferee takes a cost basis. 6. 4 months. Holding period on a sale or exchange commences upon acquisition The holding period of an asset is measured in calendar months, beginning on the day after acquisition. Study Unit 7 Corporate Taxable Income Page 266, Subunit 7.2, item 3.a.1): 1) If an employer purchases a policy that covers an employee and is issued after August 17, 2006, the proceeds from the policy are taxable to the extent proceeds exceed premiums paid. An exception is made for key employees, for whom the full amount of life insurance proceeds is excluded from gross income. Study Unit 9 Corporate Tax Special Topics Page 356, Subunit 9.9, Question 29: This information was previously edited in our October 2016 update. 29. A calendar-year C corporation received an automatic extension of time for filing its Year 1 return by submitting an application on Form 7004. On what date is the corporation s return due? A. September 30, Year 2. B. September 15, Year 2. C. August 15, Year 2. D. March April 15, Year 2. Answer (B) is correct. REQUIRED: The due date for the corporation s federal income tax return. DISCUSSION: A C corporation must file its return on or before the 15th day of the 3rd 4th month following the close of the tax year. For a calendar-year-end corporation, the due date for a tax return is 3/15/Yr 2 4/15/Yr 2. By filing Form 7004, the corporation receives an automatic 6-month 5-month extension for filing the tax return, which moves the due date to 9/15/Yr 2. However, the corporation must pay its estimated tax liability by the original due date. The time for payment of the taxes is not extended.
Page 9 of 11 Study Unit 10 S Corporations Page 376, Subunit 10.4, item 3.b.: This information was previously edited in our June 2016 update. b. For conversions made after the 2010 tax year, the recognition period normally is the 10 5-year period beginning on the date the S election became effective. For 2009 and 2010, the 10-year period was reduced to a 7-year period. This means if 2008 was the 7th year of S election, then the recognition period has ended for sales in 2009. Likewise, if 2009 was the 7th year, then the recognition period has ended for sales in 2010. 1) For 2011-2014, the recognition period is reduced to 5 years for disposals by S corporations if the 5th taxable year precedes the applicable year (2011-2014). a) Thus, the conversion must have taken place effective 2008 2011 for 2013 2016 disposals. Study Unit 12 Estates, Trusts, and Wealth Transfer Taxes Page 449, Subunit 12.4, new item 6.: 6. Consistent Basis Reporting for Estate Tax and Income Tax a. Those who file a Form 709, Estate Tax Return, after July 2015 are required to report the final estate tax value of property distributed from an estate. Form 8971, Information Regarding Beneficiaries Acquiring Property From a Decedent, along with a copy of every Schedule A (Form 8971), is used to report values to the IRS. Each beneficiary receiving property is only provided his or her corresponding Schedule A. This filing requirement ties beneficiaries to the value the estate put on the asset when the beneficiary later sells the asset. EXAMPLE: Peter dies in 2015 and leaves his son Victor a tract of land worth $6 million, which Peter had originally purchased for $1 million. The value of the land listed on Peter s estate tax return is $6 million, the stepped-up basis that Victor will have in the land. Victor cannot use a different appraisal amount to give the land a higher basis. b. If a decedent has no estate tax filing requirement [perhaps due to the gross estate being valued at less than the basic exclusion amount ($2,125,800 in 2016)] and for whom a return is filed for the sole purpose of making an allocation or election respecting the generation-skipping transfer tax, a Form 8971 is not required. c. For estate tax returns filed after July 2015 and before June 2016, the due date for the corresponding Form 8971 is June 30, 2016. For estate tax returns filed after June 2016, the due date is 30 days after the due date of the estate tax return. d. Form 8971 is subject to both the $250 failure to file penalty, and the accuracy-related penalty equal to 20% of the underpayment. The latter applies to the beneficiary overstating the basis upon a subsequent sale. This prevents estates from claiming a low basis to avoid estate tax and a high basis to prevent a gain on the subsequent sale.
Study Unit 13 Federal Tax Legislation, Procedures, Planning, and Accounting Page 474, Subunit 13.2, new item 2.b.: Page 10 of 11 b. Another significant filing requirement is the reporting of foreign financial accounts and specified foreign assets. Generally, any U.S. citizen, resident, or person doing business in the United States who has an ownership interest in or signatory authority or other authority over any number of financial accounts in a foreign country with an aggregate value in excess of $10,000 at any time during the calendar year, must file a Form FinCEN Report 114, Report of Foreign Bank and Financial Accounts (commonly referred to as an FBAR), reporting certain information with respect to those accounts by April 15 of the subsequent year or the extension due date of October 15, if applicable. Failure to file an FBAR is subject to both civil and criminal penalties. 1) Individuals must use Form 8938 to report specified foreign financial assets with an aggregate value that exceeds $50,000 on the last day of the year or exceeds $75,000 at any time during the tax year (this threshold is doubled for married individuals filing jointly). Form 8938 is required to be filed with an individual s annual income tax return. Individuals not required to file an annual income tax return are not required to file Form 8938. 2) The purposes of Form 8938 and the FBAR are similar, and there is significant overlap. Yet, filing Form 8938 does not relieve an individual of the requirement to file an FBAR. Many individuals will be required to file both Form 8938 and an FBAR to report substantially the same information. Despite the similarities, there are some differences between Form 8938 and the FBAR. The FBAR is not filed with an individual s federal income tax return to the IRS, but is instead filed electronically through the Bank Secrecy Act (BSA) e-file system with the Treasury s Financial Crimes Enforcement Network (FinCEN). Study Unit 16 Agency and Regulation Page 603, Subunit 16.8, item 7.: 7. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 a. The act created the Bureau of Consumer Financial Protection (BCFP), an independent entity. Its purposes include 1) Providing consumers with timely and understandable information; 2) Protecting consumers from unfair, deceptive, abusive, or discriminatory practices; 3) Promoting fair competition; and 4) Ensuring that consumer financial markets operate transparently and efficiently. b. The BCFP regulates 1) Large banks and credit unions, 2) Mortgage lenders, 3) Private student loan companies, 4) Payday lenders, 5) Other nonbank lenders not previously regulated, and 6) Sellers of financial products and services to consumers.
c. The BCFP 1) Provides education programs, 2) Investigates consumer complaints, 3) Publishes information on financial product markets and risks to consumers, 4) Supervises compliance by persons who offer or provide a consumer financial product or service, 5) Issues rules on consumer financial products or services, and 6) Enforces existing laws and regulations and monitors consumer lending and investment. Page 11 of 11