Tax Planning: Tax Characteristics of Entities (Module 4)

Juan acquires 100 shares of Allied Corporation stock during the current year for $40,000. Allied Corporation is a qualifying calendar-year S corporation. Juan's share of Allied's current year ordinary income is $10,000. In addition, his share of separately stated items includes $4,000 of long-term capital gains and $2,000 of Sec. 1231 losses. Allied Corporation also distributes $5,000 cash to Juan on November 9. What is Juan's basis in the S-corp stock on December 31?

$47k 40 + 10 + 4 - 2 - 5 = $47k

What are the steps to completely liquidate a corporation?

- Shareholders determine that they wish to completely terminate a corporation's existence - Assets are either distributed in-kind to the shareholders in exchange for their stock or sold and converted to cash in exchange for their stock - Once the assets are distributed, the liquidated corporation usually is dissolved under state law

What are the qualifications to create an S-corp?

- domestic corporation - maximum of 100 shareholders - Only individuals, estates and certain trusts - Only one class of stock

What two tests must be met for a company to be classified as a personal holding company?

- during the last six months of the tax year, 50% or more of the outstanding stock is owned by five or fewer individuals - 60% or more of the AGI is personal holding company income (dividends, interest , and under certain circumstances, rental income)

NOL would generally be important to a sole proprietor who just started a business because of which of the following reasons? (Presume tax year 2018) 1. Losses from the business can be claimed on his/her 1040. 2. Losses in his/her business in excess of taxable income may be carried back two years to recover tax paid in those prior years.

1 Schedule C losses attributable to a sole proprietorship may be claimed on that proprietor's personal 1040 and thus reduce AGI and ultimately taxable income. Regarding statement II, the TCJA eliminates NOL carrybacks for business losses incurred in tax years 2018 and beyond.

Which of the following forms of business organization can pass losses through to the owner(s)? 1. S corporation 2. C corporation 3. Sole proprietorship 4. General partnership 5. Limited partnership

1, 3, 4, 5

Which of the following are considered organizational expenses for a partnership? 1. Printing costs of a prospectus 2. Legal fees 3. Brokerage fees 4. Accounting fees 5. Filling fees

2, 4, 5 Organizational expenses include legal and accounting fees incident to organizing the partnership, filing fees and other expenses

Your client Pete operates as a sole proprietorship with net earnings of $400,000. Pete reads an article in the Sunday paper about incorporating to limit the owner's liability. He comes to you for advice. Which of the following statements would be proper advice for you to tell Pete? Why? 1. He should not incorporate because the top corporate income tax bracket is 21%. 2. A limited partnership also protects him from liability. 3. An S corporation would save him money because it does not have to file income tax returns. 4. He can reduce his current income tax liability by splitting his income between himself and a C corporation. 5. An S corporation could allow him to shift income to his children if he gives them stock.

4, 5 The corporate tax rate is 21%. He cannot establish a limited partnership. He is an active participant. He will be considered a general partner. As a general partner, he has full exposure to liability. If he took a salary of $400,000, the client's marginal tax bracket is 35%. This way the client could reduce his/her income tax liability. An S corporation could shift income. Answers IV and V are the best choice.

If an S corporation terminates its election, the corporation may not reelect S corporation status for how long?

5 years If an S corporation terminates its election, the corporation may not reelect S corporation status for five years unless the IRS consents to an early reelection. For purposes of the five-year rule, tax years beginning before January 1, 1997 are not counted

Bill Bradley and Alice Cates are going to buy a $20 million dollar hotel together. The hotel needs a substantial upgrade but the price is a bargain. They plan to put up $4 million in cash ($2 million each). The remaining $16 million is coming from a bank loan. The bank is requiring a personal endorsement by Bill and Alice to make the loan. If the hotel must have major changes which will require floors to be shut down, they feel losses could total $10 million in the first year. Which entity should they elect to cover them for conduit of losses and liability protection? Why? a. LLP/LLC b. S Corporation c. Partnership d. C Corporation

A A Partnership subjects them to tremendous liability exposure. The C Corporation will not allow conduit of losses. The S Corporation has a limit of losses of $4 million (bank debt does not increase their basis). The LLP provides for both of their needs.

Is there an advantage between taking excessive income as a stockholder from a corporation or an S corporation if the company is very profitable? a. Taking limited income from an S corporation will reduce FICA and FUTA taxes because the remainder of income will be unearned income. b. Taking limited earned income from an S corporation and the remainder as unearned income will reduce corporate taxes. c. Taking earned income as compensation from a corporation will qualify the stockholder to ultimately qualify for a large retirement contributions. d. Taking earned income as compensation from a corporation will qualify the stockholder to ultimately get more Social Security benefits.

A In answer A and B there are salary caps that limit what qualifies for Social Security benefits and retirement contributions, but compensation from a regular corporation is subject to unlimited Medicare taxes. That is why an S corporation (Answer C) is a better answer. Unearned is not subject to Medicare tax. Answer D is incorrect, an S corporation has conduit income. No taxes are paid by the corporation.

Tory starts a small financial planning practice. The business is a sole proprietorship. Tory anticipates taking a regular salary. As a result, she anticipates marginal profits or losses for the next several years. She wants to establish a family business so that her daughter and son can join her in future operations after they graduate from college. What is the most appropriate business form for Tory's practice? a. Change to an S corporation and issue both voting and nonvoting stock. b. Change to a corporation. c. Stay as a sole proprietorship for the time being. d. Change to a general partnership and issue limited partnership interests.

