Ch 10: Business Entities

Question 1

What are the two classes of business entities for tax purposes?

Answer 1

Business organizations fall into one of two
categories:

(1) Organizations that are not taxable entities, where the
taxpayer is the owner of the organization

(2) Corporations, which are both persons under the law
and taxpayers in their own right.

Question 2

What is a “SOLE PROPRIETORSHIP” ?

Answer 2

———————-Sole Proprietorship————————
• An unincorporated business activity owned by
one individual.

• The sole proprietor owns the business assets in
his or her own name and is personally liable for
the business debts.

• The business has no legal identity separate from
the owner.

• The most common form of business entity in the
US

Question 3

—————————— BACKGROUND ————————
Assume a Sole Proprietorship

------------------------------ Question ---------------------------------
Net Income (or a Net Loss) is considered \_\_\_\_\_\_\_\_ income (or loss).

Answer 3

Ordinary

Question 4

What is “QUALIFIED BUSINESS INCOME” ?

Answer 4

Qualified business income (QBI) is ordinary
income associated with a qualified trade or
business.

Question 5

What is “QUALIFIED BUSINESS INCOME” deduction?

Answer 5

In general, deduction equals 20% of qualified
business income earned by an individual through
a sole proprietorship, partnership, or S
corporation.

Question 6

—————————— BACKGROUND ————————
A sole proprietor has qualified business income
(after all deductions) of $1 million. The owner
paid W-2 wages of $380,000 and owns qualified
property with an unadjusted basis of $800,000.

—————————— Question ———————————
What is the maximum allowable QBI deduction?

Answer 6

Tentative deduction is $200,000 ($1 million x 20%)
• Deduction is limited to the greater of:
• $190,000 ($380,000 x 50%)
• $115,000 (($380,000 x 25%) + ($800,000 x 2.5%))
• QBI deduction before taxable income limitation is
$190,000.

Question 7

—————————— BACKGROUND ————————
Assume a sole proprietorship

—————————— TRUE /FALSE ——————————-
If a sole proprietor has employees, they must
obtain an employer identification number (EID)
from the IRS and comply with the state and
federal employment tax requirements imposed on
every business organization.

Answer 7

TRUE

Question 8

What are two employment taxes?

Answer 8

• Social Security tax of 6.2% on base wages up to $142,800

* Medicare tax of 1.45% on all wages

Question 9

—————————— BACKGROUND ————————
In 2021, Soprano Co. paid Mr. Moltisanti $145,000 in
salary and withheld $21,800 for federal income taxes.

——————————- QUESTION —————————
How much social security tax did he pay?

Answer 9

Mr. Moltisanti’s Social Security W/H = (.062 × $142,800) =

$8,854.

Question 10

—————————— BACKGROUND ————————
In 2021, Soprano Co. paid Mr. Moltisanti $145,000 in
salary and withheld $21,800 for federal income taxes.

——————————- QUESTION —————————
How much medicare tax did he pay?

Answer 10

Mr. Moltisanti’s Medicare W/H: (.0145 × $145,000) = $2,103

Question 11

—————————— BACKGROUND ————————
In 2021, Soprano Co. paid Mr. Moltisanti $145,000 in
salary and withheld $21,800 for federal income taxes.

——————————- QUESTION —————————
How much cash was dispersed to Mr. Moltisanti?

Answer 11

Cash disbursed to Mr. Moltisanti = $145,000 − $21,800 −

$8,854 − $2,103 = $112,243.

Question 12

—————————— BACKGROUND ————————
In 2021, Soprano Co. paid Mr. Moltisanti $145,000 in
salary and withheld $21,800 for federal income taxes.

——————————- QUESTION —————————
How much is Soprano Co’s portion of FICA?

Answer 12

Soprano Co.’s portion of FICA = (.062 × $142,800) + (.0145 ×
$145,000) = $10,967

Question 13

What is a “PARTNERSHIP” ?

Answer 13

• Partnerships are unincorporated entities created
by contractual agreement among two or more
business associates.

• Associates can be individuals, corporations, or even
other partnerships.
• The first step in the formation of a partnership is
drafting an agreement by the prospective
partners.
• The partnership agreement states the rights and
obligations of partners and the percentage of profits
and losses allocable to each partner. Distribution of
profits and losses is flexible.

Question 14

What is a “GENERAL PARTNERSHIP” ?

Answer 14

General partnership

• All partners have unlimited liability (joint and severable).

Question 15

What is a “LIMITED PARTNERSHIP” ?

Answer 15

Limited partnership
• One or more limited partners are only liable for their
contributed capital. Legally, all limited partnerships
have at least one general partner.

Question 16

What is a “LIMITED LIABILITY COMPANY (LLC)” ?

Answer 16

• LLCs are unincorporated legal entities owned by
one or more members.

• LLC membership can include individuals,
partnerships, corporations, and other LLCs.

• In contrast to partnerships, every member has
limited liability for the LLC’s debts.

Question 17

—————————— BACKGROUND ————————
Rick and Morty each contributed $25,000 cash to
a new partnership.

——————————- QUESTION —————————
What is Rick’s basis in his partnership interest assuming that the partnership takes out a $10,000 loan and the partnership assets secure the loan?

Answer 17

$30,000 ($25,000 + (.5 × $10,000))

Question 18

—————————— BACKGROUND ————————
Rick and Morty each contributed $25,000 cash to
a new partnership.

——————————- QUESTION —————————
What is Rick’s basis in his partnership interest assuming that the partnership takes out a $10,000 loan and Rick personally secures the loan?

Answer 18

$35,000 ($25,000 + $10,000)

Question 19

—————————— BACKGROUND ————————
Assume a partnership

——————————- TRUE or FALSE —————————
Because the partnership does not pay tax, the partnership is referred to as a flow-through or pass-through entity

Answer 19

TRUE

Because the partnership does not pay tax, the
partnership is referred to as a flow-through or
pass-through entity

Question 20

—————————— BACKGROUND ————————
Assume a partnership

——————————- QUESTION —————————
What is a guaranteed payment?

Answer 20

• A guaranteed payment is a special allocation of
ordinary income to the partner receiving it.

• Guaranteed payments are analogous to salaries
paid to partnership employees, except that FICA
and income tax are not withheld.

• The receiving partner reports as ordinary income.
• The partnership is allowed a deduction for the
guaranteed payment

Question 21

—————————— BACKGROUND ————————
James, Alex, and Naomi form the Rocinante
partnership. James will do most of the work, so he
will receive a guaranteed payment of $25,000 per
year. The partners agree to share any remaining
income one-third each. The partnership earns
$85,000 during the year.

——————————- QUESTION —————————
How much partnership income does James report?

How much partnership income do Alex and Naomi
report?

Answer 21

James = $45,000 ($25,000 + (1/3 × $60,000))

Alex / Naomi = $20,000 of partnership income (1/3 × $60,000).

Question 22

—————————— BACKGROUND ————————
What is an “S Corporation”?

——————————- QUESTION —————————
What is a guaranteed payment?

Answer 22

• Before the advent of LLCs, business owners who
wanted to avoid both the corporate income tax
and the risk of unlimited personal liability had one
choice: the subchapter S corporation.

• Legally a corporation under state law, an S
corporation is a flow-through entity for tax
purposes.

• S corporations file an informational return (1120-
S) and a Schedule K