Regulation (REG)

The Regulation (REG) section of the CPA exam tests your knowledge of ethics, professional responsibilities, business law, and federal taxation. It bridges the legal and tax frameworks that every practicing CPA must understand — from advising clients on entity formation to preparing compliant tax returns to navigating disputes with the IRS.

REG is unique among the CPA exam sections because it spans two fundamentally different disciplines: law and taxation. You will need to think like a lawyer when analyzing contracts and agency relationships, and like a tax adviser when computing basis, characterizing gains, and optimizing entity structures.

:::info Why REG Matters

Whether you work in public accounting, industry, or government, the material in this section forms the backbone of everyday CPA practice. Tax compliance alone generates billions of dollars in professional fees, and understanding business law protects both clients and practitioners from costly mistakes.

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What This Section Covers

REG is organized into five major topic areas, each building on the others.

1. Ethics, Professional Responsibilities, and Federal Tax Procedures

This area covers the rules of the game — the professional and legal standards that govern how CPAs interact with clients, the IRS, and the public.

Key topics include:

• Treasury Circular 230 — regulations governing practice before the IRS, including due diligence requirements, restrictions on contingent fees, and rules for written tax advice
• AICPA Statements on Standards for Tax Services (SSTS) — ethical guidelines for tax return positions, answering questions on returns, and advising clients
• IRS Examination and Appeals Process — how audits are initiated, the 3-year and 6-year statutes of limitation, the burden of proof, and penalty structures (accuracy-related penalties, fraud penalties, preparer penalties)
• Taxpayer Rights — the Taxpayer Bill of Rights, innocent spouse relief, offers in compromise, and installment agreements
• Privileged Communications — the limited tax practitioner–client privilege under IRC §7525

:::tip Exam Strategy

Circular 230 and the penalty regime are heavily tested. Know the difference between a $5,000 penalty for a frivolous return and the 75% civil fraud penalty. Memorize the key due-diligence standards — they appear in almost every REG exam.

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2. Business Law

Business law questions test your understanding of the legal frameworks that govern commercial activity. You do not need to be a lawyer, but you must recognize legal issues and apply fundamental rules.

Sub-Topic	Key Concepts
Agency	Formation, authority (actual, apparent, implied), principal's liability for agent's acts, duties of agents and principals, termination of agency
Contracts	Offer and acceptance, consideration, capacity, legality, Statute of Frauds, parol evidence rule, assignment and delegation, breach and remedies
Debtor-Creditor Relationships	Suretyship, guaranty, the Bankruptcy Code (Chapters 7, 11, 13), secured transactions under UCC Article 9, liens, and priorities
Government Regulation of Business	Federal securities regulation (Securities Act of 1933, Securities Exchange Act of 1934), antitrust, employment law
Business Structures	Sole proprietorships, general and limited partnerships, LLCs, S corporations, C corporations — formation, operation, dissolution
Sales Article of the UCC	Contract formation for goods, warranties, risk of loss, remedies for breach, merchant rules

:::note UCC Focus

The Uniform Commercial Code (UCC) Article 2 governs the sale of goods and modifies many common-law contract rules. For example, the UCC does not require the mirror-image rule — additional terms in an acceptance may become part of the contract. Understanding where the UCC departs from common law is critical for the exam.

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3. Federal Taxation of Property Transactions

Property transactions test your ability to determine basis, characterize gains and losses, and apply the cost-recovery system.

• Determination of Basis — cost basis, adjusted basis, basis of gifted property (donor's basis with potential FMV adjustment), inherited property (stepped-up basis), basis in property converted from personal to business use
• Gains and Losses — realization vs. recognition, like-kind exchanges under IRC §1031, involuntary conversions under §1033, installment sales under §453, wash-sale rules under §1091
• Cost Recovery — MACRS depreciation, §179 immediate expensing, bonus depreciation, amortization of §197 intangibles, depletion

:::caution Common Trap

When Bear Co. receives property as a gift with a fair market value (FMV) below the donor's adjusted basis, the basis for computing a loss is the FMV at the date of the gift — not the donor's basis. This "dual basis" rule trips up many candidates. If Bear Co. later sells the property at a price between the donor's basis and the FMV, the result is no gain and no loss.

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4. Federal Taxation of Individuals

Individual taxation covers the computation of taxable income from gross income through the final tax liability.