A The S Corporation will enable Tory to claim losses from her business. As limited partners, her son and daughter cannot actively participate in the business. A regular corporation does not enable Tory to claim the business losses on her personal 1040. The solution is somewhat subjective. Staying a sole proprietorship, although acceptable, is not the best choice.

Non-liquidating distribution

A distribution may result in a reduction of a partner's capital interest in the partnership. Property distributed to a partner in a non-liquidating distribution does not result in a taxable gain or loss to the partner unless the distribution includes cash or marketable securities in excess of the partner's basis in his or her partnership interest.

Which of the following businesses must file federal tax returns? 1. S corporation 2. C corporation 3. General partnership 4. Limited partnership

All

During the year, Freddy's business generated $13,000 of income. Unfortunately, he had $23,000 of expenses. He is a sole proprietor. Which of the following is true? a. Sole proprietors cannot take losses. They have no basis. b. Schedule C losses can be applied against income earned in the same year. c. The losses will be suspended until he makes a profit. d. If he had taxable income in the prior two years, he can carry back any excess losses against prior income.

B

Tom, age 61, is self-employed. He has no employees. He is paying $3,600 for medical, $1,200 for dental, and $2,000 for LTC insurance. His Schedule C net income is $90,000. What is his AGI? a. $83,200 b. $76,841 c. $84,474 d. $77,674 e. $79,674

B Net Schedule C income $90,000.00 Less self-employment tax adjustment* - 6,358.50 Less insurance premiums** - 6,800.00 AGI $76,841.50 *$90,000 x 0.07065 = $6,358 **Maximum LTC at age 61 is $3,720 ($2,000 LTC premium is under the phaseout/threshold). Premium = $3,600 + 1,200 + 2,000 = $6,800, which is deductible on the front of the 1040.

Q Corporation has the following items of income and expense: Taxable income $200,000 Federal income tax paid $75,000 Dividends paid $25,000 Accumulated earnings and profits at the end of the prior year come to $200,000. Q Corporation is not a personal service corporation. What amount, if any, of accumulated earnings tax is due? a. $39,100 b. $7,500 c. Zero d. $19,300

B Prior accumulated earnings $200,000 Income $200,000 Tax paid - $75,000 Dividends paid - $25,000 This year's earnings + $100,000 Total accumulated earnings $300,000 Less credit - $250,000 Accumulated taxable income $50,000 Tax due (15%) $7,500

Which of the following conditions would prevent a corporation from qualifying as an S corporation? a. a corporation that has only one class of stock b. a corporation that has nonresident aliens as shareholders c. a corporation that has an estate as a shareholder d. a corporation that is not a member of an affiliated group

B In order to qualify as an S corporation, the corporation must not have a nonresident alien as a shareholder

On what tax forms are S corporation distributions normally received by individuals? a. 1099 b. Schedule K-1 of 1120S c. Schedule K-1 from Form 1065 d. Schedule K-1 of the 1041 e. Schedule E

B K-1 of 1120S is for S corporation distributions. K-1 of the 1041 is for trusts and estates. 1099 is for self-employed income. K-1 of the 1065 is for partnerships. Schedule E is for the reporting of K-1 income.

David Leonard, a successful CPA, is going to merge his practice with John Murphy. John is also a successful CPA. Which would be the most appropriate business form for David and John? Why? a. A partnership b. A limited liability partnership (LLP) c. A limited partnership (LP) d. An S corporation e. A corporation

B The LLP offers limited liability for the practice and no liability to one partner for the professional acts of the other. A corporation would be classified as a PSC subjecting any retained earnings to a 21% tax rate. A partnership increases the professional liability to each partner (the acts of the partnership and the partners). A limited partnership only works for passive investors. If an LLP was not offered as an answer, the best answer becomes an S corporation.

Alan is buying a business that was in receivership. He anticipates business difficulties and potential losses before the business becomes profitable. What do you suggest Alan do? Why? a. Establish the new business as a sole proprietorship. b. Establish the new business as an S-corporation. c. Establish the new business as a regular corporation. d. Establish the new business as a limited partnership.

B The business is risky so Alan needs limited liability. The S Corporation provides both limited liability and the pass through of losses.

Bobbie was an employee of XYZ, an S corporation. He stills owns stock. Which of the following tax reporting forms will he receive? a. 1099-Misc b. Schedule K-1 c. W-9 d. W-2

B The form K-1 reflects Bobbie's unearned income; W-2 and a K-1 would apply if he was still employed.

Which of the following provides unlimited interest deductibility on a personal tax return? a. Personal loan interest b. Mortgage interest on a primary residence c. Business investment interest paid (or "expensed") d. Margin account investment interest

C Deductions for mortgage interest and margin interest are limited. Personal loan interest isn't deductible. Business interest is unlimited.

Paul owns a business that produces $50k of annual profits. If the business were incorporated, it could justify the retention of all of its earnings and pay little or no dividends. Paul also has $400k of taxable income from other sources. Should Paul organize the business as an S corporation or as a C corporation? Why?

C corporation Although many factors could be involved, one important tax factor is that Paul's income from the business could be taxed at the 35% marginal tax rate in 2005 if it is an S corporation. The tax rate on the C corporation is 15% on the first $50k of taxable income. Double taxation would result, however if the profits were withdrawn as a dividend payment or as a capital gain when the stock was sold

An S corporation tax year is restricted to a calendar year unless the corporation establishes a business purpose for a fiscal year. A. True B. False

Correct Answer: A. True Explanation: The tax year is restricted to a calendar year unless the corporation establishes a business purpose (e.g., a natural business cycle) for a fiscal year. Other special rules allow a tax year resulting in a maximum three-month deferral.

