Ch 12

True or false: General partners and S corporation shareholders must pay self-employment tax on their share of the entity's ordinary business income.

False. S corporation shareholders do not pay self-employment tax.

A family partnership might be a bad idea under which of the following circumstances? (Choose all that apply.) -Family members have difficulty managing money. -Family members have difficulty cooperating in making decisions. -The original business owner needs the cash flow from the business for personal consumption. -Other family members need cash flow from the business for personal consumption.

Family members have difficulty managing money. Family members have difficulty cooperating in making decisions. The original business owner needs the cash flow from the business for personal consumption.

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 debt-equity balances might lead to an IRS challenge of thin capitalization? -$1,000,000 of equity and $100,000 of shareholder debt -$500,000 of equity and $500,000 of shareholder debt -$100,000 of equity and $1,000,000 of shareholder debt

$100,000 of equity and $1,000,000 of shareholder debt

Which of the following are subject to self-employment tax? (Select all that apply.)

-LLC members' guaranteed payment for working for the LLC -General partners' share of partnership ordinary income

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? (Select all that apply.)

-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.

Which of the following are tax advantages of operating a business as a passthrough entity? (Select all that apply.) -Lower tax rate on owners than would be paid by a corporation earning the same before-tax profit -No income tax at the entity level -Flow through of losses for deduction by the owner

-No income tax at the entity level -Flow through of losses for deduction by the owner

The creation of a family partnership to shift income to lower tax rate family members ______. (Select all that apply.) -reduces the after-tax cash flow of the family member transferring ownership to others -increases the family's overall after-tax cash flow -increases the family's overall before-tax earnings and tax costs

-reduces the after-tax cash flow of the family member transferring ownership to others -increases the family's overall after-tax cash flow

Constructive dividend treatment ______. (Select all that apply.)

-typically arises as a result of an IRS audit -results in the loss of a corporate deduction and dividend treatment for the shareholder

Lopez Corporation earned $100,000 this year and distributed $80,000 in dividends to its shareholders. If Leon is a 50% shareholder in Lopez and has a 37 percent tax rate on ordinary income and a 20 percent tax rate on dividends, Leon's after-tax cash flow from his investment in Lopez this year is $_______.

32,000

Corporations that accumulate their earnings without a valid business purpose risk liability for the _______ _________ tax.

Accumulated earnings

Which of the following passthrough entity owners are personally liable for entity debts?

General partners in a partnership

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 payments received by a corporate investor is not taxable?

Principal payment received on corporate debt

A personal holding company is ______.

a corporation owned by a small number of individuals and earning primarily nonbusiness income

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

When a taxable corporate entity incurs a start-up loss, the loss ______.

carries forward as a net operating loss, deductible against future operating income

Nontax issues that should be considered before forming a family partnership include ______. (Select all that apply.)

dilution of ownership control for the original owner of the business potential for future family discord

Common transaction costs of forming a family partnership or S corporation include ______. (Select all that apply.)

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, ______. (Select all that apply.)

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 a passthrough entity incurs a start-up loss, the loss ______.

passes through to the owners of the business and is generally deductible against income from other sources (with limitations)

When comparing the tax treatment of passthrough entities versus taxable corporate entities, _________ entities are often preferred to ______________ entities.

passthrough; corporate

In terms of the legal and accounting costs of forming a partnership versus an S corporation, the costs are likely higher for the _______.

s corporation

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

True or false: If corporations accumulate profits rather than distribute them as dividends, corporate shares increase in value. A shareholder that sells their stock realizes capital gains taxed at preferential rates. The combination of deferral of taxation until sale and preferential tax rates increases the attractiveness of a corporation as a tax shelter.

true

For several years, ABC 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

Pain Corporation earned $500,000 this year and paid $105,000 of corporate tax. Pain distributed all of its after-tax profit of $395,000 to its sole shareholder, Paula. If Paula'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 Pain and what is the overall effective tax rate on Pain'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's before-tax cash flow declines by $60,000 = $100,000 × 60%. However, his tax costs decrease by $100,000 × 60% × 37% = $22,200. Thus, his after-tax cash flow decreases by $60,000 - $22,200.

Which of the following partnerships is unlikely to be subject to statutory restrictions applicable to family partnerships? (Select all that apply.) -Partnership providing legal services in which only two family members have law degrees -Partnership providing landscaping services in which all partners work for the business -Partnership engaged in real estate rental activities

-Partnership providing landscaping services in which all partners work for the business -Partnership engaged in real estate rental activities

A family partnership or S corporation ______. (Select all that apply.) -generally increases the overall tax cost of business income earned by the passthrough entity -can be used as an example of entity variable tax planning -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 -can shift income from high-tax rate family members to low-tax rate family members

In terms of the formation costs of a partnership versus an S corporation, ______. (Select all that apply.)

-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

Which of the following taxpayers are not at risk for the accumulated earnings tax? (Select all that apply.)

Accumulated taxable income of only $200,0000 Growing business that accumulated earnings to finance business expansion costs Business operated through a partnership

Which of the following risks are associated with thin capitalization? (Select all that apply.)

IRS recharacterization of principal payments as dividends IRS reclassification of shareholder debt as equity

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 ______. (Select all that apply.)

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

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 are common strategies for getting cash out of a closely-held corporation at lower tax cost? (Select all that apply.)

Shareholder loans to the corporation Salary payments to owner-employees

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.

Historically, corporations have been used as tax shelters when the following conditions existed: (Select all that apply.)

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.

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