Tax Final

How do the tax laws treat family members for purposes of limiting the number of owners an S corporation may have?

- Family members and their estates count as one shareholder for the 100 shareholder limit. Family members include a common ancestor.

Natasha is not a citizen of the United States, but she spends 200 days per year in the United States on business. She does not have a green card. True or false. Natasha will always be considered a resident of the United States for U.S. tax purposes because of her physical presence in the United States. Explain

- :False. Natasha will be treated as a resident because she meets the physical presence test. She could qualify for nonresident status if she meets an exception in the Internal Revenue Code or she qualifies for nonresident status under a treaty between the United States and her country of residence

Lars Operates Keep flying Incorporated, a used airplane parts business, in Laramie, Wyoming. Lars employs sales agents that visit mechanics in all 50 states to solicit orders. All orders are sent to Wyoming for approval, and all parts are shipped via common carrier. The sales agents are always on the lookout for wrecked, abandoned, or salvage aircraft with rare parts because they receive substantial bonuses for purchasing and salvaging these parts and shipping them to Wyoming. Discuss the states where Keep Flying has income tax nexus.

- Keep Flying has nexus is all 50 states. While Keep Flying sells tangible personal property and is protected by Public Law 86-272, its sales personnel violate this by salvaging parts off planes during their travels.

Compare and contrast the method of allocating income or loss to owners for partnerships and for S corporations.

- S corporations, like partnerships, are flow-through entities, and thus their profits and losses flow through to their shareholders annually for tax purposes. Partnerships have considerable flexibility in making special profit and loss allocations to their partners. In contrast, S corporations must allocate profits and losses pro rata, based on the number of outstanding shares each shareholder owns on each day of the tax year

Theodore, Alvin and Simon are equal shareholders of Timelss Corp (S corp). Simon wants to terminate the S election but Theodore and Alvin disagree. Can Simon unilaterally elect to have the S election terminated?

- Simon cannot voluntarily terminate the S election because he does not own more than 50percent of the corporation. However, Simon could have the S election "involuntarily" terminated by selling some of his stock to an ineligible shareholder (such as a corporation, partnership or nonresident alien)

Why is a shareholder's basis in an S corporate stock adjusted annually?

- The annual adjustment is required to prevent income or losses from being double-counted (i.e., double-taxed or double-deducted) by shareholders either when they sell stock or receive distributions, and to ensure that tax-exempt income and non-deductible expenses are not ultimately taxed or deducted

What role does the foreign tax credit limitation play in US tax policy?

- The foreign tax credit limitation is designed to limit the credit allowed for foreign taxes paid to the amount of US tax that would have been paid on the income if it was earned in the US.

- Explain how a purchase of realty could result in a taxable gift

-A completed gift results when realty is purchased in the name of a donee as sole owner of the property, as tenants in common, or as joint tenants with the right of survivorship if the donee does not provide adequate consideration for their ownership interest.

Why is a treaty important to a nonresident worker in the US?

-A nonresident worker in the United States generally will be subject to U.S. tax on his or her U.S. source wages. A treaty may exempt such wages from U.S. tax if the worker is in the United States for less than a prescribed number of days or the total wages do not exceed a stated amount

What is the permanent establishment, and why is it an important part of most income tax treaties?

-A permanent establishment generally is a fixed place of business such as an office or factory, although employees acting as agents can create a permanent establishment. U.S. (non-U.S.) businesses generally are not taxed on business profits earned in the host treaty country (United States) unless they conduct their business in that country through a permanent establishment

In what circumstances would a business be subject to income taxes in more than one state?

-Anytime a business conducts its trade or business in a manner exceeding the nexus standard in more than one state (which chooses to assert its sovereign right to tax) the business will be subject to business taxes in multiple states. However, businesses subject to tax in more than one state have the ability to apportion or divide their income between or among the states in which they have income tax nexus to mitigate the consequences of taxing the same income more than once.

Can a shareholder's basis in S corporation stock ever be adjusted to a negative number? Why or why not?

-As with a partnership, adjustments that decrease basis cannot reduce an S corporation shareholder's tax basis below zero. This feature of our tax system makes sense because basis represents the shareholder's investment in the stock of a corporation. Because it is not possible to have a negative investment, it is not possible to have a negative basis

Henri is a resident of the US fo US tax purposes and earns $10,000 from an investment in a French Company. Will Henri be subject to US tax under a residence based approach to taxation? A source based approach?

-Henri will be subject to U.S. tax on the income under a residence-based approach. Henri will not be subject to U.S. tax on the income under a source-based approach because the income is not U.S. source income

List the conditions for making an election to split gifts.

-In order to utilize gift splitting, each spouse must be a citizen or resident of the United States, be married at the time of the gift and not remarry during the remainder of the calendar year. In addition, both spouses must consent to the election by filing a timely gift tax return.

Maria is not a citizen of the US, but she spends 180 days per year in the United States on business related activities. Under what conditions will Maria be considered a resident of the US for US tax purposes.