What is the basis of each partnership interest adjusted to reflect? A. partner's share of original contribution B. partner's share of income and deduction items C. partner's share of dividends D. partner's share of loans

Correct Answer: B. partner's share of income and deduction items Explanation: Under Section 705, the basis of each partnership interest is adjusted to reflect the partner's share of income and deduction items.

Carl, partner with a $10,000 basis in the ABC Partnership, receives property having a FMV of $20,000 and a basis of $8,000 in a non-liquidating distribution. How much gain does Carl recognize? Why? A. $10,000 B. $12,000 C. $0 D. $28,000

Correct Answer: C. $0 Explanation: A partner recognizes gain only when the amount of cash distributed exceeds the basis of the partnership interest.

Grace is a financial planner hired by Joel to develop a financial plan. Joel owns a consulting business as a sole proprietor and is a general partner for a small publishing firm. Which of the following statements are correct about the debts of these entities that Joel owns an interest in? 1. The consulting company's debt is part of Joel's personal debt. 2. The consulting company's creditors may place liens on his property. 3. The publishing company's debt may have increased Joel's share of debt. 4. Neither the consulting nor the publishing companies' debts effects Joel's personal debt.

Correct Answers: 1, 2, 3 Explanation: Both the consulting company and the publishing company's debt effects Joel's personal debt obligations. It is likely that creditors require some sort of collateral from Joel's personal property to secure loans for his business. An increase of borrowing by the partnership will result in an additional share of the debt for Joel.

What is the advantage of establishing an S corporation versus a regular (C) corporation? Why? a. The ability to provide a defined benefit plan. b. The ability to issue preferred stock. c. The ability to issue voting and nonvoting common stock. d. The ability of an owner to take excessive compensation and not have it classified as dividends.

D A high salary paid to the owner(s) does not affect S corporations. The IRS would not reclassify salary as dividends (conduit theory) but may try to reclassify excessive compensation in a regular corporation. S corporations cannot issue preferred stock (disadvantage). Both S and regular corporations can provide defined benefit plans and issue voting and nonvoting common stock.

Erica contributes cash to the XYZ partnership in exchange for interest in that partnership. When does the holding period begin for Erica? a. the date the interest is acquired by the partnership b. the date the partnership's fiscal year c. the date the partnership receives the cash d. the date the interest is acquired by Erica

D If a partner contributes only cash to the partnership in exchange for a partnership interest, the holding period begins on the date the interest is acquired

A CPA starts out in practice. She is reasonably successful during the first years using an S corporation entity. Due to retaining a large client she expects her income from the corporation to double this year. What should she do with her business entity? a. Convert to a regular C corporation b. Stay as an S corporation and issue preferred shares so she can qualify for the preferred dividend tax rates. c. Form a limited partnership d. Stay as an S corporation

D If she converts to a regular C corporation she becomes a PSC. PSC profits are subject to a flat tax 35%. As an S owner the excess income above salary just flows through to her at her personal tax bracket (unearned K-1 income). She cannot be a limited partner because she is active. S corporations cannot issue preferred shares.

Bob and Fred, brothers, want to start a new restaurant. They will materially participate. They anticipate losses for the first three years due to competition. If one of the brothers dies, they want the survivor to be able to continue the business. They anticipate that they may have to raise additional capital through the sale of interests or have the business borrow funds. Which one of the following business forms is most appropriate? Why? a. C corporation b. S corporation c. General partnership d. LLC

D If they have an S corporation, their basis would be limited to cash invested in the business and direct loans, not corporate debt. The LLC would have the same basis as a partnership. This would allow the LLC to take more losses than an S corporation could take. This is an advantage over an S corporation.

Mel has the following income: Net schedule C income $50,000 K-1 income from a general partnership $20,000 K-1 income from a S corporation $15,000 Interest $2,000 Dividends $3,000 What amount of self-employment tax must Mel pay? a. $8,596 b. $10,710 c. $12,010 d. $9,891

D Shortcut: $70,000 x 0.1413 = $9,891

What happens to a partners basis in a partnership should there be a pass-through of ordinary loss?

Decrease

Michelle has the following income: Net Schedule C income $40,000 Travel and entertainment expenses $10,000 K-1 income from a general partnership $5,858 K-1 income from an S corporation (distributed) $20,000 What amount of self-employment tax must Michelle pay? a. $9,305 b. $3,240 c. $5,632 d. $7,016 e. $6,480

E $45,858 x 0.9235 x 15.3% = $6,479.53 Shortcut: $45,858 x 0.1413 = $6,479.73 The question says net Schedule C that means the travel and entertainment has already been deducted. This is only true to $128,400. There should be no questions with income exceeding $128,400. NOTE: Then subtracting half on the front of the 1040 will work this year. The 1040 subtraction is as follows. 45,858 x 0.9235 x 0.0765 = $3,239.76 or 45,858 x (0.5 x 0.1413) = $3,239.86 or $45,858 x 0.07065 (0.5 x 0.1413)

Ellen, who has a 50% interest in the EF Partnership, has a $10,000 basis in her partnership interest at the end of the current tax year (before deducting her share of losses). The EF Partnership incurs a $50,000 ordinary loss this year, and Ellen's share of the loss is $25,000 ($50,000 x 0.50). What is Ellen's basis?

Ellen can only deduct $10,000 in the current year. The remaining $15,000 of loss carries over to future years. The deductible loss of $10,000 reduces Ellen's partnership basis to zero at the end of the current year.

