Chapter 12
A personal holding company is ______.
a corporation owned by a small number of individuals and earning primarily nonbusiness income
Corporations that accumulate their earnings without a valid business purpose risk liability for the _____ _____ tax.
accumulated earnings
Fill in the blanks to complete the sentence. Corporations that accumulate their earnings without a valid business purpose risk liability for the _____ _____ tax.
accumulated earnings
The _____ ______ ______ doctrine restricts the ability to shift income in a personal services partnership to nonworking family members.
assignment of income
The use of a family partnership or S corporation ______.
can be used to shift income to lower tax rate family members
A family partnership or S corporation ______.
can shift income from high-tax rate family members to low-tax rate family members can be used as an example of entity variable tax planning
When a taxable corporate entity incurs a start-up loss, the loss ______.
carries forward as a net operating loss, deductible against future operating income
When a business is operated as a passthrough entity rather than as a taxable corporation, ______.
cash distributions to the owners are generally tax-free
In terms of the legal and accounting costs of forming a partnership versus an S corporation, the costs are likely higher for the _____.
corporation
The current relationship between corporate and individual tax rates ______.
creates an opportunity for high-wealth individuals to use corporations as a tax shelter
The purpose of the personal holding company tax is to ______.
discourage individuals from incorporating their investment portfolios to take advantage of corporate tax rates that are lower than individual rates
In terms of the formation costs of a partnership versus an S corporation, ______.
either alternative has no upfront income tax cost the accounting costs of forming an S corporation may be greater than those of forming a partnership
The use of a family partnership to shift income to lower tax rate taxpayers is an example of tax planning using the _____ variable.
entity
When an individual creates a family partnership by giving interest in a business to family members, the transfer of equity in the business may be subject to _____ tax.
gift
The creation of a family partnership to shift income to lower tax rate family members ______.
increases the family's overall after-tax cash flow reduces the after-tax cash flow of the family member transferring ownership to others
Common transaction costs of forming a family partnership or S corporation include ______.
legal costs of forming the new entity federal gift tax
Statutory restrictions under the assignment of income doctrine ______.
limit the ability to shift income from personal service partnerships to nonworking family members
In allocating income and loss items to owners of a passthrough entity, ______.
partnerships are permitted to choose different sharing arrangements for different items of income, gain, deduction, and loss S corporation allocations are based solely on proportionate ownership of common stock
When comparing the tax treatment of passthrough entities versus taxable corporate entities, _____ entities are often preferred to _____ entities.
passthrough corporate
Nontax issues that should be considered before forming a family partnership include ______.
potential for future family discord dilution of ownership control for the original owner of the business
The potential tax savings from start-up business losses are ______.
potentially realized immediately if the business is organized as a passthrough entity
The state tax costs of operating as an S corporation may be greater than those of operating as a partnership because ______.
several states levy income and franchise taxes on S corporations that do not apply to partnerships
When attempting to get cash out of a closely-held corporation at lower tax cost than a dividend, most strategies involve payments that are ______.
tax-deductible by the corporation and taxed as income to the shareholders
Shareholders often fund closely held corporations with a mix of debt and equity financing. From a tax perspective, ______.
there is a trade-off between deductibility of interest payments by the corporation and preferential tax rates on dividend income to the shareholders
Historically, corporations have been used as tax shelters when the following conditions existed ______.
top marginal tax rates for individuals exceeded the top marginal rates for corporations preferential capital gains rates applied to appreciation in value of corporate stock
Constructive dividend treatment ______.
typically arises as a result of an IRS audit results in the loss of a corporate deduction and dividend treatment for the shareholder
May Corporation earned $1,000,000 of taxable income this year and paid $210,000 of income tax. If May is a personal holding company and made $800,000 in distributions to its shareholders this year, calculate its personal holding company tax liability.
$0
Which of the following debt-equity balances might lead to an IRS challenge of thin capitalization?
$100,000 of equity and $1,000,000 of shareholder debt
Evans Corporation earned $1,000,000 of taxable income this year and paid $210,000 of income tax. If Evans is a personal holding company and made no distributions to its shareholders, calculate its personal holding company tax liability.
$158,000
For several years, Ennui Corporation has accumulated several million dollars of earnings without a valid business purpose. If its current year accumulated taxable income is $1,250,000, calculate its accumulated earnings tax.
