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Michael F. Farrell, J.D. and Arthur E. Reed, MBA, MST, CPA,
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Paul Debole, J.D
William A. Grubbs, MBA, CPA
2
Regulation
BUSINESS LAW & PROFESSIONAL RESPONSIBILITY
(Chapters 1-13)
FEDERAL INCOME TAXES
(Chapters 1-13 plus Appendix)
by
Joseph R. Lanciano, CPA
Michael F. Farrell, J.D.
Arthur E. Reed, MBA, MST, CPA
Paul DeBole, J.D.
Published by
Copyright © 2012 by LearnForce Partners, LLC.
All rights reserved. No part of this publication
may be reproduced in any form without the
written permission of the publisher.
Chapter Subjects of VOLUME 2—REGULATION
BUSINESS LAW & PROFESSIONAL RESPONSIBILITIES
Chapter One — CONTRACTS
Chapter Two — SALES
Chapter Three — SECURED TRANSACTIONS
Chapter Four — NEGOTIABLE INSTRUMENTS
Chapter Five — DOCUMENTS OF TITLE
Chapter Six — AGENCY
Chapter Seven — BANKRUPTCY
Chapter Eight — SURETY AND DEBT COLLECTION REMEDIES
Chapter Nine — NON-CORPORATE ENTITIES
Chapter Ten — CORPORATIONS
Chapter Eleven — SECURITIES ACTS AND ANTITRUST REGULATION
Chapter Twelve — REGULATION OF EMPLOYMENT
Chapter Thirteen — ACCOUNTANT’S LEGAL LIABILITY
FEDERAL INCOME TAXES
Chapter One — FILING STATUS AND EXEMPTIONS, FILING REQUIREMENTS AND PENALTIES
Chapter Two — INCOME – INCLUSIONS AND EXCLUSIONS
Chapter Three — DEDUCTIONS FOR ADJUSTED GROSS INCOME
Chapter Four — DEDUCTIONS FROM ADJUSTED GROSS INCOME
Chapter Five — ACCOUNTING METHODS & PERIODS, AND
COMPUTATION OF TAX LIABILITY & TAX CREDITS
Chapter Six — CAPITAL TRANSACTIONS
Chapter Seven — PARTNERSHIPS
Chapter Eight — C CORPORATIONS
Chapter Nine — TAX COMPUTATION AND CONTROLLED GROUPS
Chapter Ten — CORPORATE DISTRIBUTIONS AND OTHER MATTERS
Chapter Eleven — S CORPORATIONS
Chapter Twelve — TAXATION OF GIFTS, ESTATES AND FIDUCIARIES, AND EXEMPT
ORGANIZATIONS
Chapter Thirteen— PROFESSIONAL RESPONSIBILITIES FROM A TAX PERSPECTIVE
Appendix — OTHER OBJECTIVE ANSWER FORMAT PROBLEMS FROM RECENT EXAMS
Material from Uniform CPA Examination Questions and Unofficial Answers, copyright
© 1977 through 2010 by the American Institute of Certified Public Accountants, Inc., is
reprinted (or adapted) with permission.
Chapter One
Contracts
ELEMENTS OF A CONTRACT................................................................................................................1-1
OFFERS AND ACCEPTANCE..................................................................................................................1-1
When Offers End
When Acceptances Are Effective
TYPES OF CONTRACTS..........................................................................................................................1-3
CONSIDERATION.....................................................................................................................................1-3
STATUTE OF FRAUDS............................................................................................................................1-4
COMPETENT PARTIES: MINORS, DRUNKS & THE INSANE...........................................................1-5
ILLEGAL CONTRACTS...........................................................................................................................1-5
FRAUD AND INNOCENT MISREPRESENTATIONS...........................................................................1-5
MISTAKES, DURESS AND UNDUE INFLUENCE................................................................................1-6
PAROL EVIDENCE RULE........................................................................................................................1-7
THIRD PARTY RIGHTS AND ASSIGNMENTS.....................................................................................1-7
Third Party Beneficiary Contracts
Assuming and Buying Subject To a Mortgage
Assignments and Delegations
DISCHARGE AND CONTRACT REMEDIES.........................................................................................1-8
