Tax - Exam 3
Which of the following elections is NOT reserved to the individual partners in a partnership?
Taxable year
After an S corporation revokes or terminates its S election, how long must the corporation wait to make a new election? What circumstances permit an early reelection?
The corporation must wait five tax years before making a new election. An early reelection can occur when (1) more than 50% of the corporation's stock is owned by persons who did not own stock on the date of the termination, or (2) the termination was caused by events not reasonably within the control of the corporation or the shareholders owning a substantial interest in the corporation and was not part of a plan to terminate the election involving the corporation or its shareholders.
Tyra has a zero basis in her partnership interest and a share in partnership liabilities, which are quite large. Explain how these facts will affect the taxation of her departure from the partnership using the following methods of terminating her interest in the partnership. a. A liquidating distribution of property b. A sale of the partnership interest to a current partner for cash
a. In the case of a liquidating distribution of property, the amount realized will equal her interest in partnership liabilities. Because she has a zero basis, she must report a gain equal to her share of the partnership liabilities. b. The amount realized will equal the sum of the money received and any liabilities assumed by the purchaser. Because her basis is zero she will report a large gain.
A ________ is a "syndicate, group, pool, joint venture, or other unincorporated organization" that carries on any business, financial operation, or venture.
partnership
A partner's guaranteed payment is included in
self-employment income but not in qualified business income
What are Subchapter C earnings and profits (E&P)?
- Subchapter C E&P are profits that the S corporation inherited from a C corporation under the tax attribute carryover rules. - Subchapter C E&P are profits earned in a tax year for which an S election was not in effect.
Lance and Rodney are contemplating starting a new business to manufacture computer software games. They expect to encounter losses in the initial years. Lance's CPA has talked to them about using an S corporation. Rodney, while reading a business publication, encounters a discussion on limited liability companies (LLCs). The article talks about the advantages of using an LLC instead of an S corporation. How would you respond to their inquiry?
An LLC has no restrictions on the type or number of owners. An S corporation is limited to 100 shareholders, none of which may be a corporation or a partnership.
What are the advantages of a firm being formed as a limited liability company (LLC) instead of as a limited partnership?
An LLC provides its owners with limited liability for debts of the firm and an LLC with more than one owner can choose to be treated as either a partnership or a corporation.
What limitations apply to the amount of loss pass-through an S corporation shareholder can deduct? What happens to any losses exceeding this limitation? What happens to losses if the shareholder transfers his or her stock?
Each shareholder's deduction for his or her share of the ordinary loss and the separately stated loss and deduction items is limited to the sum of the adjusted basis for his or her S corporation stock plus the adjusted basis of any indebtedness owed directly by the S corporation to the shareholder. - Excess loss and deduction items carry over to subsequent years in which the shareholder again has a positive basis amount. Unused losses lapse if the shareholder transfers his or her stock to anyone other than a spouse or former spouse incident to a divorce.
Which of the following will NOT reduce AAA for an S corporation with accumulated earnings and profits?
Expenses associated with tax-exempt income
A corporation makes the S election by filing ________.
Form 2553
What income, gain, loss, and deduction items do not affect this account assuming the S corporation has an accumulated E&P balance?
Tax-exempt income and nondeductible expenses related to tax-exempt income do not increase or decrease the AAA. They are included in the other adjustments accounts (OAA), which is not a separate earnings balance but is included in the basis of the S corporation stock.
Tom is a 55% general partner in the RST Partnership. Tom wants to retire, and the other two partners, Stacy and Rich, want to continue the partnership business. They agree that the partnership will liquidate Tom's interest in the partnership by paying him 20% of partnership profits for each of the next ten years. Explain why Sec. 736 does (or does not) apply to the partnership's payments to Tom.
The Sec. 736 provisions apply in this scenario since the partnership is not terminating.
When is the S corporation's tax return due? What extensions are available for filing the return?
