Free EA Part 2 practice questions

Answer: B. No, Jennifer can file only Form 2553 by May 15, 2025, which implicitly elects corporate classification

Filing Form 2553 alone is sufficient for an LLC to elect S corporation status. The S election implicitly includes the corporate classification election, so Form 8832 is not required (Treas Reg §301.7701-3(a) and IRC §1362(a)). For a newly formed entity starting on March 1, Jennifer must file Form 2553 within 2 months and 15 days of the beginning of the tax year (May 15, 2025) for the election to be effective for 2025. Option A is incorrect because it states Form 8832 is required when it is not. Option C is wrong because simultaneous filing is unnecessary. Option D is incorrect because there is no 60-day waiting period between forms, and Form 8832 is not needed at all in this scenario.

IRS source: Treas Reg §301.7701-3(b)(1)(ii), §301.7701-3(a)

Answer: B. Chen recognizes no loss and takes $55,000 total basis in the distributed property; David recognizes a $43,000 loss and takes $12,000 basis in inventory

Under IRC §731(a)(2), a loss is recognized in a liquidating distribution ONLY if the partner receives no property other than cash, unrealized receivables, and/or inventory. Chen received a computer (a capital asset), which precludes loss recognition. Under IRC §732(b), his remaining outside basis of $55,000 ($80,000 basis - $25,000 cash) is allocated as follows: the inventory takes a carryover basis of $12,000 (it cannot be stepped up per §732(c)), and the remaining $43,000 is substituted as the basis for the computer, resulting in a total property basis of $55,000. David, however, received only cash and inventory. His recognized capital loss is the difference between his outside basis and the sum of the cash and the partnership's basis in the inventory ($80,000 - $25,000 - $12,000 = $43,000 loss). In this scenario, the inventory's basis in David's hands remains the partnership's basis ($12,000) and cannot be stepped up to absorb the remaining outside basis.

IRS source: IRC §731, §732

Answer: B. Independent contractor, because Maya uses her own equipment, has multiple clients, and determines her own work schedule

Maya is properly classified as an independent contractor. Under the three-factor common law test: (1) Behavioral control: TechStart does not control when or how Maya performs her work; she sets her own schedule. (2) Financial control: Maya uses her own equipment, pays her own expenses (software subscriptions), has multiple clients (opportunity for profit/loss), and makes her services available to the market. (3) Type of relationship: No benefits are provided, the relationship is project-based rather than permanent. Option A is incorrect because the written contract label is only one factor and is not determinative; the IRS examines the actual working relationship. Option C is incorrect because social media managers do not fall into any of the four statutory employee categories (life insurance salesperson, agent-driver, traveling salesperson, home worker). Option D is incorrect because whether services are a key business activity is only one factor among many in the 'type of relationship' category and does not override the strong independent contractor indicators in behavioral and financial control.

IRS source: Pub 15-A

Answer: B. Lodging and meals are not deductible because Keisha has no regular place of business, making her an itinerant worker with no tax home

Keisha's tax home is NOT her Austin apartment but rather her principal place of business. A taxpayer's tax home is generally their regular place of business, not their residence. Because Keisha works in temporary assignments of equal duration in different cities with no regular principal place of business, she is considered an itinerant worker with no tax home. Without a tax home, she cannot be 'traveling away from home' and therefore cannot deduct lodging and meals as travel expenses under IRC §162. Option A is incorrect because tax home is based on principal place of business, not residence. Option C is incorrect because the duration comparison is irrelevant when there is no established principal place of business. Option D is incorrect because the issue is not the indefinite nature of any one assignment but rather the lack of a tax home altogether. This is a classic edge case where maintaining a residence is insufficient to establish a tax home for travel expense purposes.