Performance & Discharge of Contract Duties
Contract Remedies
Chapter One
Contracts
ELEMENTS OF A CONTRACT
1. A contract is an agreement, a meeting of the minds.
2. A contract contains the following six essential elements:
a. an offer
b. an acceptance
c. consideration
d. in proper form (i.e. the Statute of Frauds may require a writing)
e. for a lawful object
f. by two or more competent parties
Memory Device: Only Accuracy Can Pass Law Candidates
6 Elements of a Contract
Only = Offer
Accuracy = Acceptance
Can = Consideration
Pass = Proper form (Statute of Frauds may require a writing)
Law = Lawful object
Candidates = 2 or more Competent Parties
OFFERS AND ACCEPTANCES
1. An agreement requires both an Offer and an Acceptance
2. An Offer has 3 elements
a. it must be seriously intended (the test is whether a reasonable person would consider it to be a
serious offer)
b. it must be communicated by either words or actions
c. it must be definite in its terms (must include a price)
3. Advertisements and price quotes are not usually offers; they are invitations to deal
4. An Acceptance has 3 elements
a. an acceptance must be unconditional - the offeree must comply with all of the offeror's terms or a
counteroffer is created
b. an acceptance must be communicated by words or actions (e.g. silence is rarely an acceptance
unless there is a long course of dealing between the parties)
c. an acceptance may only be accepted by the party to whom it's made (e.g. offeree cannot assign
his/her right to accept to accept an offer to a 3rd party)
1-1
WHEN OFFERS END
1. Counteroffers end offers but they are only effective when they are received
Example: A mails an offer to B on April 1 which is received on April 3. On April 3 B mails a counteroffer
to A. On April 4 B changes her mind and telephones an acceptance. On April 5 the counteroffer arrives.
There is a contract between A and B because the offer was accepted on April 4 before the counteroffer took
effect.
a. requests and inquiries are not counteroffers
b. on the exam an inquiry will usually end in a question mark, not a period
2. Rejections end offers but they are only effective when received
3. Revocations end offers but they are only effective when received. Offeror may usually revoke anytime
before acceptance even if (s)he promises the offer will be held open
a. exception: Option Contracts can't be revoked
1). the offeree pays consideration to keep offer open (note: there is no option contract until the
consideration is actually paid by the offeree)
2). counteroffers will not end an option contract
Example: A pays X $1,000 for the right to buy X's house for the price of $250,000 anytime prior to June 1.
An option contract has been created and X may not revoke the offer to sell for $250,000. If on May 1 A
offers X $225,000 for the house, the option contract will not end and A will still have until June 1 to buy for
$250,000
b. exception: In UCC Sales Firm Offers are irrevocable without consideration if: made by a merchant,
in writing, and a guarantee the offer will be held open
4. Offers end at the time stated (if no termination time is stated, it ends at reasonable time)
5. Death or insanity ends offers immediately, but does not end most contracts
Example: X purchases goods on credit from A and dies prior to payment. The contract is still valid and X's
estate owes A the balance of the purchase price)
6. Destruction or sale of the subject matter will end an offer
a. destruction of the subject matter ends the offer immediately
b. sale of the subject only revokes the offer when the offeree learns of it, not when the subject is sold
WHEN ACCEPTANCES ARE EFFECTIVE
1. MAILBOX RULE (also called the deposited acceptance rule) an acceptance is valid when sent if the
offeree uses either of the following means of communication:
a. the express means (the form of communication the offeror said to use) OR
b. any reasonable means if none is specified (the same means offeror used or faster)
Example: A mails an offer to B without specifying how acceptances are to be sent. If B mails a valid
acceptance, the acceptance is effective when sent. If B telegraphs an acceptance, it is still effective when
sent because a telegram is faster than the mail. There would be a valid contract even if the acceptance were
lost or never arrived.
c. if a slower means of communication is used, it is valid when received
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2. Exceptions when the mailbox rule does not apply
a. if an offer states an acceptance must be received by a specified date, then the acceptance must be
received by that date to be valid and cannot be effective when sent (reason: the offeree must comply
with all of the offeror’s terms)
b. if the offeree has sent a previous rejection of the offer, for a later acceptance to be effective it must
be received before the prior rejection
TYPES OF CONTRACTS
1. Bilateral and Unilateral contracts
a. a bilateral contract is a promise for a promise (most contracts are bilateral)
b. a unilateral contract is a promise for an act (e.g. a reward)
1). note: the offeree must know of the reward to accept
2). if the offeree has made a substantial start on performing a unilateral offer, the offeror cannot
revoke the offer
2. Requirement and Output contracts
a. in a requirement contract, one party agrees to purchase all their requirements from another. The
contract is valid if the amounts requested are made in good faith and reasonable to normal amounts
b. in an output contract, one party agrees to purchase the entire output of a factory or manufacturer.
