Income Tax-M5: Multiple Choice

8. Which of the following incomes is not taxed under Social Security self-employment tax? I. Rental real estate income II. Small part-time repair shop income III. Shareholder's share of S corporation's income in excess of salary IV. Income of an individual working as an independent contractor A. I and III B. II and IV C. I, II, and III D. I, II, III, and IV

A. Income from rental property is not subject to Social Security tax, nor are dividends to S corporation shareholders/employees as long as the employees' compensation is considered reasonable.

Cheryl and her sister, Georgette, are interested in forming a business together. They are primarily concerned about the following: ○ Whether the business will have losses for the next 3 years ○ Whether the business will continue in the event that one of the sisters dies ○ Whether they will have limited liability protection After considering each of these concerns, which of the following business forms should they adopt? A. C corporation B. S corporation C. General partnership D. Limited partnership

B. From the choices given, an S corporation will allow losses to flow through to the sisters, continue if one sister dies, and still enjoy the limited liability protection of a regular corporation. An LLC taxed as a general partnership also would be viable if it were among the choices.

S Corporation: S corporation shareholders have the ability to deduct losses to the extent of A. their original contribution of capital to the business. B. their adjusted basis in the stock, adjusted for corporate loans personally guaranteed. C. their adjusted basis in the stock, adjusted for money they have directly loaned to the corporation.

C. A shareholder's basis and ability to deduct losses from an S corporation are determined by the shareholder's adjusted basis in the stock, increased by loans he has made to the corporation (basis in debt). A personal guarantee of a corporate loan does not establish basis in an S corporation.

General Partnership: All of the following may be described as a strength of the general partnership form of business except A. ease of formation. B. ease of management. C. joint and several liability. D. special allocation of income and loss.

C. General partners have joint and several (personal) liability for the acts of the partnership and of other partners. This is a weakness of the form.

10. Don had an AGI of $50,000 in 2020 and is self-employed. He had the following expenses during the year: ○ Meals for employees to enable them for his convenience of $300 ○ Gifts for clients for $575 (15 gifts at $15 each and 10 gifts at $35 each) How much can Don deduct on his 2020 federal income tax return for these entertainment expenses? A. Don has a $625 miscellaneous deduction. B. Don may deduct $150 for the meals and $575 for the gifts on Schedule C. C. Don may deduct $150 on Schedule C as a business expense. Because Don is self-employed, he may deduct $875 on Schedule C.

C. His expenses are limited to 50% of the expense for meals.

Hobby Loss: Susan pursues a hobby of selling antique furniture in her spare time. This year, she sold furniture for $3,000 and incurred expenses the following expenses: Cost of goods sold $2,000 Supplies 1,200 Interest on signature loan 800 Advertising 750 Assuming the activity constitutes a hobby and that Susan cannot itemize her deductions this year, how should she report income and expenses on her tax return? A. Include $3,000 in income and deduct $4,750 for adjusted gross income (AGI). B. Ignore both income and expenses because the activity is a hobby. C. Include $3,000 in income and deduct nothing. D. Include $3,000 in income and deduct interest of $800 for AGI.

C. Susan must include the $3,000 as income and deduct nothing. Consumer interest is not deductible and neither are the rest of her expenses.

Which of the following is a nontax disadvantage of operating as a sole proprietorship? I. Inability to raise capital II. Unlimited liability III. Lack of continuity of life A. I and II B. II and III C. I, II, and III

C. The inability to raise capital, unlimited personal liability, and lack of continuity of business life are all nontax disadvantages of operating as a sole proprietorship.

Sole Proprietorship: Which of the following describes the sole proprietorship form of conducting business? A. The businessowner usually has no difficulty raising capital from third-party lenders. B. The businessowner has creditor protection against personal liability for business debts. C. The businessowner must file legal documents with the state government in order to form the business. D. The business's success or failure depends exclusively on the owner.

D. A sole proprietorship is a business that is controlled and operated by only one individual. Therefore, the success or failure of the business depends exclusively on the owner.

14. Which of the following statements best describes a weakness of the sole proprietorship form of business? A. The owner has no control. B. The business is in constant danger of bankruptcy. C. The owner has too many partners. D. The business depends solely on the owner.

D. A sole proprietorship is owned by one individual who is personally liable for the business and all its operations. Therefore, the business depends solely on the owner.

2. Which of the following statements regarding calculating self-employment (SE) tax is CORRECT? I. The method for calculating the deductible employer share of SE tax is to multiply the net SE income by 0.9235 × 0.0765 up to the taxable wage base of $137,700 in 2020. II. The shortcut method for calculating total SE tax for SE income at or below the taxable wage base in 2020 is to simply multiply the amount of SE income by 0.1413 (0.9235 × 0.1530). A. I only B. Neither I nor II C. II only D. Both I and II

D. Both statements are correct.

Which of the following statements regarding an S corporation is true? I. Shareholders have limited liability. II. The number of shareholders is limited to 100. III. The death of an owner requires reorganization of the corporation. IV. The corporation is a conduit for items of income, deductions, and tax credits. A. III only B. I and IV C. II and III D. I, II, and IV E. II, III, and IV

D. Options I, II, and IV are accurate. The death of a shareholder does not require reorganization of the corporation.