A statutory employee

If a worker falls into one of these four categories- a driver who is paid on commission or is your agent, a life insurance sales agent, a person who works at home on materials or goods that you supply, or a salesperson who turns in orders for resale from wholesalers, retailers, contractors or hotel or restaurant establishments. Social Security and Medicare taxes are withheld if these services are performed on a continuous basis for the same payer and if the worker does not have a substantial investment in the equipment and property used to perform these services.

Compare the manner in which income of an S corporation is allocated among the shareholders to the manner in which partnership income is allocated among the partners

In the case of an S corporation, the income must be allocated based on the percentage of stock owned on a daily basis. Partners have a much greater flexibility. The partnership agreement serves as the basis for allocation, with special allocations being permitted. No special allocations are permitted for an S corporation

Why do partners increase the basis of their partnership interests by their share of tax-exempt income?

Increasing the basis ensures that the tax-exempt income will retain its tax-free character when the income is subsequently distributed in the form of cash or the partners interest in the partnership is sold or exchange

Can NLTCLs and NSTCLs be deducted against ordinary income for corporations?

No they cannot. Only individuals can do that

Which business structure has income that is derived from personal investments?

Personal Holding Company

Which business structure may use the cash method of accounting?

Personal Service Corporation

Sole Proprietorship, General Partnership, Limited Partnership, Limited Liability Company, Corporation: Owner's liability for business debts?

Sole Proprietorship - unlimited liability General Partnership - unlimited liability Limited Partnership - general partners have unlimited liability. Limited partners have liability in what they invested Limited Liability Company - limited to investment in business Corporation - limited to investment in business

At any one time, how many different individuals could be shareholders in a single S corporation?

The S corporation could have as many as 200 shareholders if the group consisted of 100 married couples

For example, Austin Corporation, an electing S corporation, distributes land (a capital asset) to its sole shareholder Sue. The land has a $10,000 basis and a $90,000 fair market value. What are the tax consequences to the corporation and to Sue?

The S corporation recognizes an $80,000 capital gain, which passes through to Sue and increases the basis of her Austin stock. The basis of the land to Sue is $90,000 (its fair market value).

Tax-exempt organizations

The federal tax law exempts certain types of organizations from income tax, such as churches and charitable organizations. Charitable organizations are known as Section 501(c)(3) organizations, after the specific provision in the federal tax law providing for their tax-exempt status.

Liquidating distribution

The partnership may desire to liquidate a partner's entire interest due to retirement, death or other business reasons. In such cases, the liquidating distribution is treated as a sale or exchange of the partnership interest.

The maximum deferral an S corporation may elect if it agrees to make a special tax payment each year that approximates the deferral benefit is _______ month(s)

Three months

Accumulated Earnings Tax

To discourage companies from retaining excessive amounts of earning if the funds are invested in nonoperating assets. A primary purpose is to force dividend payments of excess earnings.

Personal Holding Company (PHC) Tax-Section 541

To prevent closely held companies from converting an operating company into a passive investment company. A primary purpose is to force dividend payments of passive income.

An S corporation can have both voting and nonvoting common stock as long as the shares of stock have identical rights to shares in the profits and assets of the corporation. True of false? Why?

True Treasury regulation allow that a corporation is treated as having only one class of stock if all outstanding shares of stock confer identical rights to distribution and liquidation proceeds

Partnerships

Two or more owners. are a legal entity separate from its owners. Partnerships can be classified as general or limited. Partners have unlimited personal liability for all debts incurred by the business. Family limited partnerships must have a business purpose and have many gift and estate tax advantages.

What happens if during a tax year the partnership changes (either a partner cashes out or a new partner is added)?

all of the partners must determine their distributive share of the partnership income, deductions, losses and credits according to their varying interests in the partnership during the year. Retroactive allocations (for example, an allocation of deductions or losses incurred before admission of a new partner to the partnership) may not be made to new partners admitted during the partnership's tax year.

What happens to the partnership's basis should there be a partnership has nondeductible expenses?

decrease

What happens to the partnership's basis should there be cash distribution to partners?

decrease

What happens to the partnership's basis should there be partnership decreases liabilities?

decrease

What happens to the partnership's basis should there be partnership has section 179 expenses?

decrease

What happens to the partnership's basis should there be a partnership has tax-exempt income?

increase

What happens to the partnership's basis should there be a pass-through of capital gain?

increase

What happens to the partnership's basis should there be a pass-through of dividend and interest income?

increase

What happens to the partnership's basis should there be a pass-through of ordinary net income?

increase

What happens to the partnership's basis should there be cash contributions from partners?

increase

What happens to the partnership's basis should there be partnership increases liabilities?

increase

Section 332

provides an exception to the general rule that gain or loss is recognized in a liquidating distribution. Under this exception (along with Section 337), neither the parent nor the subsidiary recognizes gain or loss if a parent corporation liquidates an 80%-owned subsidiary corporation.

if Allen contributes business equipment having a $10,000 FMV and a $4,000 adjusted basis to the ABC Partnership in exchange for a 30% interest in the partnership. What is Allen's basis of the partnership?

the basis of Allen's partnership interest is $4,000 (a substituted basis) because he recognizes no gain or loss under Section 721.

A qualified personal service corporation must use the ___% maximum corporate tax rate to calculate its tax liability.

21%

BEGINNING IN 2018 THE CORPORATE TAX RATE IS A FLAT ___%.

21%

Non-business bad debts are deductible as a long-term capital loss, subject to the $3,000 per year limitation. True or false? Why?

False Non-business bad debts are deductible as a short-term capital loss, subject to the $3,000 per year limitation

An independent contractor

If the person for whom the services are performed has the right to control or direct only the result of the work and not the means and methods of accomplishing the result.

