104-6 Characteristics & Income Taxation of Business Entities Flashcards
Most business entities are pass-through entities
Most entities are pass through entities where income, losses flow through to the individual owners or shareholders
Regular or C Corporation is a separate taxable entity
Regular or C Corporation
Least likely to be used by the majority of self-employed individuals
Separate from its shareholders/owners for income tax purposes
Major disadvantage: double taxation of profits
Dividends-received deduction
Deduction available to Regular/C Corporations
The amount of the dividends-received deduction is based on the % owned of the dividend-paying corporation by the corporation receiving the dividend
Special taxes only applicable to regular/C Corporations:
1) Accumulated earnings tax
2) Personal service corporation (PSC) tax
3) Personal holding company (PHC) tax
Accumulated Earnings Tax
Intended to coerce the regular corporation into paying dividends to its shareholders
Every regular corporation can accumulate up to $250k in retained earnings without having to prove a reasonable business need
Personal Service Corporation (PSC) Tax
PSCs are regular corporations operating in the professional fields of:
1) health
2) accounting, architecture, and actuarial science
3) law
4) engineering
acronym: HALE
If in any of these professional fields, the business should not be operated as a regular corporation
If it is, and the biz has any taxable income, the PSC tax is imposed on the income at a flat rate of 21%
Personal Holding Company (PHC) Tax
Intended to discourage (primarily) closely held corporate owners from using the separate corporate entity as an investment shell
The PHC tax applies if the corporation meets both:
1) ownership test: during the last 1/2 of the taxable year, > 50% of the value of the outstanding stock of the corporation is owned by 5 or fewer individuals
2) passive income test: at least 60% of the corporation’s adjusted ordinary gross income consists of personal holding company income
PHC tax is calculated by multiplying the undistributed personal holding company income by a flat rate of 20%
This tax is levied in addition to the regular corporate tax
Section 1244 Stock
Separately categorized for tax purposes upon the formation of a C Corporation
If a married investor sells such stock at a loss (or if the stock becomes worthless), up to $100k of the loss may be deducted as an ordinary loss
This limit is $50k if the investor is a single taxpayer
Sole Proprietorship
No formal legal docs need to be filed to form a business
All income & losses pass directly through to the business owner and reported on business owner’s income tax return
Taxable income or losses reported on Schedule C of IRS Form 1040
Disadvantage: the businessowner is personally liable for all debts and claims against the business
Deduction for pass-through income allowed to a noncorporate taxpayer
Beginning in 2018, there is a deduction for pass-through income of 20% allwoed to a noncorporate taxpayer, including a trust or estate, who has qualified business income (QBI) from a partnership, S corporation, or sole proprietorship
General partnership
Treated as a separate entity from its members, but only for limited purposes
The partnership is distinguished by 3 elements:
1) Common ownership in the business by more than 1 owner
2) Sharing of profits and losses of the business
3) General partners (not limited partners) are afforded the right to participate in the management and operation of the business
Pass-through entity for purposes of federal income taxation
Limited partnership
A type of partnership in which the partner is liable to the creditors of the partnership only to the extent of that partner’s contributed or promised cash or property
In exchange for this limited liability, the limited partner has neither the authority to bind the partnership entity nor participate in the management of the entity
At least 1 GP and at least 1 LP
Family Limited Partnership (FLP)
A type of LP that is typically set up by a senior family member
The senior family member transfers business of investment assets to the FLP in exchange for a 1% GP interest and a 99% LP interest
Then, over time, the senior family member makes tax-advantaged transfers of the LP interests to younger members of the family
Major benefit: its ability to reduce the senior family member’s gift & estate tax exposure
Limited Liability Partnership (LLP)
Exemplifies the characteristics of a GP w/ 1 major difference - in an LLP, the GP’s are not liable for the acts of the other partners
Often used by accounting firms
The form is only available to professionals, such as attorneys, accountants, and medical doctors
S Corporation
A type of regular corporation that has made a special election to be taxed as a GP (to obtain pass-through treatment)
A partnership or regular corporation may not be a shareholder
No preferred stock is allowed
No more than 100 shareholders
The IRS treats S corporation shareholders as GP’s
May be required to pay one of the following taxes:
1) Built-in gains tax
2) LIFO recapture tax
3) Excess net passive income tax
Built-in gains tax
Applies to S corporations that used to be C corporations
The tax is imposed on the unrealized built-in gain that is recognized on the sale of any asset by the S corporation for a period of 5 years from the date of the S corporation election