-Maria will be considered a resident if she meets one of two tests. Maria will be treated as a resident if she possesses a permanent resident visa (green card) at any time during the calendar year. Maria also will be treated as a resident if she meets the substantial presence test, which will be met if she is physically present in the United States for 31 days or more during the current calendar year, and the number of days of physical presence during the current calendar year plus 1/3 times the number of days of physical presence during the first preceding year plus 1/6 times the number of days of physical presence during the second preceding year equals or exceeds 183. Maria does not meet the substantial presence test if she has not been physically present in the United States during the previous two years

Describe briefly the nexus concept and explain its importance to state and local taxation.

-Nexus is the sufficient connection between a taxpayer and a state that allows the imposition of a tax. The level of connection varies based on the type of tax. For example, any physical presence in a state will create nexus for sales tax while the nexus standard for income taxes is generally higher.

JB corporation is a C corporation owned 80% by Jacob and 20% by Bauer. Jacob would like JB to make an S election but Bauer is opposed to the idea. Can JB elect to be taxed as an S corp without Bauer's consent?

-No JB will not be able unless all owners consent to become an S corp.

Climb Higher is a distributor of high-end climbing gear located in Paradise, Washington. Its sales personnel regularly perform the following activities in an effort to maximize sales: -- Carry Swag (free samples) for distribution to climbing shop employees. --Perform credit checks of new customers to reduce delivery time of first order of merchandise --Check customer inventory for proper display and proper quantities --Accept returns of defective goods Identify which of climb higher's sales activities are protected and unprotected from nexus under the Wringley Supreme Court decision.

-Selling activities or solicitation are not well defined by P.L. 86-272. The Wrigley decision defines what activities are considered solicitation (protected) and which activities exceed solicitation. Distribution of free samples and checking inventory for display and quantity are considered solicitation. Performing credit checks and accepting returns exceed solicitation and create nexus for Climb Higher

What is the primary goal of the US in negotiating income tax treaties with other countries?

-The general purpose of an income tax treaty is to eliminate or reduce the impact of double taxation on cross-border transactions so that residents paying taxes to one country will not have the full burden of taxes in the other country

List two questions you might pose to a client to find out whether a program of serial gifts would be an advantageous wealth transfer plan.

-The most obvious question would be whether the client could afford to make gifts given the level of income expected to be necessary to support the client in the future. Another important question involves the health/age of the client and the past and expected rate of appreciation for the proposed gift property. Serial giving is less beneficial for clients who might be expected to die soon and for property that has substantially appreciated in the past.

Describe the unified credit and the purpose it serves in the gift and estate tax.

-The objective of the unified credit is to prevent the application of either the gift or estate tax to taxpayers who would not accumulate a relatively large amount of property transfers during their lifetime and/or would not have a relatively large value of assets to pass on to heirs upon their death. The amount of cumulative taxable transfers that can be made without exceeding the unified credit is referred to as the exemption equivalent and is set at $1 million for the gift tax and $3.5 million for the estate tax

How does a shareholder create debt basis in an S corporation? How is debt basis similar and dissimilar to stock basis?

-The shareholder is able to create debt basis by lending money directly to the S corporation. Debt basis is similar to stock basis in the sense that a shareholder may deduct S corporation losses to the extent of both stock basis and debt basis. Debt basis is dissimilar to stock basis in that distributions are only nontaxable to the extent of stock basis. Thus, distributions received by a shareholder with debt basis but no stock basis are taxable

What is the difference between a sales tax and a use tax?

-The tax base for sales taxes is retail sales of goods (and some services). The tax base for the use tax is the retail price of goods owned, possessed or consumed within a state that were not purchased within the state (e.g., goods purchased over the internet)

Describe the three hurdles a taxpayer must pass if he wants to deduct a loss from his share in an S corporation.

-The three hurdles are tax basis, at-risk amount, and the passive activity loss rules. The tax basis hurdle disallows allocated losses to the extent that they exceed the shareholder's stock and debt basis. While S corporation debt is not included in the stockholder's stock basis, shareholders can create debt basis in an S corporation by loaning money directly to the S corporation. When a stockholder has stock and debt basis in an S corporation, the losses are first applied to the stock basis and second to the debt basis. The non-deductible losses are not necessarily lost but are suspended until the shareholder generates additional basis. The carryover period for the suspended loss is indefinite. However, if the shareholder sells the stock before creating additional basis, the suspended losses disappear unused.

- What are the two categories of income that can be taxed by the United States when earned by a nonresident? How does the United States tax each category of income?

-U.S. source income earned by a nonresident is classified as either effectively connected income (ECI) or fixed and determinable, annual or periodic income (FDAP). Income that is effectively connected with a U.S. trade or business is subject to net taxation (that is, gross income minus deductions) at the U.S. graduated tax rates.

How does a residence-based approach to taxing worldwide income differ from a source- based approach to taxing the same income?