The contract is valid if the amounts are produced in good faith and reasonable to normal amounts
3. Executed and Executory contracts
a. executed contracts are those that have been fully performed by both parties
b. executory contracts are those that have not been fully performed by both
4. Valid, Void and Voidable contracts
a. a valid contract is legally binding and enforceable against both parties
b. a void contract is not enforceable against either party (e.g. it's not a legal contract)
c. a voidable contract is a legal contract wherein one or both of the parties has the right to disaffirm or
rescind the contract (e.g. minor contracts are voidable by the minor and most fraud is voidable by the
injured party)
***CONSIDERATION***
1. An essential element of a contract is that it be supported by adequate consideration
a. consideration is giving up of a legal right (e.g. something you're legally free not to do)
b. consideration must be mutually bargained for (e.g. one promise was given in exchange for the other
party's promise or act) and legally sufficient
2. Courts aren't usually concerned with the adequacy of consideration, only that it be present for both parties
a. thus, there is no requirement that the consideration be of equal value
b. exception: courts will consider the adequacy of consideration if the contract is unconscionable (so
grossly one sided that it shocks the conscience of a court)
3. Two cases where consideration is not present
a. past consideration is no good (e.g. an employer promises a cash payment to a deceased employee's
family in recognition of the employee's years of service)
b. there is no consideration when a party is already contractually or legally obligated to perform
4. Additional consideration is needed from both parties to modify a contract
exception: in UCC Sales contracts can be modified without additional consideration
1-3
5. Exceptions: some promises are enforceable without any consideration:
a. promises to donate to charity are often enforceable without consideration
b. a written promise to pay a debt barred by the Statute of Limitations can be enforced without
consideration
c. promissory estoppel: a promise by one party relied upon by another can be enforced without
consideration if the reliance was:
1). reasonable: a reasonable person would have relied on the promise
2). detrimental: party relying on the promise would be substantially harmed
***STATUTE OF FRAUDS***
1. There are 6 types of contracts that require some type of writing to be enforceable
6 TYPES OF CONTRACTS = GRIPE + MARRIAGE
G sale of Goods of $500 or more - the writing must state a quantity
R Real estate contracts
I contracts Impossible to perform in 1 year - begin measuring from when the contract is made -
not when performance is to begin
P Promise to answer the debt of another
E Executor's promise to be liable for the debt of an estate
Marriage contracts where Marriage is the consideration
2. Any type of writing that states the major contract terms can satisfy the Statute of Frauds
a. the writing need only be signed by one party but it is only enforceable against the one who signed
b. the terms may be stated in more than one document
3. Exceptions: no writing is required even though it is one of the 6 types if:
a. the contract is fully performed by both parties (executed)
b. a contract impossible to perform in one year is enforceable without a writing if one side has fully
performed (e.g. X orally promises an employee a $25,000 bonus, if the employee will remain with
her for 4 years. If the employee works for X for the 4 years, X's oral promise is enforceable)
c. an oral real estate contract is enforceable in two different cases:
1). if the buyer is in possession of the land and has made a substantial payment or substantial
improvements or
2). if the seller has completely performed (e.g. delivered the deed to the buyer)
d. a promise to answer the debt of another is enforceable if the main or primary purpose of the
promise was to benefit the promisor and not the debtor
Example: X hires a contractor to build a house and the contractor subcontracts with a plumber. The
plumber threatens to quit due to contractor's nonpayment. X, fearing the house will not be finished on time,
orally promises to pay the plumber if the contractor doesn't. Although X's oral promise to pay the plumber is
a promise to pay the debt of another, it is enforceable because the main purpose was to benefit X, not the
contractor.)