Sun Corporation makes a liquidating distribution of land with a $70,000 adjusted basis and a $100,000 FMV to shareholder John, who surrenders his Sun stock to the corporation. Joan, another shareholder, receives $100,000 cash for her shares. John's adjusted basis in the Sun stock is $40,000. Joan's adjusted basis in her stock is $120,000. What are the tax consequences to the shareholders?

John recognizes a $60,000 ($100,000 - $40,000) capital gain. Joan recognizes a $20,000 ($120,000 - $100,000) capital loss. The tax basis of the land received by John is $100,000 (the land's FMV on the distribution date).

Mario and Nancy are equal owners of Texas Corporation, which is highly profitable and has substantial E&P. Mario and Nancy are the key officers and are each paid a $100,000 salary. A reasonable salary for each would be $150,000. Should the corporation distribute the E&P via dividend or salary payments?

To increase cash distributions to the owners, additional salary payments of $50,000 should be made to both Mario and Nancy because the corporation can deduct salary payments, whereas the dividend payments are not deductible. The salary payments result in only a single level of taxation, while the dividend payments result in double taxation.

Section 752

Under the general rules of Section 752, a partner's basis in the partnership interest increases by the partner's share of any changes in the partnership's liabilities during the year. For example, if total partnership liabilities (including accounts and notes payable, mortgages, bank loans, etc.) increase during the year from $100,000 to $200,000, the basis of a partner with a 50% interest in the partnership increases by $50,000 ($100,000 increase in liabilities x 0.50).

Personal Holding Companies (PHCs)

are closely held C corporations with a certain percentage of their income derived from investments, such as interest, dividends, and real estate rents.

What happens to the partnership's basis should there be partnership makes charitable contribution?

decrease

General Partnership

each partner has unlimited liability for partnership debts. Thus, these partners are at risk for more than their investment in the partnership

A publicly held corporation is prohibited a deduction for compensation in excess of $_______ paid to the CEO, CFO, or any of the three highest paid employees.

$1 million

Ajax Inc., a C-Corporation which is not a person service corporation, has the following items of income and expense: - Taxable Income = $715,000 - Dividends paid = $62,500 - Federal income tax = $129,800 - Accumulated Earnings and profits at the end of the preceding year = $210,000 Calculate the Accumulated Earnings Penalty

$72,405 - Since Ajax is not a personal service corporation, they are allowed to accumulate up to $250,000 of accumulated earnings 715000-62500-129800 = 522700 522700+210000-250000 = 482700 482700 x .15 = $72,405

Tina contributes a building worth $80k (adjusted basis is $60k) and $15k in services to a partnership for an interest in the partnership. What is Tina's basis in the partnership interest?

$75k Disregarding the effect of any liabilities, the basis of the contributing partner's partnership interest equals the sum of money contributed plus the adjusted basis of other property transferred to the partnership

Section 721

(Nonrecognition Rules) prevents the recognition of gain or loss upon either the transfer of property in exchange for a partnership interest or subsequent transfers of property by the partners in exchange for a pro rata increase in their partnership interests.

A business trust

(also known as a common-law trust, Massachusetts trust) is a trust that is created for the purpose of making a profit. This entity is characterized by some kind of commercial activity, transferable certificates of interest, continuity after the death of beneficiaries, limited liability, legal title in the hands of trustees and officers having duties of management.

What are the advantages of personal service corporations (PSC)?

- A qualified personal service corporation (QPSC) can use the cash method or the accrual method. C corporations can only use the accrual method - A qualified personal service corporation (QPSC) must use the 21% maximum corporate tax rate to calculate its tax liability.

What do states normally require corporations to file?

- A statement listing the name and purpose of the corporation, and the names of its directors and organizers. - A filing fee. - The articles of incorporation. - Information about the stock to be issued.

When a corporation repurchases (redeems) some of its outstanding stock from a shareholder, the redemption is treated as what?

- A taxable dividend (to the extent of E&P) - An exchange of the stock, generally resulting in capital gain or loss treatment by the shareholder

When determining if a worker is considered an employee, facts that provide evidence of the degree of control and independence fall into what three categories?

- Behavioral: Does the company have the right to control what the worker does and how the worker does his job? - Financial: Are the business aspects of the worker's job controlled by the payer? - Type of Relationship: Are there written contracts or employee type benefits? Will the relationship continue and is the work performed a key aspect of the business?

There are many tax planning considerations that a corporation must consider, such as what?

- Capital structure and Section 1244, - Dividend policy, - Use of losses, - Charitable contributions, and - Dividend-received deduction.

When the PHC tax is owed, there is triple taxation that includes what?

- Corporate income tax paid by the corporation, - PHC tax paid by the corporation, and - Income tax paid by the shareholders when a dividend is eventually paid.

What are the three major advantages of a sole proprietorship?

- Ease of formation - No double taxation - Autonomy (there is no board of directors or co-owners to report to)

What are the two types of partnerships?

- General Partnership - Limited Partnership

What are the disadvantages of partnerships?

- General partners do not enjoy limited liability. Even in a limited partnership, at least one partner must be a general partner with unlimited liability. - A partnership cannot choose any tax year it desires. - The business may be altered or even destroyed by the death or withdrawal of a partner, or a transfer of a partner's interest.

What are the qualifications to be classified as an S Corporation?

- Have no more than 100 shareholders, - Be a domestic corporation, - Have no shareholder who is a nonresident alien, and - Have only one class of stock (S corporations cannot have common and preferred shares, but shares can be voting and non-voting stock).

What are the advantages of partnerships?

- No restrictions on either the number or types of partners. - Not subject to double taxation.

What are three special C corporations?