-Under a residence-based approach, a country taxes the worldwide income of the person earning the income. Under a source-based approach, a country taxes only the income earned within its boundaries.

- Describe a situation in which it would be advantageous for a business to establish income tax nexus in a state.

-While nexus creates a potential income tax liability, it can be advantageous in two ways. First, creating nexus in a state that chooses not to tax a business can create nowhere income (income that will go untaxed). Second, creating nexus in a state with a lower effective tax rate than the business' current effective tax rate can lower the total state taxes paid

Explain the purpose of adding prior taxable gifts to current taxable gifts and show whether these prior gifts could be taxed as multiple times over the years.

-With a progressive tax rate schedule, adding to the tax base increases the likelihood that a higher marginal tax rate will apply to the latest increment (transfer). To prevent double taxation of prior gifts, the gift tax on prior taxable gifts is then subtracted from the total gift tax

Describe the circumstances in which an S election may be involuntarily terminated.

A failure to meet the S corporation requirements will result in the termination of the S election. This includes exceeding the 100 shareholder limit or ownership by ineligible shareholders (such as a corporation or nonresident alien). The S election will also be terminated if the corporation has excess passive investment income (over 25 percent of gross receipts) for three consecutive years and has prior earnings and profits from previous operation as a C corporation.

Describe the requirements for a complete gift, and contrast a gift of a present interest with a gift of a future interest.

A gift is defined as a transfer for inadequate consideration. The gift tax is not imposed on payments associated with sales of goods or services because these transfers occur in a business context where consideration (money) is exchanged for the goods or services. That is, there is adequate consideration. Neither is the satisfaction of an obligation considered a gift. For example, tuition payments for a child's education would satisfy a support obligation and would not be considered a gift.

Why must an S corporation report separately stated items to its shareholders? How is the character of a separately stated item determined? How does the S corporation report this information to each shareholder?

An S corporation must separately state those items that are taxed differently than ordinary business income (loss) to shareholders. The character of a separately stated item is determined at the corporate level and the information is reported to the shareholder on his or her specific schedule K-1

How do S corporations report dividends they receive? Are they entitled to a dividends received deduction? Why or why not?

Dividends that are received by the S corporation are reported as a separately stated item to each owner. The S corporation is not entitled to the dividends received deduction because the dividends flow directly through the company to the owner. Therefore, since the S corporation will not pay a tax on the dividend it would not qualify for the dividends received deduction.

What are the limitations on the number and type of shareholders an S corporation may have? How are these limitations different from restrictions on the number and type of shareholders C corporations or partnerships may have?

Only U.S. citizens or residents, certain trusts, and certain tax-exempt organizations may be shareholders, no corporations or partnerships. In addition, S corporations may have no more than 100 shareholders; family members and their estates count as one. C corporations and partnerships do not have a limit on the amount or type of shareholders or partners.

How does the tax treatment of employee fringe benefits reflect the hybrid nature of the S corporation?

S corporations are treated in part like C corporations and in part like partnerships with respect to tax deductions for qualifying employee fringe benefits. For shareholder-employees who own 2 percent or less of the entity, the S corporation receives C corporation tax treatment. That is, it gets a tax deduction for qualifying fringe benefits, and the benefits are nontaxable to all employees. For shareholder-employees who own more than 2 percent of the S corporation, it receives partnership treatment. That is, it gets a tax deduction, but the otherwise qualifying fringe benefits are taxable to the more-than-2-percent shareholder-employees.

What does the accumulated adjustments account represent? How is it adjusted by year? Can it have a negative balance?

The AAA represents the cumulative income or losses for the period the corporation has been an S corporation. It is calculated as:The beginning of year AAA balance + Separately stated income/gain items (excluding tax-exempt income)+ Ordinary income-Separately stated losses and deductions -Ordinary losses-Nondeductible expenses that are not capital expenditures (except deductions related to generating tax-exempt income)-Distributions out of AAA= End of year AAA balance

Describe the conditions for using the annual exclusion to offset an otherwise taxable transfer.

The annual exclusion can only offset a gift of present interest. A gift of a future interest is not eligible for an annual exclusion. The only exception is a transfer in trust for a minor (under age 21) where the property can be used to support the minor and any remaining property is distributed once the child reaches age 21

Explain why the Gross estate includes the value of certain property transferred by the decedent at death, such as property held in joint tenancy with the right of survivorship, even though this property is not subject to probate.

The gross estate includes testamentary transfers even though this property is transferred outside of the probate court (automatically through operation of law). While he didn't "own" the property at death, the decedent had control of the ultimate disposition of the property

What are the major US tax issues that apply to an outbound transaction?

The major U.S. tax issues that apply to an outbound transaction involve 1) whether the income earned by the U.S. person is from foreign sources, 2) whether the U.S. person incurs a foreign income tax on the income that is eligible for a credit, and 3) the type of foreign source income earned (passive or general), and 4) what deductions taken on the U.S. tax return must be allocated and apportioned to the foreign source income for foreign tax credit purposes