Ch9. CPA/EA Exam — Top Error Analysis: The Points Candidates Most Often Miss

Corporate Tax Common Errors

① Nondeductible expenses vs. tax-exempt income
   → Nondeductible: disallowed business expense (increases taxable income)
   → Tax-exempt income: excluded from gross income entirely (no tax owed)

② Corporate tax rate
   → 21% flat rate (post-TCJA) — no brackets
   → Confusing with pre-TCJA graduated rates is a common trap

③ Meals deduction = 50%; Entertainment = 0%
   → Post-TCJA: entertainment is fully nondeductible
   → Meals with a business purpose: 50% deductible (document purpose)

④ Temporary vs. permanent differences
   → Temporary = creates deferred tax asset/liability (reverses in future)
   → Permanent = never reverses (e.g., meals 50% disallowance, tax-exempt interest)

⑤ Net Operating Loss (NOL) deduction
   → Post-TCJA: NOL deduction limited to 80% of taxable income per year
   → Indefinite carryforward (no more 2-year carryback for most taxpayers)
   → Pre-2018 NOLs: different rules (20-year carryforward, 2-year carryback)

Individual Tax Common Errors

⑥ Investment income threshold for NIIT = $200K / $250K MAGI
   → Net Investment Income Tax (3.8%) applies above these thresholds
   → Not just interest and dividends — includes rental income and capital gains

⑦ Capital gains = preferential rates (not ordinary income)
   → Short-term (≤1 year) = ordinary income rates
   → Long-term (>1 year) = 0% / 15% / 20% preferential rates

⑧ Standard deduction vs. personal exemption
   → Post-TCJA: personal exemptions = $0 (suspended through 2025)
   → Standard deduction: $15,000 single / $30,000 MFJ (2025)

⑨ Tax credits vs. tax deductions
   → Deduction = reduces taxable income (value = deduction × tax rate)
   → Credit = reduces tax dollar-for-dollar (always more valuable per dollar)

⑩ Individual return filing deadline = April 15 (with 6-month extension to Oct 15)
    → Corporate return (C-Corp) = April 15 (with 6-month extension to Oct 15)
    → Partnership/S-Corp = March 15 (with 6-month extension to Sept 15)

Estate & Gift Tax Common Errors

⑪ Annual gift exclusion = $19,000 per donee per year (2025)
   → Unlimited marital deduction for transfers to US citizen spouse
   → §2503(e) exclusion: direct tuition/medical payments — no dollar limit

⑫ Estate tax basic exclusion = $13,990,000 (2025); rate = 40%
   → Portability allows surviving spouse to use deceased spouse's unused exclusion
   → DSUE must be elected on timely filed Form 706

⑬ Gifts within 3 years of death — §2035
   → Gift tax paid on gifts within 3 years of death is added back to the gross estate
   → Life insurance transferred within 3 years of death: proceeds included in estate

⑭ Generation-skipping transfer (GST) tax
   → 40% GST tax applies to transfers to skip persons (grandchildren, etc.)
   → Annual and lifetime GST exemptions (same amount as gift/estate exemption)

⑮ State estate taxes
   → Many states have their own estate taxes with lower exemptions than federal
   → Some states also impose inheritance taxes (paid by beneficiaries, not estate)

IRS Procedure Common Errors

⑯ Statute of limitations: 3 / 6 / unlimited
   → 3 years: standard assessment SOL from filing date
   → 6 years: substantial omission of income (>25% of gross income)
   → Unlimited: fraud or willful evasion

⑰ NOL vs. capital loss treatment
   → Net Operating Loss: deduct against ordinary income, 80% limit/year, indefinite carryforward
   → Capital loss: $3,000/year deduction against ordinary income, indefinite carryforward

⑱ Estimated tax payments — when required
   → Required if expected tax liability ≥ $1,000 after withholding
   → Safe harbors: 100% of prior year tax (110% if prior AGI >$150K) or 90% of current year tax

⑲ Tax Court vs. District Court
   → Tax Court: no prepayment required, no jury, tax specialists
   → District Court: full payment required first, jury trial available

⑳ Enrolled Agent practice rights
    → EA: unlimited right to practice before the IRS (all administrative levels)
    → CPA: right to practice before IRS, but state-licensed (may vary)
    → Attorney: unlimited practice rights including Tax Court

Key Concept Cards

NIIT Threshold = $200K /$ 250K MAGI ★★★★★ : 3.8% Net Investment Income Tax above threshold on lesser of NII or excess MAGI. Memory hook: NII + 3.8% = high-income investment surcharge

Tax Credit > Tax Deduction in value ★★★★★ : Credit reduces tax dollar-for-dollar. Deduction reduces taxable income (value = deduction × rate). Memory hook: Credit = direct tax reduction; deduction = indirect

Tax Appeals = administrative remedy first ★★★★☆ : Exhaust IRS administrative remedies before Tax Court. Filing petition in Tax Court stops assessment clock. Memory hook: Appeals before Court — Tax Court is last administrative resort

Practice Quiz

Q. Why does the 80% NOL limitation benefit large corporations less than it did under pre-TCJA rules?

Pre-TCJA, corporations could carry NOLs back 2 years for immediate refunds, and carry forward 20 years with no percentage limitation — a NOL year could completely offset a profitable year. Post-TCJA (for NOLs arising in tax years after 2017), the carryback is eliminated for most entities, carryforward is indefinite, but the deduction is capped at 80% of taxable income. This means a corporation with a very profitable year cannot fully offset it with NOL — it must pay at least 4.2% on taxable income (21% × 20% minimum). This change significantly affects companies emerging from large loss periods.

Q. How does EA / CPA representation benefit a taxpayer during an IRS field exam?

During a field examination, an IRS Revenue Agent visits the business and requests broad categories of records. Without representation, taxpayers often provide more information than required, raising additional audit issues. A CPA or EA: (1) controls the flow of documents — provides only what is legally required; (2) limits the scope of the examination to issues on the initial IDR (Information Document Request); (3) negotiates with the agent on disputed factual matters; (4) uses the pre-assessment review process strategically to resolve issues before formal assessment. Studies show represented taxpayers achieve materially better outcomes on proposed adjustments compared to unrepresented taxpayers.