- Personal service corporations - Personal holding companies - Professional corporations

What are the disadvantages of personal service corporations (PSC)?

- Some PSCs must use the calendar year as their tax year so unlike other kinds of C corporations, they cannot elect to use an alternative tax year.

What are the disadvantages of the S Corporation Form?

- The limits placed on the types and number of shareholders can hamper the corporation's ability to raise capital. - Must use calendar year as tax year - Shareholders with more than 2% of stock are not eligible for tax-free fringe benefits such as health insurance and group term life. It will be counted as income to the shareholder and deducted by the S-corp

An S corporation has two significant advantages over C corporations and partnerships, what are they?

- Unlike a C corporation, an S corporation (with limited exceptions) is not subject to double taxation. - Unlike a partnership, shareholders of an S corporation enjoy the benefits of limited liability because the entity is a corporation under state law.

In deciding whether a meaningful reduction has occurred, the IRS looks at the shareholder's interest in what right?

- Voting Power - Participation in Earnings and Profits - Share of Net Assets upon Liquidation

What are the disadvantages of C Corporations?

- if the corporation was not properly formed, then personal assets could be exposed to personal liability - income is taxed twice - Complex computations are necessary for filing on consolidated taxable income.

Limited Liability Partnership (LLP)

- liable for their own acts except they are typically not liable for negligence, wrongful acts, or misconduct of other partners - each partner has potential liability for partnership liabilities (i.e. wage) - must pay state registration fees and liability insurance

What are the advantages of C Corporations?

- personal assets are protected - can raise additional capital by issuing new stock - Corporate form involves special shareholder and employee tax rules and the ability to file a consolidated tax return if the corporation is part of an affiliated group. - no restrictions on the number or types of shareholders that a C Corporation can have

What are the three major disadvantages of a sole proprietorship?

- potential liability of personal assets - no continuity plan for when owner dies or terminates business - Business assets are included in owners gross estate when they die

What are the disadvantages of the S-Corp from on the state level?

- some states in which a company does business may not recognize the S-corp status - Some states that treat an S corporation as a pass-through entity nevertheless assess an income tax directly on the S corporation. - Some states do not define an S corporation exactly as it is defined under the federal tax law, so a corporation that meets the federal definition may not meet the state definition, or vice versa, which can lead to problems.

What does a complete termination of a shareholder's stock interest qualify for? 1. Ownership 2. Refund 3. Loss treatment 4. Capital gain

3, 4 Under Section 302(b)(3), a complete termination of a shareholder's stock interest also qualifies for capital gain or loss treatment

Which factor qualifies a person as an employee? a. employer provides training and tools to the worker b. worker is not required to follow the employer's instructions c. worker could suffer a loss or make a profit d. employee sets the work hours

A Employees can receive training but they cannot set their own work hours and must comply with employer directives

What expenses can be deducted when forming a partnership?

A partnership can deduct up to $5,000 of costs of organizing the partnership in the year the partnership begins business. The deduction is limited to the lesser of (1) the amount of organizational expenditures or (2) $5,000, reduced by the amount by which such organizational expenditures exceed $50,000.

What are the tax filing deadlines for sole proprietor's?

A sole proprietor's income tax return Form 1040 is due on April 15 following the end of the calendar year. An automatic six-month extension may be obtained by filing an extension form by April 15.

Sole Proprietorship

A sole proprietorship is a business owned and controlled by one person and is not a separate entity from its owner. He and his practice will be considered as a single taxpayer

Limited Partnership

At least one partner must be a general partner, and at least one partner must be a limited partner. General partners are liable for all partnership debts, and the limited partners are liable only to the extent of their investment plus any amount they commit to contribute to the partnership if called upon

Which type of tax treatment prevents corporations from paying disguised dividends in the form of a stock redemption, taxable as a capital gain? a. Exchange of stock b. Outstanding shares c. Taxable dividend d. Exchange of bond

C Taxable dividend treatment prevents corporations from paying disguised dividends in the form of a stock redemption, taxable as a capital gain

What is the holding period for the partnership interest if the following is used to enter the partnership: cash, property or property other than capital asset or Section 1231 property?

Cash = starts when the partnership interest is acquired Property = includes the holding period of the contributed property other = starts when the partnership interest is acquired

The tax consequences for an asset sale closely parallel a liquidating distribution. For example, if a corporation sells its assets pursuant to a complete liquidation and then distributes the money received from the sale to its shareholders, all gain or loss realized on the sale of the assets is recognized by the _____________________.

Corporation

First Corporation, which is in its fifth year of operations, has the following capital gains and losses in the current year: LTCG $20,000 LTCL 4,000 STCG 16,000 STCL 40,000 Taxable income (exclusive of the capital gains and losses) is $60,000. What is First Corporation's capital gain or loss position? A. Capital loss of $8,000 B. Capital gain of $2,000 C. Neither capital gain or capital loss D. Capital loss of $10,000

Correct Answer: A. Capital loss of $8,000 Explanation: NLTCG $16,000 NSTCL 24,000 ------------- First Corporation thus has a net capital loss of $8,000.

When a corporation repurchases (redeems) a portion of its outstanding stock from a shareholder, redemption is treated as either a taxable dividend or as an exchange of the stock, generally resulting in capital gain or loss treatment by the shareholder. A. True B. False

Correct Answer: A. True Explanation: When a corporation repurchases (redeems) a portion of its outstanding stock from a shareholder, redemption is treated as: a taxable dividend (to the extent of E&P); an exchange of the stock, generally resulting in capital gain or loss treatment by the shareholder.