IRS source: Pub 463, IRC §162

Answer: B. Deduct $25,000 as an ordinary business loss and $3,000 as a short-term capital loss with $27,000 carried forward

The Client A receivable is a business bad debt created in Elena's consulting business. Business bad debts may be partially deducted when partial worthlessness is established (IRC §166(a)(2)), so the $25,000 uncollectible portion is deductible as an ordinary loss in 2025. The loan to Marcus is a nonbusiness bad debt because it was made for personal reasons unrelated to Elena's trade or business. Nonbusiness bad debts are deductible only when totally worthless (which occurred in 2025 with Marcus's bankruptcy) and only as short-term capital losses (IRC §166(d)). The $30,000 nonbusiness bad debt is treated as a short-term capital loss, subject to the $3,000 annual capital loss limitation for individuals, with the remaining $27,000 carried forward. Option A incorrectly allows the full $30,000 capital loss in one year. Option C incorrectly treats the personal loan as a business debt. Option D incorrectly delays the business bad debt deduction when partial worthlessness is already established.

IRS source: IRC §166, Pub 535

Answer: C. Both the orchard development and storage facility costs must be capitalized because the partnership's gross receipts exceed the $31 million threshold, making it subject to UNICAP.

For tax year 2025, the small business exemption from UNICAP (IRC §263A(i)) applies to taxpayers with average annual gross receipts for the three prior years of $31 million or less. Because Orchard Valley LLC's average annual gross receipts are $45 million, it exceeds the 2025 threshold ($31 million) and is subject to UNICAP. Furthermore, under §263A(d)(1)(B), the general farming exemption from UNICAP does not apply to partnerships with a corporate partner that are required to use the accrual method under §448 (which Orchard Valley is, having exceeded the gross receipts threshold). Because the apple trees have a preproductive period of 4 years (exceeding 2 years) and no §263A(d)(3) election was made, the orchard development costs must be capitalized. Additionally, §263A applies to real property produced by the taxpayer for use in its trade or business. The storage facility is a self-constructed asset, and since the partnership does not qualify for the small business exemption, these construction costs must also be capitalized. Therefore, both sets of costs must be capitalized.

IRS source: IRC §263A(i); IRC §448(c); IRS Pub 225

Answer: B. Only the $180,000 distribution is QBI; the $120,000 salary is excluded from the QBI calculation

For S corporation owners, reasonable compensation (W-2 wages paid to the owner-employee) is NOT QBI. Only the profit distribution that passes through after the salary is paid qualifies as QBI. Amir's $120,000 salary is ordinary W-2 wage income, and the $180,000 distribution is his QBI. However, because Amir's taxable income ($315,000) exceeds the full phase-out threshold for single filers ($247,300), and accounting is an SSTB, his QBI deduction will be fully phased out to zero. But the question asks about the correct TREATMENT, not the final deduction amount. The correct treatment is that only the $180,000 qualifies as QBI. Option A incorrectly includes the salary as QBI. Option C reaches the right conclusion about the final deduction (zero) but for the wrong reason in terms of what constitutes QBI. The $180,000 IS QBI, it's just that the deduction is phased out. Option D reverses the correct treatment, incorrectly treating salary as QBI.

IRS source: IRC §199A(d)(2)

Answer: A. Deduct $13,200 on Schedule 1 and file a corrected W-2 removing the amount from Boxes 3 and 5

Carmen should deduct the $13,200 on Schedule 1 as a self-employed health insurance deduction because >2% S corporation shareholders are treated as self-employed for this purpose. However, the W-2 was incorrectly prepared. The premiums should be included in Box 1 (wages) but NOT in Boxes 3 or 5. They are not subject to Social Security or Medicare taxes (FICA). Carmen should request a corrected W-2 (W-2c) to avoid overpayment of FICA taxes. Option B is incorrect because Carmen qualifies for the above-the-line deduction under §162(l). Option C is incorrect because the tax code specifically treats >2% S corp shareholders as self-employed for health insurance purposes. Option D is incorrect because the W-2 error does affect Carmen's FICA tax liability and must be corrected.