1-4
COMPETENT PARTIES: MINORS, DRUNKS & THE INSANE
1. A contract must be made by two or more competent parties
note: the exam normally tests competent parties with minors, drunks and the insane
2. Minors may disaffirm contracts anytime while a minor or a reasonable time thereafter (thus, minor contracts
are voidable because the minor has the right to rescind)
a. minors cannot disaffirm real estate contracts while they are still a minor
b. minors cannot disaffirm necessary contracts (things like food, clothing or shelter)
3. To disaffirm a minor need only return what (s)he possesses or controls at that time
4. Minor may ratify a contract by words or actions (i.e. use of the object)
a. minors can only ratify after becoming an adult; they can't ratify while still a minor
b. minors must ratify the entire contract - they can't ratify part and disaffirm part
5. Minors may disaffirm contracts, but they are liable in damages for torts (civil wrongs)
Example: A minor buys a car by misrepresenting that (s)he was an adult. After putting 200,000 miles on the car,
the minor attempts to disaffirm. The minor may disaffirm the contract, but must pay damages for the tort of fraud.
6. A drunk may disaffirm only if (s)he was incapable of understanding what (s)he did
7. Insane may usually disaffirm, but once adjudicated insane all future contracts are void
ILLEGAL CONTRACTS
1. Illegal contracts are void - courts won't aid either party in an illegal contract
2. Failure to have a required license makes all your contracts void
exception: the contract is enforceable if the license was a mere revenue raising measure
3. Covenants not to compete in a sale of business or employment contract are valid if reasonable. They must
meet 3 tests of reasonableness:
a. must be reasonably needed to protect a legitimate business interests
b. must be reasonable as to time
c. must be reasonable as to distance
***FRAUD*** and INNOCENT MISREPRESENTATIONS
1. Actual Fraud has 5 elements - MS RID
5 Elements of Fraud = MS RID
M Must have a Material Misrepresentation of fact or a deliberate concealment
- must be a fact (opinions don't count unless made by experts)
- no duty to disclose unless there is a known hidden defect, or to correct a previous
representation later found out to be false or if the parties are in a fiduciary relationship
S Must have Scienter (an intent to deceive - made knowingly or intentionally)
R Must have Reasonable Reliance (justifiable reliance)
I Must have Intent to rely
D Must have Damages
1-5
2. Constructive Fraud - has the same 5 elements as actual fraud but the intent to deceive element is fulfilled
by a reckless disregard for the truth (making a statement without knowing if the statement is true or false)
not scienter - MR RID
5 Elements of Constructive Fraud = MR RID
M Must have a Material Misrepresentation of fact
R Must have Reckless disregard for the truth
( making a statement without knowing if it is true or false )
R Must have Reasonable Reliance (justifiable reliance)
I Must have Intent to rely
D Must have Damages
3. Fraud in the execution is void (defrauded party didn't know a contract was made)
4. Fraud in the inducement (party knows they made a contract but one or more terms are misrepresented) makes
a contract voidable. This means the injured party has 2 choices:
a. rescission: cancel the contract and restore parties to their former positions
b. or the injured party may accept the contract and sue in tort for money damages
c. note: in UCC Sales a party may rescind and sue for money damages
5. An Innocent Misrepresentation has 4 of the elements of fraud but no scienter or reckless disregard for the
truth
- the injured party may only rescind and cannot sue for damages - MR ID
4 Elements of Innocent Misrepresentation = MR ID
M Must have Material Misrepresentation of fact
R Must have Reasonable Reliance (justifiable reliance)
I Must have Intent to rely
D Must have Damages
MISTAKES, DURESS & UNDUE INFLUENCE
1. Most mistakes have no effect on a contract. There are 2 exceptions:
a. mutual mistakes of material facts make a contract voidable
b. with material unilateral mistakes, one may disaffirm only if the other party knew or should have
known a mistake was being made
2. Duress is forcing someone into a contract by wrongful acts or improper threats of violence, economic
devastation or criminal action
a. to constitute duress, it must actually induce the other party to enter the contract
b. forcing someone into a contract by actual physical force makes the contract void
c. forcing someone into a contract by improper threats makes a contract voidable
1). threat of economic devastation or criminal prosecution is voidable
2). threat of civil litigation is not duress, only threat of criminal action
3. Undue Influence is an unfair use of a position of trust, confidence or affection to overcome another's free
will in contract. It makes a contract voidable
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