Deep Dive into US Tax Law — Individual, Corporate, and Consumption Taxes

The Nature of CPA/EA Tax Questions

CPA REG and EA exam questions are not pure memorization tests. Case-based multiple-choice questions and task-based simulations require you to apply tax code provisions to specific fact patterns — computing the correct tax liability or identifying the proper treatment.

Individual Income Tax: Complete Computation Flow

The 6-Step Computation Structure

① Identify all items of gross income (IRC §61)
   Wages, salaries, tips, interest, dividends, business income,
   gains, rents, alimony (pre-2019 agreements), other income
       ↓
② Compute Adjusted Gross Income (AGI)
   Gross income − above-the-line deductions:
   (educator expenses, student loan interest, alimony paid pre-2019,
   self-employment tax deduction, HSA contributions, IRA contributions)
       ↓
③ Compute Taxable Income
   AGI − (Standard Deduction or Itemized Deductions)
   AGI − QBI Deduction (§199A, up to 20% of qualified business income)
       ↓
④ Apply Tax Rates → Tentative Tax
   10% / 12% / 22% / 24% / 32% / 35% / 37% (2024 MFJ brackets)
       ↓
⑤ Apply Tax Credits
   Child Tax Credit, Earned Income Credit, American Opportunity Credit,
   Child and Dependent Care Credit, Foreign Tax Credit
       ↓
Final tax liability (amount owed or refund)

3 Key Individual Tax Issues

① Employee vs Independent Contractor Classification

This distinction is one of the most frequently tested issues on both the CPA REG and EA exams.

② Excluded Income (Major Nontaxable Items)

• Gifts and inheritances (§102) — not income to recipient
• Life insurance death benefits (§101)
• Workers’ compensation (§104)
• Up to $250,000 /$500,000 (MFJ) gain on qualified home sale (§121)
• Qualified scholarships (§117) — amounts used for tuition and fees
• Municipal bond interest (§103)

③ Net Operating Loss (NOL) Treatment

• TCJA 2017 changes: NOL carryforward is indefinite; carryback eliminated (except farming NOLs)
• Deduction limited to 80% of taxable income in carryforward year
• Excess business losses (§461(l)): annual cap applies to non-corporate taxpayers
• Passive activity rules (§469): rental and passive activity losses offset only passive income (with exceptions)

Corporate Income Tax: Complete Computation Flow

The 7-Step Computation Structure

① Start with book net income (GAAP income)
       ↓
② Make tax adjustments (Schedule M-1 / M-3 reconciliation)
   + Add back non-deductible items (book expenses not allowed for tax)
   − Remove book income not recognized for tax
       ↓
③ Adjusted Taxable Income (pre-NOL)
       ↓
④ Deduct NOL carryforward (80% of taxable income limit)
       ↓
⑤ Deduct dividends-received deduction (DRD)
   (70%, 65%, or 100% depending on ownership %)
       ↓
⑥ Taxable Income
       ↓
⑦ Apply Flat 21% Corporate Rate → Tentative Tax
   − Tax credits (R&D credit, foreign tax credit, general business credit)
   → Net tax liability

3 Key Corporate Tax Issues

① Non-Deductible (Disallowed) Expenses

Frequently tested — must know the major categories.

② Related Party Transactions (§267 and Transfer Pricing)

When transactions occur between related parties (e.g., majority shareholders, family members, controlled entities), the IRS scrutinizes pricing.

• §267: Losses on sales to related parties are disallowed; deferred gain rules apply
• Transfer pricing (§482): IRS may reallocate income between commonly controlled entities to reflect arm’s-length pricing
• Application: difference between transaction price and fair market value ≥ 5% or ≥ $10,000 triggers scrutiny

③ Depreciation and Cost Recovery

• MACRS (Modified Accelerated Cost Recovery System): applies to tangible property placed in service after 1986
• Common recovery periods: 5-year (computers, cars), 7-year (office furniture, most equipment), 27.5-year (residential rental), 39-year (commercial real estate)
• §179 Expensing: elect to deduct up to ~$1.22M (2024) of qualifying property in year placed in service (phase-out above ~$3.05M)
• Bonus Depreciation (§168(k)): 60% in 2024 (phasing down), first-year additional depreciation on qualified property
• Luxury auto limitations: annual caps on vehicle depreciation (§280F)

Consumption and Excise Taxes

Federal Excise Taxes and State Sales Taxes

Federal Excise Taxes:
Sales price × applicable excise tax rate

Major Federal Excise Tax Categories:
  - Fuel taxes (gasoline, diesel, aviation fuel)
  - Tobacco and alcohol (cigarettes, beer, wine, spirits)
  - Communications (telephone excise tax, historically)
  - Transportation (airline tickets — 7.5% federal excise)
  - Environmental taxes (certain chemicals, petroleum)

State Sales and Use Tax:
  - Imposed by 45 states + D.C. (no state sales tax: NH, OR, MT, DE, AK)
  - Rates vary: approximately 4%–10%+
  - Nexus rules post-Wayfair (2018): economic nexus applies to remote sellers
  - Use tax: applies to out-of-state purchases used in-state (self-assessed)

Zero-Rate vs Exemption Comparison

Tax Procedures and Collections (EA Part 3 / CPA REG)

IRS Collection Process

IRS Appeals and Dispute Resolution

High-Frequency Topic Summary Table

Study Checklist

• Individual Tax — Compute AGI and taxable income from a complete fact pattern
• Individual Tax — Distinguish deductions (reduce taxable income) vs credits (reduce tax)
• Individual Tax — NOL carryforward rules: 80% limit, indefinite carryforward
• Corporate Tax — List 6+ major non-deductible (disallowed) expense categories
• Corporate Tax — Perform Schedule M-1 book-to-tax reconciliation
• Corporate Tax — Related-party transaction: §267 loss disallowance requirements
• Consumption Tax — Sales tax nexus rules post-Wayfair
• Consumption Tax — List 5+ states with no state sales tax
• IRS Procedure — Statute of limitations: 3 / 6 / unlimited / 10-year rules
• IRS Appeals — Explain when to use Appeals vs Tax Court vs District Court
• Ethics — Circular 230: list key due diligence and prohibited conduct rules
• Full Exam — Complete 3 full-length REG practice sections under timed conditions