The S corporation's tax return is due on the fifteenth day of the third month following the close of the tax year. The corporation can request an automatic six-month extension of time to file the return.
What is an accumulated adjustments account (AAA)?
The accumulated adjustments account (AAA) is the cumulative total of ordinary income or loss and separately stated items for the S period. The AAA is required only of S corporations that have an accumulated E&P balance.
Which of the following fact patterns would NOT suggest that a donor has retained too much control in a family partnership?
The donor is a general partner in the partnership.
Which of the following is NOT a requirement for an S corporation election?
The electing corporation must not own stock in a C corporation.
Can a partner recognize both a gain and a loss on the sale of a partnership interest? If so, under what conditions?
Yes, when a partner sells his or her partnership interest, the partnership is deemed to sell all its assets in a hypothetical sale for their FMVs. The selling partner is allocated his or her share of the ordinary income or loss from the sale of Sec. 751 and non-Sec. 751 assets, and the partner's residual gain or loss on the sale is capital gain or loss.
Which of the following events would NOT terminate an S corporation election?
Issuing a stock dividend; Failing the passive income test for the current year
What conditions are required for a partner to recognize a loss upon receipt of a distribution from a partnership?
A partner can recognize a loss on a distribution only if it is a liquidating distribution consisting of money, unrealized receivables, and/or inventory and the sum of these amounts is less than the partner's predistribution basis in his or her partnership interest.
Which of the following provides limited liability for all owners, but is not allowed in professional organizations of public accountants and attorneys?
Limited liability company
Each of the Big 4 public accounting firms is organized as a(n) ________.
Limited liability partnership
Voyles Corporation, a calendar year taxpayer formed five years ago, desires to make an S election beginning in 2021. Sue and Andrea each own one-half of the Voyles stock. Requirements a. How does Voyles make the S election? b. When can Voyles file its election form? c. If in Part b the corporation does not file the election in a timely manner, when will the election take effect?
Requirement a. How does Voyles make the S election? Voyles Corporation makes the S election by filing Form 2553 in a timely manner with all its shareholders consenting to the election. Requirement b. When can Voyles file its election form? The corporation can make the S election (1) any time during the tax year preceding the year for which the election is to be effective or (2) on or before the fifteenth day of the third month of the year for which the election is effective. Corporations making an S election in their initial tax year must make the election not later than the fifteenth day of the third month of the initial tax year. Requirement c. If in Part b the corporation does not file the election in a timely manner, when will the election take effect? The election will take effect on the first day of the next tax year unless the corporation obtains relief from the IRS for its late election.
The BCD Partnership is formed in April of the current year. The three equal partners, Boris, Carlton Corporation, and Damien have had tax years ending on December 31, August 30, and December 31, respectively, for the last three years. The BCD Partnership has no natural business year.
Requirement a. What tax year is required for the BCD Partnership under Sec. 706? The partnership must use December 31 as its year-end. The tax year-end is determined by the majority partners, Boris and Damien, making this the required year-end for the partnership. Requirement b. Can the BCD Partnership make a Sec. 444 election? If so, what are the alternative tax years BCD could select? Yes. If BCD makes a Sec. 444 election, the partnership could have a tax year that ends on September 30, October 31, or November 30.
S corporations are subject to all of the following taxes EXCEPT ________.
accumulated earnings tax
All of the following are requirements for S corporations EXCEPT ________.
the corporation must be a domestic or foreign corporation; the corporation must not have investment income
Mariel has a $60,000 basis in her partnership interest just before receiving a parcel of land as a liquidating distribution. She has no remaining precontribution gain and will receive no other distributions. Under what conditions will Mariel's basis in the land be $60,000?
Mariel's basis in the land will be $60,000 since this is the amount of her pre-liquidation basis in the partnership and she is receiving no other liquidating distributions.
List three advantages for operating this business as a partnership instead of a C corporation.