• Gross Income — wages, interest, dividends, business income, capital gains, rental income, alimony (pre-2019 divorce agreements), Social Security benefits, and items of exclusion (municipal bond interest, life insurance proceeds, gifts, inheritances)
• Adjustments and Deductions — above-the-line deductions (educator expenses, student loan interest, HSA contributions, SE tax deduction), standard vs. itemized deductions (medical expenses exceeding 7.5% of AGI, state and local taxes capped at $10,000, mortgage interest, charitable contributions)
• Tax Computation and Credits — filing status, tax brackets, AMT, child tax credit, earned income credit, education credits, estimated tax payment requirements

tip

When Gies Co.'s owner, a sole proprietor, computes self-employment tax, remember: the SE tax base is 92.35% of net self-employment income (the equivalent of the employer's share adjustment). The deduction for one-half of SE tax is an above-the-line deduction — it reduces AGI, not taxable income directly.

5. Federal Taxation of Entities

Entity taxation requires you to understand how different business structures are taxed, how income flows to owners, and when entity-level taxes apply.

• Sole Proprietorships — Schedule C reporting, SE tax, single level of taxation
• Partnerships (General and Limited) and LLCs — formation (tax-free under §721), distributive share, guaranteed payments, basis adjustments, distributions, special allocations, at-risk and passive activity rules
• C Corporations — double taxation, dividends-received deduction, accumulated earnings tax, personal holding company tax, NOL rules, charitable contribution limits (10% of taxable income before certain deductions)
• S Corporations — eligibility requirements (100 shareholders, one class of stock, eligible shareholders), built-in gains tax, AAA and OAA accounts, shareholder basis computation

:::warning Entity Selection

Choosing between a C corporation and an S corporation — or a partnership-taxed LLC — has enormous tax consequences. For example, when MAS Inc. (a C corporation) distributes $50,000 in dividends, those dividends are taxed at the corporate level and again at the shareholder level. If MAS Inc. were instead structured as an S corporation, the income would pass through and be taxed only once at the shareholder level. Always analyze the total tax burden across all levels.

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Key Legal and Regulatory Frameworks

Throughout your REG studies, you will encounter these foundational authorities:

Framework	Description
Internal Revenue Code (IRC)	The statutory foundation of federal tax law — all tax rules trace back to specific IRC sections
Treasury Regulations	Official IRS interpretations of the IRC; carry significant legal weight
Treasury Circular 230	Governs who may practice before the IRS and the ethical standards they must follow
Uniform Commercial Code (UCC)	Standardized state laws governing commercial transactions, especially the sale of goods (Article 2) and secured transactions (Article 9)
Bankruptcy Code	Federal law governing the rights of debtors and creditors in bankruptcy proceedings (Chapters 7, 11, 13)
Securities Acts	The Securities Act of 1933 (new issuances) and the Securities Exchange Act of 1934 (secondary trading and reporting)

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Study Guide

:::tip How to Approach REG

Divide and conquer. REG rewards a structured study plan because its two halves — law and tax — use different reasoning skills.

1. Start with Business Law. Many candidates find law concepts more intuitive. Build momentum here, focusing on contracts, agency, and the UCC.

2. Master the IRC framework. Understand the flow of an individual tax return (gross income → AGI → taxable income → tax liability → credits) before diving into entity-specific rules.

3. Use a fact-pattern approach. REG questions are scenario-heavy. Practice by working through examples:

   • BIF Partners contributes property to a new partnership — what is each partner's basis?
   • Kingfisher Industries sells equipment at a gain — is the gain ordinary, §1231, or capital?
   • Illini Entertainment enters a contract for concert equipment — does the UCC or common law apply?

4. Memorize key thresholds.

   • Statute of Frauds for goods: $500 (UCC)
   • General statute of limitations for tax: 3 years from filing
   • 25% gross income omission extends SOL to 6 years
   • Accuracy-related penalty: 20% of the underpayment
   • Civil fraud penalty: 75% of the underpayment

5. Connect the dots across topics. Entity formation rules (§351, §721) connect to basis, which connects to gain/loss recognition. Illini Security's choice of entity structure affects everything from self-employment tax to loss limitations.

6. Review consistently. Tax law changes, but the exam tests evergreen principles. Focus on understanding why rules exist, not just memorizing them.

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Ready to begin? Select a topic area from the sidebar to start your REG journey.