Jean owns a bed and breakfast establishment as a sole proprietor. When she files the earnings of the establishment, she reports it under the business' own tax identification number and on its own business tax forms. A. True B. False

Correct Answer: B. False Explanation: The sole proprietorship is not a separate entity from its owner. This extends to the tax treatment of the business' profits and loss as well. The business' earnings are reported as part of the owner's personal tax form under Schedule C.

If a customer sues Jean for injuries obtained at Jean's bed and breakfast that she owns as a sole proprietor, which of the following statements is true? A. The Bed and Breakfast will bear the settlement alone B. Jean will be personally liable for the settlement C. Jean will not be responsible for the settlement D. Jean's personal property is not exposed to the suit

Correct Answer: B. Jean will be personally liable for the settlement Explanation: The sole proprietorship is not a separate entity from its owner. Hence, the owner has to assume full responsibility for all business debts and liabilities. The owner's personal property is not immune to the business' debts and liabilities. This is the greatest disadvantage of a sole proprietorship.

Dean Accounting did not want to be liable for each partners' conduct, so it converted to a different flow-through business entity. Identify the most suitable form of flow-through entity for Dean Accounting. Why? A. Limited Liability Company B. Limited Liability Partnership C. S Corporation D. General partnership

Correct Answer: B. Limited Liability Partnership Explanation: The LLP form limits legal liability. Under state LLP laws, partners are liable for their own acts and the acts of individuals under their direction. LLP partners are not liable for the negligence or misconduct of other partners. This entity is attractive to professional service partnerships, such as public accounting firms.

All of the following are tax consequences for LLCs that meet the federal income tax definition of a partnership, except: Why? A. The LLC will avoid double taxation on income. B. The members of an LLC will not be subject to self-employment tax. C. Health insurance premiums are 100% deductible for LLC members. D. The LLC is liable for payroll taxes on employee wages and excise taxes.

Correct Answer: B. The members of an LLC will not be subject to self-employment tax. Explanation: Members of an LLC that meet the federal income tax definition of a partnership are subject to self-employment tax and can deduct health insurance premiums. An LLC is liable for payroll and excise taxes but avoids double taxation on income.

In computing corporate net operating loss (NOL), which of the following is taken into consideration? A. Non-business deductions B. Capital gains and losses C. Dividend-received deductions D. Carryover, carryback deductions

Correct Answer: C. Dividend-received deductions Explanation: The computation of a corporate net operating loss (NOL) does not involve making adjustments for non-business deductions and capital gains and losses as are required for individuals. In computing a corporation's NOL, the full dividends-received deduction is allowed. However, no deduction is permitted for an NOL carryover or carryback from a preceding or succeeding year.

For purposes of the accumulated earnings tax, all of the following are reasonable needs of the business EXCEPT which? A. Acquiring the assets or stock of another business. B. Retiring debts. C. Providing working capital for the business. D. Making loans to stockholders.

Correct Answer: D. Making loans to stockholders. Explanation: Reasonable needs of businesses include: reasonably anticipated expansion of the business and plant replacement, acquiring the assets or stock of another business, providing working capital for the business, establishing a sinking fund to retire corporate debt, and making investments or loans to suppliers and customers, not stockholders.

Which of the following statements concerning business entities are correct? 1. A qualified personal service corporation must use the 21% maximum corporate tax rate to calculate its tax liability. 2. Professionals may incorporate as professional corporations to take advantage of retirement and other tax advantages available to corporate employees. 3. A trust is subject to the same tax rates as corporations. 4. An association is a legally established entity.

Correct Answers: 1, 2 Explanation: A trust is subject to the same tax rates as individuals, not corporations. An association is not a legally established entity it is a group of people joined together for a common purpose. Professionals may incorporate as professional corporations to take advantage of tax advantages available to corporate employees that aren't available to self-employed individuals such as proprietors and partners. A qualified personal service corporation must use the 21% maximum corporate tax rate to calculate its tax liability.

Which of the following are features of a partnership? 1. Profits and losses are shared according to the partnership agreement. 2. A partnership can be created without formality. 3. A partner can be an individual, corporation, trust or estate. 4. A partnership cannot have more than 100 shareholders.

Correct Answers: 1, 2, 3 Explanation: An S corporation can only have 100 shareholders or less, but there are no restrictions on the number or types of partners in a partnership. A partnership can be created informally and profits and losses are divided according to the partnership agreement. A partnership is defined as a syndicate, group, pool, joint venture or unincorporated organization that carries on any business, financial operation or venture, and a partner is a member who can be an individual, corporation, trust or estate.

Which of the following statements is true regarding the liability of business owners? 1. A sole proprietor has unlimited liability for business debts and judgments. 2. A general partner's business and personal assets are at risk to creditors. 3. All members in an LLC typically enjoy limited liability. 4. Shareholders of an S corporation do not have limited liability because the entity is a corporation under state law.

Correct Answers: 1, 2, 3 Explanation: Shareholders of an S corporation have limited liability as do members of an LLC. A sole proprietor or a general partner has unlimited personal liability for business debts and judgments.

What are the advantages for establishing a C corporation over other forms of business entities? 1. Double taxation 2. Additional options for raising capital 3. Limited liability for owners 4. Restrictions on the number and type of shareholders that can own stock

Correct Answers: 2, 3 Explanation: Advantages of a C corporation include limited liability for the amount invested by shareholders, and the ability to raise capital through debt or by issuing equity. A disadvantage includes double taxation since shareholders pay taxes on distributed dividends and companies pay corporate taxes. There are no restrictions on the number and type of shareholders that can own stock in a C corporation.