Advantages include (1) partnerships are not subject to tax, thereby eliminating the problem of double taxation that exists for C corporations, (2) partners may divide the partnership's profit or loss among themselves without regard to their proportionate capital interests, (3) under the conduit principle of taxation, partnership losses and other items receiving special tax treatment flow through to the partners.
What is an inadvertent termination?
An inadvertent termination is one where the IRS, corporation, and shareholders all agree was unintentional (e.g., failing the passive investment income test for three consecutive years as a result of improperly computing the corporation's Subchapter C E&P).
Why did Congress enact the 20% qualified business income deduction?
Congress enacted the qualified business income deduction to give pass-through entity owners a tax rate somewhat comparable to the 21% corporate tax rate. Thus, Congress did not want to give a tax break to C corporations while not giving a tax break to businesses operating in a pass-through form.
The AB Partnership purchases plastic components and assembles children's toys. The assembly operation requires a number of special machines that are housed in a building the partnership owns. The partnership has depreciated all its property under MACRS. The partnership sells the toys on account to a number of retail establishments and uses the accrual method of accounting. Identify any items you think might be classified as unrealized receivables.
Depreciation recapture potential under Sec. 1245 for the machinery used to produce the inventory.
Which of the following items are considered to be inventory for purposes of Sec. 751? a. Supplies b. Inventory c. Notes receivable d. Land held for investment purposes e. Lots held for resale
Items a, b, c, and e are considered inventory under Sec. 751.
Can a recourse debt of a partnership increase the basis of a limited partner's partnership interest? Explain.
No, because a limited partner normally has no economic risk for recourse debt.
What nonliquidating distributions made by an S corporation are taxable to its shareholders?
Nonliquidating distributions paid by an S corporation that has no accumulated E&P are treated as a return of the shareholder's basis for his or her stock investment. All distributions paid to the shareholder up to the amount of his or her stock basis are nontaxable. Distributions exceeding the shareholder's stock basis are taxable as capital gains.
Which of the following events would NOT terminate an S corporation election?
S corporations cannot be used to split income among family members.
Which of the following items is NOT separately stated for an S corporation?
Salary and wage expenses
The ABC Partnership has a nonrecourse liability that it incurred by borrowing from an unrelated bank. It is secured by an apartment building owned and managed by the partnership. The liability is not convertible into an equity interest. How does this liability affect the at-risk basis of general partner Anna and limited partner Bob?
The financing meets the requirements for qualified nonrecourse real estate financing so is therefore included in the at-risk basis of both general and limited partners.
Where allowed by state law, organizing as a ________ will allow the partnership agreement to provide general partners with limited liability.
limited liability limited partnership
What is a post-termination transition period? What loss carryovers can an S corporation shareholder deduct during this period?
A one-year period immediately following the last day of the final S corporation tax year in which loss and deduction carryovers can be used by the S corporation's shareholders even though the S election has been revoked or terminated. Loss carryovers can be deducted only up to the adjusted basis of the shareholder's stock at the end of the post-termination transition period.
How will a partner's distributive share be determined if the partner sells one-half of his or her beginning-of-the-year partnership interest at the beginning of the tenth month of the partnership's tax year?
A partner's distributive share will equal the sum of the partner's earnings for one-half of his or her beginning-of-the-year interest for the full year and the partner's earnings for the other one-half of his or her beginning-of-the year interest for nine months.
What nonliquidating distributions made by an S corporation are tax-free to its shareholders?
Different rules apply to S corporations that have accumulated E&P. Distributions out of the accumulated adjustments account (AAA) are nontaxable and reduce (but not below zero) the shareholder's stock basis. Distributions out of the S corporation's accumulated E&P are taxable as dividend income. Distributions exceeding the S corporation's accumulated E&P are nontaxable and reduce the shareholder's stock basis. Distributions exceeding the shareholder's stock basis are taxable as capital gains.
Which of the following is NOT an advantage of operating a business as an S corporation?
Earnings of an S corporation are not taxed until they are distributed to shareholders.
