Business Planning - Review Questions

Question 1

Lack of Marketability Discount

Answer 1

Closely held business stocks with no ready market available.

Question 2

Minority Interest Discount

Answer 2

A shareholder has less than majority interest, and has no control over the business.

Question 3

Key Person Discount

Answer 3

Discount for the loss to the business due to the owner’s death.

Question 4

Blockage Discount

Answer 4

Sale of sizable amount of publicly traded stock at owner’s death would depress its market price.

Question 5

A lock-in discount

Answer 5

Circumstance in which a limited partner cannot withdraw from the partnership and is locked into his investment.

Question 6

A fractional interest discount

Answer 6

A fractional interest discount or a “co-ownership discount” is available in the decedent’s estate for real property that is owned with another party who is unwilling to sell their partial interest to a third party or to the decedent’s estate, or who will not buy out the decedent’s partial interest in the property. The co-owner of the property cannot be the decedent’s spouse, heirs, business partners or joint tenants under JTWROS.

Question 7

The Paul Daniels estate has an estimated FMV of $2.8 million. The principal asset in the estate is Daniels Farms, an unincorporated business that Paul operated for the last 15 years. The total FMV of the farm operation is $1.5 million, of which $1.3 million is the value of the land. Paul’s will leaves the land and all other assets used in the farming operation to his son, John who will continue the farming operation. The estate has administrative expenses and debts totaling $200,000.

Does Daniels Farm qualify for special use valuation in Paul Daniels’ estate?

Why aren’t the estate administrative expenses and debts totaling $200,000 subtracted from the gross estate in order to calculate these tests?

Answer 7

Yes
50% Test: 1.5/2.8 = 54%
25% Test: 1.3/2.8 = 46%

The decedent’s gross estate is used for these calculations- not the decedent’s adjusted gross estate. The Paul Daniel’s estate is valued at $2.8 million. The debts and administrative expenses apply to the Daniel estate, not to the qualified property in the estate, so these debts and administrative expenses are not deducted from the gross estate when calculating the 50% and 25% tests.

Question 8

Partnership liquidation agreement discount

Answer 8

Identifies the business continuation plan for a partner’s interest in case of death or withdrawal

Question 9

Stock Redemption Agreement discount

Answer 9

Corporation purchases or redeems stock of the withdrawing or deceased shareholder

Question 10

Cross-purchase or criss-cross agreement discount

Answer 10

Individuals agree among themselves to purchase the interest of a withdrawing or deceased shareholder

Question 11

Business buyout agreement discount

Answer 11

Key person, family member, or outside individual to purchase interest

Question 12

Which of the following events can trigger business continuity contingencies? (Check all that are true.)

1) Death
2) Disability
3) Divorce
4) Retirement
5) Loss of professional license needed to continue performing business-related tasks

Answer 12

1) Death
2) Disability
3) Divorce
4) Retirement
5) Loss of professional license needed to continue performing business-related tasks

The buy-sell agreement specifies the triggering event. Generally that event is death, disability, or retirement of the owner. It can include divorce or insolvency, and events such as loss of a professional license by an owner or conviction of an owner of a crime.

Question 13

What is the purpose of trying to qualify a stock redemption as a Sec. 303 redemption?

Choose the best answer.

1) Avoid being taxed as dividends
2) To extend control beyond family members
3) Avoid being taxed as capital gains
4) To break the chain of family attribution

Answer 13

1) Avoid being taxed as dividends

IRC Sec. 303 allows a corporation to make a distribution in redemption of a portion of the stock of a decedent that will not be taxed as a dividend to use to pay death taxes and other expenses.

Question 14

Dan’s gross estate is $2,250,000, administrative and funeral costs are $250,000. To qualify for Sec. 303 redemption, the value of the stock in question must exceed what amount?

Choose the best answer.

1) $350,000
2) $700,000
3) $2,000,000
4) $1,000,000

Answer 14

2) $700,000

35% ($2,250,000 - $250,000) = $700,000

Question 15

The Jim Bradley estate has an estimated FMV of $6.1 million. The estate has administrative expenses and debts totaling $400,000. The largest asset in Jim’s estate is his interest in Birchwood Industries, a closely held corporation. The FMV of Jim’s stock interest at death was $2.8 million. This amount is 25% of the value of all voting shares of Birchwood Industries stock. The corporation has real estate interests associated with the business worth $6.4 million.

Does this estate qualify for special use valuation?

Yes
No

Answer 15

No.

The 50% Test 2.8/6.1 = 46% The 25% Test: 1.6/6.1 = 26%. Jim owned 25% of Birchwood Industries therefore 25% of the corporation’s real estate is $1,600,000 which is used to calculate the 25% Test.

Note: the estate qualifies for IRC Sections 303 & 6166 by meeting the 35% test 2.8/5.7 = 49%

Question 16

Jill died with a gross estate of $3,100,000. The administrative and funeral costs were 175,000. In order to qualify for a section 303 stock redemption, the value of the stock must exceed what amount?

1) $970,500
2) $1,023,750
3) $1,000,750
4) $1,100,500

Answer 16

2) $1,023,750
35% ($3,100,000. - $175,000) = $1,023,750

Question 17

Which of the following statements are true in regards to a Self-Canceling Installment Note?

1) Any outstanding installment payments are included in the business owner’s estate.
2) A SCIN has a provision to have the note partially or fully cancelled before the note matures or at the business
owner’s death.
3) The buyer pays a discount on SCINs since the actual payment received by the seller may be less.
4) Any unrealized capital gains must be recognized when the note is cancelled or at the owner’s death.

Answer 17

2) A SCIN has a provision to have the note partially or fully cancelled before the note matures or at the business
owner’s death.
4) Any unrealized capital gains must be recognized when the note is cancelled or at the owner’s death.

Question 18

When looking at a cross purchase agreement, which type of policies would be considered for each owner?

1) Life insurance
2) Health insurance
3) Disability insurance
4) Long term care insurance

Answer 18

1) Life insurance
3) Disability insurance

Question 19

Which statement is correct regarding corporate stock redemptions?

1) Redemption of all the deceased shareholder’s stock by the corporation is treated as a dividend distribution
2) It is preferable for a corporation to have redeemed stock treated as a dividend rather than as capital gains.
3) The shareholder’s estate is obligated to sell all of the deceased owner’s stock to the corporation, which
guarantees a market for the stock in the shareholder’s estate.
4) Life insurance premiums used to fund the agreement are deductible by the corporation.

Answer 19

3) The shareholder’s estate is obligated to sell all of the deceased owner’s stock to the corporation, which
guarantees a market for the stock in the shareholder’s estate.

Corporations want to avoid having the stock redemption treated as a dividend distribution because it is taxed as ordinary income rather than as a sale or exchange, which is treated as a capital gain. Redemption of all of a shareholder’s stock results in a complete termination of the shareholder’s interest, and is treated as a capital gain.

Question 20

Which of the following is true in regards to life insurance and sinking funds?

1) Premiums paid by the corporation on the insurance policies are taxable to the shareholders.
2) Death proceeds that are received by the insurance corporation are taxable as ordinary income.
3) In a tax year that the corporation’s taxable income is retained for paying insurance premiums in excess of the
accumulated earning credit, they should show the retention is necessary to meet reasonable needs of the
business.
4) Life insurance premiums used to fund the purchase of an owner’s interest are deductible.

Answer 20

3) In a tax year that the corporation’s taxable income is retained for paying insurance premiums in excess of the
accumulated earning credit, they should show the retention is necessary to meet reasonable needs of the
business.