Jean is planning on opening her own bed and breakfast establishment in the form of a sole proprietorship. Which of the following procedures will she need to complete? 1. Set up the bed and breakfast establishment as a separate entity 2. Obtain a business license required under the state law 3. Obtain an employer identification number (EIN) from the IRS for her employees 4. Obtain sufficient insurance to fulfill state requirements

Correct Answers: 2, 3, 4 Explanation: As a sole proprietor, Jean may be required to obtain a business license in the city in which she operates. If she has employees or is required to pay federal excise taxes, she must obtain an employer identification number (EIN) from the IRS. A sole proprietor is required to obtain sufficient insurance (although, the sufficient amount required could be $0), nor will the establishment be set up as a separate entity.

Which of the following statements is true about LLCs? a. there are a limited number of partners allowed b. they are taxed similar to corporations c. they require a less formal creation process than general partnerships d. they have similar limited liability advantage as corporations

D LLCs having similar liability advantage as corporations and tax advantage of partnerships

Do you think the following statement, "All tax-exempt organizations are non-profit organizations," is true or false? Why?

False Non-profit status is a state law concept. Non-profit status may make an organization eligible for certain benefits, such as state sales, property, and income tax exemptions. Although most federal tax-exempt organizations are non-profit organizations, organizing as a non-profit organization at the state level does not automatically grant the organization exemption from federal income tax

Anwar contributes cash of $30,000 and Beth contributes land having a $30,000 FMV and a $20,000 adjusted basis to the AB Partnership. Each partner receives a 50% interest in the partnership. What are the tax consequences if they later sell the land for $30k?

For financial accounting purposes, the land is recorded at $30,000. For tax purposes, the carryover basis of the land to the partnership is $20,000. No gain or loss is recorded for financial accounting purposes if the partnership later sells the land for $30,000. However, the partnership recognizes a $10,000 gain under the tax rules because the land's adjusted basis for tax purposes is only $20,000. The $10,000 precontribution gain is allocated to Beth.

A statutory nonemployee

If all payments for their services are derived from direct sales rather than from the number of hours worked. An example is a licensed real estate agent.

A common-law employee

If someone can control what services will be performed and how it will be done, even if the employee has freedom of action.

Section 722

If the Section 721 nonrecognition rules apply, Section 722 provides a substituted basis rule for determining the basis of a partnership interest. Disregarding the effect of any liabilities, the basis of the contributing partner's partnership interest equals the sum of money contributed plus the adjusted basis of other property transferred to the partnership.

S Corporation

Legally, S corporations are the same as other corporations but for tax purposes, they are special corporations treated by the tax laws as flow-through entities. S corporations are not taxed, and income, deduction, loss and credit items flow through to the shareholders. Corporate tax rules will apply unless overridden by the Subchapter S provisions.

Pacific Corporation, a calendar-year taxpayer, has a $100,000 accumulated E&P deficit as of January 1. It reports $30,000 of current E&P. The corporation makes a $40,000 distribution to its shareholders. How is the distribution characterized?

Of the $40,000 distribution, $30,000 is a taxable dividend to the extent of current E&P, and the remaining $10,000 is a tax-free return of capital (to the extent that Pacific's shareholders have basis in their stock) because of the accumulated E&P deficit. The E&P deficit is not increased by the tax-free distribution.

Pursuant to a complete liquidation, Southern Corporation distributes the following assets to its shareholders: - Inventory: $10,000 basis, $20,000 FMV - Land held as an investment: $5,000 basis, $40,000 FMV, subject to a $30,000 liability - Marketable securities: $20,000 basis, $15,000 FMV What are the tax consequences?

Southern Corporation recognizes $10,000 ($20,000 - $10,000) of ordinary income on the distribution of the inventory, $35,000 ($40,000 - $5,000) of capital gain on the distribution of the land, and $5,000 ($15,000 - $20,000) of capital loss on the distribution of the marketable securities.

What are the tax consequences if a corporation makes a pro rata stock dividend, meaning, it issues additional shares of its own single class of stock to existing shareholders?

The economic situation for the shareholders does not change as a result of the stock dividend. The shareholders still own the same proportion of the corporation, but they have additional shares of stock. Consequently, the shareholders recognize no income on receiving the stock dividend. Instead, they spread the basis of their old stock over the combined old and new stock, thereby causing the per share basis to decrease while the total basis remains unchanged. In addition, the corporation recognizes no gain or loss and does not reduce its E&P

What happens to the partnership's basis should there be a pass-through of capital loss?

decrease

Personal Service Corporation (PSC)

is a business that provides personal services to customers in such fields as accounting, law, health, architecture and consulting. Certain federal tax rules apply differently to a PSC than to a general C corporation.

Professional Corporation or Association

is a closely held corporation formed by professionals such as doctors, lawyers, accountants, and engineers. All states and the District of Columbia have passed enabling statutes allowing professionals to incorporate professional corporations.

Family Limited Partnership (FLP)

is a financial planning technique that enables a family to hold and manage its wealth, including the family business, with several generations of family members as the partners.

An Association

is a group of people who have joined together for a common purpose, ranging from social to business purposes. Associations are organized by a state's Articles of Association. The association itself can be formal, with rules and/or bylaws, membership requirements and other trappings of an organization, or it can be formed without structure.

If a corporation reports both a NLTCG and a NSTCG after the netting procedure is completed, both the NSTCG and the NLTCG are taxed at what level?

the same rates as ordinary income.

Limited Liability Company (LLC)

typically combines the advantages of a C corporation with those of a partnership. All owners called "members" enjoy limited liability, although in some states they are not shielded from liabilities stemming from personal negligence. Unlike an S corporation, an LLC can have an unlimited number of members who can be individuals, corporations, estates or trusts.