IRS source: IRC §162(l); Notice 2008-1

Answer: A. He cannot establish or fund a SEP-IRA for 2025 because the April 15 deadline has passed

Under IRC section 404(h)(1)(B) and IRS Publication 560 (2025), a SEP can be set up, and contributions for a year can be made, as late as the due date of the return for that year including extensions. Marcus did not request an extension, so his deadline for 2025 was April 15, 2026. By May 1, 2026, that deadline has passed, so he cannot establish or fund a SEP-IRA for 2025. Option A is correct. Option B is wrong because filing an amended return does not extend the SEP deadline; only a timely extension of the original return does. Option C is wrong because its reason is wrong: filing the return does not by itself end the SEP window. The deadline is the return due date (including extensions), which here was April 15, 2026, whether or not he had already filed. He can set up a SEP for 2026, but that does not make the stated reason correct. Option D is wrong because an extension request must be filed by the original due date of April 15, 2026, so a request after that date is not valid.

IRS source: Pub 560

Answer: C. Standard mileage: $13,200 [$11,200 + $1,400 + $600]; Actual expense: $6,680 [(80% × $5,850) + $1,400 + $600]

Under Pub 463, business parking fees and tolls are ALWAYS deductible in full (100% of business-related amounts) in addition to either the standard mileage rate or actual expenses. This is a critical exception: parking and tolls are never included in the standard mileage rate and are never prorated by business-use percentage. Under the standard mileage method: 16,000 miles × $0.70 = $11,200, PLUS $1,400 parking + $600 tolls = $13,200 total. Under the actual expense method: business percentage is 16,000/20,000 = 80%, so ($5,850 × 80%) = $4,680, PLUS $1,400 parking + $600 tolls (full amounts, not prorated) = $6,680 total. In this case, standard mileage yields a higher deduction ($13,200 vs. $6,680). Option A incorrectly excludes parking/tolls from standard mileage. Option B incorrectly assumes parking/tolls are included in the rate or must be prorated. Option D reverses the treatment, incorrectly suggesting parking/tolls can only be added under standard mileage.

IRS source: Pub 463

Answer: B. $25,000 long-term capital gain

Option B is correct. Both the bulldozer loss ($15,000) and the building gain ($40,000) are §1231 items because both assets are depreciable property used in business and held more than one year. Under §1231, all §1231 gains and losses are netted. Here, the net is $40,000 - $15,000 = $25,000 net §1231 gain. Under IRC §1231(a), a net §1231 gain is treated as long-term capital gain. (If there had been a net §1231 loss, it would be treated as ordinary loss.) Since Jamal has no prior §1231 losses, the 5-year lookback rule does not recharacterize any of the gain as ordinary income. Option A is incorrect because net §1231 gains are treated as LTCG, not ordinary income. Option C is incorrect because §1231 items must be netted together; they are not reported separately. Option D is incorrect because §1231 property must be held more than one year (which both assets were), and the net §1231 gain is treated as long-term capital gain, not short-term.

IRS source: IRC §1231

Answer: C. $270,000 gain, representing the acceleration of all remaining deferred gain under related party rules

The correct answer is C. Under IRC §453(e), if a related party (such as a 100%-owned S corporation) resells property within 2 years of the original installment sale, the original seller must treat the amount realized by the related party as a payment received, up to the original contract price. Sophia's total realized gain was $300,000 ($500,000 sale - $200,000 basis). Having recognized $30,000 in 2024, her remaining deferred gain is $270,000. In 2025, the S corporation's resale for $520,000 is capped at the $500,000 original contract price for calculation purposes. The deemed payment in 2025 is $450,000 ($500,000 contract price limit minus $50,000 already received in 2024). Sophia recognizes $270,000 of gain ($450,000 × 60% gross profit ratio). Furthermore, IRC §453(e)(5) prevents double taxation by stating that subsequent actual payments (the $45,000 received in 2025) are not taxed until they exceed the amount already treated as received under the acceleration rule. Option A is incorrect because it ignores the acceleration rule. Option B is incorrect because it double-counts the gain by adding the payment gain to the accelerated gain, which is prohibited by §453(e)(5). Option D is incorrect because it includes the S corporation's own separate $20,000 gain, which is a pass-through item but not part of Sophia's installment sale gain calculation.