$250,000
Paris Corporation earned $500,000 this year and paid $105,000 of corporate tax. Paris distributed all of its after-tax profit of $395,000 to its sole shareholder, Paz. If Paz's marginal tax rate on ordinary income is 37 percent, and her dividend tax rate is 20 percent, what is her after-tax cash flow from Paris and what is the overall effective tax rate on Paris's earnings?
$316,000 after-tax cash flow and 36.8 percent effective tax rate
Frank, a sole proprietor with a 37 percent marginal tax rate, plans to create a family partnership and transfer ownership of 60 percent of the business to his two children, Greg and Harry, whose marginal tax rate is 24 percent. If the business currently earns $100,000 per year, what is the effect of the transfer on Frank's after-tax cash flow?
$37,800 decrease
Frank, a sole proprietor with a 37 percent marginal tax rate, plans to create a family partnership and transfer ownership of 60 percent of the business to his two children, Greg and Harry, whose marginal tax rate is 24 percent. If the business currently earns $100,000 per year, what is the effect of the transfer on the family's overall after-tax cash flow?
$7,800 increase
Morgan Partnership earned $100,000 this year and distributed $80,000 cash to its partners. If Miles is a 50% partner in Morgan and has a 24% marginal tax rate, Miles's after-tax cash flow from his investment in Morgan this year is $_____
28000
A family partnership might be a bad idea under which of the following circumstances?
Family members have difficulty cooperating in making decisions. Family members have difficulty managing money. The original business owner needs the cash flow from the business for personal consumption.
Which of the following are tax advantages of operating a business as a passthrough entity?
Flow through of losses for deduction by the owner No income tax at the entity level
Which of the following taxpayers are not at risk for the accumulated earnings tax?
Growing business that accumulated earnings to finance business expansion costs Business operated through a partnership Accumulated taxable income of only $200,0000
Which of the following risks are associated with thin capitalization?
IRS reclassification of shareholder debt as equity IRS recharacterization of principal payments as dividends
Which of the following payments from a corporation to an investor is deductible by the corporation?
Interest payments to a corporate bondholder
Which of the following is a successful strategy for avoiding the accumulated earnings tax?
Investing excess cash in new manufacturing facilities
Which of the following are subject to self-employment tax?
LLC members' guaranteed payment for working for the LLC General partners' share of partnership ordinary income
Which of the following are advantages of an LLC?
LLC owners are protected from personal liability for entity debts. LLCs offer the tax advantages of the partnership form.
LLPs are a common form of professional services partnership. Which of the following are accurate statements regarding partner liability for partnership debts in such a partnership?
LLP partners are protected from liability for debts due to malpractice or negligence of other partners. LLP partners are personally liable for partnership debts not arising from malpractice or negligence.
Leming Corporation pays $500,000 of salary to Laura, Leming's majority shareholder. Upon audit, the IRS determines that a reasonable salary for Laura's services would be $200,000. The tax consequences of this determination are that ______.
Laura recognizes $300,000 less salary income and $300,000 more dividend income Leming may only take a tax deduction for $200,000 of salary
Which of the following are tax advantages of operating a business as a passthrough entity?
No income tax at the entity level Flow through of losses for deduction by the owner
Which of the following partnerships is unlikely to be subject to statutory restrictions applicable to family partnerships?
Partnership engaged in real estate rental activities Partnership providing landscaping services in which all partners work for the business
The owners of a passthrough entity would like to allocate all income from one project equally between its two owners, while income from a second project would be allocated only to one owner.Which type of passthrough entity permits this special allocation?
Partnership, but not an S corporation
Which of the following payments received by a corporate investor is not taxable?
Principal payment received on corporate debt
Brianna, whose marginal tax rate on ordinary income is 37 percent and dividend tax rate is 20 percent, is considering opening a business that will generate $50,000 of income annually. She wishes to have access to all after-tax cash flow from the business currently. How much more or less cash flow would she receive if the business is operated as a partnership rather than as a corporation that pays out all after-corporate-tax income as a dividend (ignore self-employment taxes and the Section 199A deduction in your answer)?
She will have $100 less cash flow using a partnership rather than a corporation that pays out all after-corporate-tax income as a dividend.
The current preferential rates on dividend income have what effect on strategies to get cash out of closely-held corporations through tax-deductible payment to shareholders?
The preferential rates reduce shareholder incentives to engage in strategies that would produce ordinary income