Cindy has a $4,000 basis in her partnership interest before receiving a nonliquidating (current) distribution of property having a $4,500 basis and a $6,000 FMV from the CDE Partnership. Cindy has a choice of receiving either inventory or a capital asset. She will hold the distributed property as an investment for no more than two years before she sells it. What tax difference (if any) will occur as a result of Cindy's selection of one property or the other to be distributed by the partnership?
If Cindy accepts inventory, the eventual sale of inventory would generate ordinary income for five years from the date of distribution, and if she accepts a capital asset, the eventual sale would generate long-term capital gain with preferential individual taxpayer rates. In either situation, the gain is calculated as the sale price less the new adjusted basis of the property distributed of $4,000.
Which of the following is NOT a correct adjustment for basis in S corporation stock?
Increase stock basis for shareholder's pro rata share of general S corporation liabilities.
In which of the following situations is inventory a Section 751 asset?
Inventory with $10,000 basis and $14,000 fair market value
Which of the following classifications make a shareholder ineligible to own stock in an S corporation? a. U.S. citizen b. Domestic corporation c. Partnership where all the partners are U.S. citizens d. Estate of a deceased U.S. citizen e. Grantor trust created by a U.S. citizen f. Nonresident alien individual
Items b, c and f would be ineligible shareholders in an S corporation.
What actions must the S corporation and its shareholders take to correct an inadvertent termination?
Once such a determination is made, the S corporation or its shareholders must take the necessary steps, within a reasonable time period after discovering the event causing the termination, to restore its small business corporation status by distributing the money or property needed to eliminate the E&P balance.
Which of the following items can be deducted (up to $5,000) and amortized as part of a partnership's organizational expenditures? a. Legal fees for drawing up the partnership agreement b. Accounting fees for establishing an accounting system c. Fees for securing an initial working capital loan d. Filing fees required under state law in initial year to conduct business in the state e. Accounting fees for preparation of initial short-period tax return f. Transportation costs for acquiring machinery essential to the partnership's business g. Syndication expenses
Only a, b, and d.
Jane contributes valuable property to a partnership in exchange for a general partnership interest. The partnership also assumes the recourse mortgage Jane incurred when she purchased the property two years ago. a. How will the liability affect the amount of gain that Jane must recognize? b. How will it affect her basis in the partnership interest?
Part A: Jane recognizes gain on the contribution of property and assumption of a liability if the amount of the liability assumed by the other partners exceed Jane's basis in the contributed property plus her share of existing partnership liabilities. Part B: Her basis in the partnership interest will be decreased by the amount of the liability assumed by the other partners.
Partnership income is
Partnership taxable income is the sum of net income from operations and long-term capital gains.
What tax years can a newly created corporation that makes an S election adopt for its first tax year? If a fiscal year is permitted, does it require IRS approval?
S corporations must generally adopt a calendar year or a 52-53 week year as its tax year. With IRS approval, an S corporation may adopt a fiscal year which is its natural business year.
Which of the following is NOT a requirement for an unwritten advance from a shareholder to be treated as debt under the safe harbor rule for S corporations?
The obligation must be non-transferrable.
Which of the following events would trigger termination of a partnership?
The partnership has no business activity for a period of 15 months and has only a nominal level of assets.
Under Section 706, which of the following has the highest rank when determining the taxable year of a partnership?
The tax year-end used by partners who own a majority interest in the partnership's capital and profits
What taxes must an S corporation prepay by making quarterly estimated tax payments? Can a shareholder owning S corporation stock use the corporation's estimated tax payments to reduce the amount of his or her individual estimated tax payments? Explain.
The two taxes S corporations must prepay are (1) excess net passive income tax and (2) built-in gains tax. These payments do not reduce shareholder's individual estimated tax payments but they do reduce ordinary income and separately stated items passed through to the shareholders.