IRS source: IRC §453(e); IRS Pub. 537

Answer: A. The ASC method produces a greater credit because the 14% rate exceeds the effective rate under the regular method when the base amount is relatively high

ASC credit: Average prior 3-year QREs = ($600,000 + $580,000 + $620,000) ÷ 3 = $600,000. Credit = 14% × ($900,000 - 50% × $600,000) = 14% × $600,000 = $84,000. Regular credit: Base amount = 2.8% × $18,000,000 = $504,000 (exceeds 50% of current QREs, so it is the base). Credit = 20% × ($900,000 - $504,000) = 20% × $396,000 = $79,200. The ASC produces $84,000 vs. $79,200 under the regular method. The key factor is that Precision's fixed-base percentage (2.8%) applied to substantial gross receipts ($18M) produces a high base amount ($504,000), which limits the excess QREs under the regular method to $396,000. Even though the regular method's 20% rate exceeds ASC's 14%, ASC's lower base (50% of average = $300,000) yields greater excess QREs ($600,000) and a higher total credit. Option B is incorrect: the regular method yields less. Option C misstates the base amount comparison. Option D is irrelevant to which method produces a greater credit.

IRS source: IRC §41(c)(5), §41(a)(1)

Answer: B. Elena: $9,000; Daniel: $2,400

The correct answer is B. Elena qualifies as a 'long-term family assistance recipient' (Target Group 9) under IRC §51(d)(13) because she received benefits for at least 18 consecutive months (26 months in this case). Under IRC §51(e), the credit for this group is 40% of the first $10,000 of first-year wages ($4,000) and 50% of the first $10,000 of second-year wages ($5,000), totaling $9,000. Daniel qualifies as a 'qualified IV-A recipient' (Target Group 1) because he received benefits for at least 9 months (10 months in this case) during the 18-month period ending on his hire date. Under IRC §51(b), the credit for this group is 40% of the first $6,000 of first-year wages ($2,400). No second-year credit is available for Target Group 1. Option A incorrectly calculates Elena's credit as if she were a standard recipient over two years ($2,400 + $2,400). Option C incorrectly treats Daniel as qualifying for a two-year credit. Option D incorrectly ignores the wage caps and the one-year limitation for standard recipients.

IRS source: IRC §51(b), §51(d)(13), §51(e)

Answer: C. Yes, because the short tax year is annualized to determine average gross receipts, and the business qualifies under the $31 million threshold

A business that maintains inventory can use the cash method only if it is a small business taxpayer that meets the gross receipts test of IRC section 448(c) (IRS Publication 538). For tax years beginning in 2025, the test is met if average annual gross receipts for the 3 prior tax years do not exceed $31 million (Rev. Proc. 2024-40). Because Rivera has existed for only one prior tax year, the test is applied using that period (IRC section 448(c)(3)(A)), and gross receipts for a short tax year are annualized (IRC section 448(c)(3)(B)). The $20 million earned in the 9-month 2024 short year annualizes to $26,666,667 ($20,000,000 × 12 ÷ 9). Because about $26.67 million does not exceed $31 million, Rivera qualifies to use the cash method for 2025. Option A is incorrect because the annualized amount is below, not above, the $31 million threshold. Option B reaches the right conclusion for the wrong reason: the test looks only at prior tax years, so the $12 million of 2025 receipts is not part of it, and the short year must be annualized rather than simply averaged with another period. Option D is incorrect because small business taxpayers that meet the gross receipts test may use the cash method even when they have inventory.

IRS source: IRC §448(c), §443