Introduction to Taxation and Regulation

Learning Objectives

• Understand the purpose and scope of the REG section of the CPA exam
• Identify the major content areas in taxation and business law
• Recognize the structure of the federal tax system
• Distinguish between key entity types and their tax treatment

What is the REG Section?

The Regulation section tests your knowledge of federal taxation and business law. Unlike FAR and AUD, which focus on financial reporting and assurance, REG requires you to apply tax rules to specific scenarios and understand the legal environment in which businesses operate.

The tax portion dominates the exam — roughly 75-85% of REG content is taxation, with the remainder covering business law, ethics, and federal tax procedures.

Key Areas of the REG Section

The REG section is organized around four content areas:

1. Ethics, Professional Responsibilities, and Federal Tax Procedures — Circular 230 rules for practice before the IRS, taxpayer penalties, and the CPA's responsibilities in tax practice.

2. Business Law — Contracts, agency relationships, debtor-creditor relationships, business structure formation, and the Uniform Commercial Code (UCC).

3. Federal Taxation of Property Transactions — Basis calculations, gains and losses on dispositions, like-kind exchanges (Section 1031), and depreciation methods.

4. Federal Taxation of Individuals and Entities — Filing status, gross income, deductions, credits, and tax calculations for individuals, corporations (C and S), partnerships, and estates/trusts.

The Tax System Structure

The U.S. federal income tax system is built on several core principles:

• Progressive taxation — Tax rates increase as taxable income increases, organized into brackets
• Self-assessment — Taxpayers calculate and report their own tax liability
• Pay-as-you-go — Taxes are collected throughout the year through withholding and estimated payments
• Annual accounting period — Tax is computed for a specific tax year (calendar or fiscal)

Entity Types and Tax Treatment

One of the most tested areas on REG is understanding how different entities are taxed:

• Individuals — File Form 1040, pay tax at graduated rates (10% to 37%), subject to standard or itemized deductions
• C Corporations — Separate taxable entity, files Form 1120, pays corporate tax at a flat 21% rate
• S Corporations — Pass-through entity, files Form 1120-S, income flows to shareholders' individual returns
• Partnerships — Pass-through entity, files Form 1065, income allocated to partners per the partnership agreement
• Estates and Trusts — Separate taxable entities with compressed tax brackets, may distribute income to beneficiaries

Entity selection questions frequently appear on the exam. Pay close attention to the differences between C corps, S corps, and partnerships — particularly the rules for eligibility, formation, and the treatment of distributions.

Key Terms

• Adjusted Gross Income (AGI) — Gross income minus above-the-line deductions; a key threshold for many tax benefits
• Basis — The taxpayer's investment in an asset for tax purposes, used to determine gain or loss on disposition
• Pass-through entity — An entity that does not pay tax itself; income passes through to the owners' individual returns
• Circular 230 — Treasury Department regulations governing practice before the IRS, including CPAs, attorneys, and enrolled agents