Javier is retiring from the JKL Partnership. In January of the current year, he has a $100,000 basis in his partnership interest when he receives a $10,000 cash distribution. The partnership plans to distribute $10,000 each month this year, and Javier will cease to be a partner after the December payment. Is the January payment to Javier a current distribution or a liquidating distribution?
It is a liquidating distribution. A current distribution is a distribution that does not terminate the partner's interest in the partnership, nor is the payment one of a series of payments intended to terminate the partner's interest in the partnership. A liquidating distribution is made with the intention of terminating the partner's entire interest in the partnership either with this payment or with a planned series of payments including this one.
Is the Sec. 704(d) loss limitation rule more or less restrictive than the at-risk rules? Explain.
It is less restrictive. Sec. 704(d) limits the loss to the adjusted basis of a partner's interest in the partnership at the end of the partnership tax year in which the loss occurs. This basis includes recourse debt and nonrecourse debt. The at-risk basis does not include nonrecourse debt.
Bob and Carol want to open a bed and breakfast inn as soon as they buy and renovate a turn-of-the-century home. What would be the major disadvantage of using a general partnership rather than a corporation for this business? Should they consider any other form for structuring their business?
Lack of limited liability; Yes. They may want to consider a limited liability company (LLC). Yes. They may want to consider a limited liability limited partnership (LLLP), if available in the taxpayer's state.
Jeff, a 10% limited partner in the recently formed JRS Partnership, expects to have losses from the partnership for several more years. He is considering purchasing an interest in a profitable general partnership in which he will materially participate. Will the purchase allow him to use his losses from the JRS Partnership?
No. As a limited partner in the JRS Partnership, Jeff is almost certainly subject to the passive loss limitation rules on losses from this partnership. Accordingly, income from a general partnership in which Jeff materially participates cannot be used to offset the passive losses. Jeff can use losses from the JRS Partnership only to offset passive income, or he can claim the losses when he sells his entire interest in the JRS Partnership or when the partnership terminates.
Orlando Corporation, a calendar year taxpayer, has been an S corporation for several years. On July 9, 2020, Orlando authorizes a second class of nonvoting preferred stock that pays a 10% annual dividend. The corporation issues the stock to Sid on September 11, 2020, to raise additional equity capital. Sid owns no other Orlando stock. Requirements a. Does Orlando's S election terminate? If so, when is the termination effective? b. What tax returns must Orlando file for 2020? When are they due? c. How would your answer to Parts a and b change if instead the second class of stock were nonvoting Class B common stock?
Requirement a. Does Orlando's S election terminate? If so, when is the termination effective? The sale of the second class of stock terminates the S election on September 11, 2020. Requirement b. What tax returns must Orlando file for 2020? When are they due? The following tax returns must be filed for 2020: (1) an S corporation return for January 1, 2020 through September 11, 2020 due on March 15 comma 2021March 15, 2021 and (2) a C corporation return for September 12, 2020 through December 31, 2020 due on April 15 comma 2021.April 15, 2021. Requirement c. How would your answer to Parts a and b change if instead the second class of stock were nonvoting Class B common stock? The IRS does not recognize the Class B common stock as a second class of stock, and the S corporation election does not terminate if the only difference between the original common stock and the Class B common stock is the voting rights.
Which of the following is NOT a separately stated item for a partnership?
Salary expense
Explain the conditions under which Sec. 751 has an impact on nonliquidating (current) distributions.
Sec. 751 affects current distributions when the distributing partnership has both Sec. 751 assets and non-Sec. 751 assets. The distribution must also be disproportionate.
Explain the procedures for allocating an S corporation's ordinary income or loss to each of the shareholders. What special allocation elections are available?
Separately stated items are allocated an equal portion of (1) the item to each day of the tax year, (2) the daily amount for the item to each share of stock outstanding on each day, (3) the total daily allocations for each outstanding share of stock, and (4) the total amounts allocated to each share of stock held by the shareholder. Special allocation elections are available only if the S election terminates in the tax year or if a shareholder no longer holds his or her entire S corporation stock interest.