CH. 15 - Entities Overview Flashcards
Corporation
business entity recognized as a separate entity from its owners under state law.
Limited liability company (LLC)
a type of flow-through entity for federal income tax purposes. By state law, the owners of the LLC have limited liability with respect to the entity’s debts or liabilities. Limited liability companies are generally taxed as partnerships for federal income tax purposes.
Limited liability companies are generally taxed as ________ for federal income tax purposes.
partnerships
General partnership (GP)
a partnership with partners who all have unlimited liability with respect to the liabilities of the entity.
Limited partnership (LP)
a partnership with at least one general partner with unlimited liability for the entity’s debts and at least one limited partner with liability limited to the limited partner’s investment in the partnership.
Sole proprietorship
a business entity that is not legally separate from the individual owner of the business. The income of a sole proprietorship is taxed and paid directly by the owner.
Articles of incorporation
a document, filed by a corporation’s founders with the state, describing the purpose, place of business, and other details of the corporation.
True or false: state laws consider LLCs to be the same legal entity as its owners
False; state law considers LLCs to be separate legal entities from its owners
Certificate of organization
a document, filed by a limited liability company’s founders with certain states, describing the purpose, place of business, and other details of the company.
Articles of organization
a document, filed by a limited liability company’s founders with certain states, describing the purpose, place of business, and other details of the company.
Partnership agreement
an agreement among the partners in a partnership stipulating the partners’ rights and responsibilities in the partnership.
Certificate of limited partnership
a document limited partnerships must file with the state to be formally recognized by the state. The document is similar to articles of incorporation or articles or organization.
Under state law, ________ is responsible for payment of a corporation’s liabilities
the corporation itself, not the shareholders
Who is responsible for an LLCs liabilities?
The LLC itself, not its members
For entities formed as partnerships, who is responsible for the liabilities of the partnership?
All general partners are ultimately responsible
True or false: limited partners are not responsible for the partnerships liabilities
True!
However, they are not allowed to actively participate in the activities of the business
What are the key facts to legal classification and nontax characteristics of business entities?
-State law generally classifies business entities as either corporations, limited liability companies, general partnerships, limited partnerships, or sole proprietorships
-Corporations and limited liability companies shield all their owners against the entities liabilities
-Corporations are less flexible than other business entities but are generally better suited to going public
Initial public offering (IPO)
the first sale of stock by a company to the public.
True or false: state laws prohibit shareholders from directly amending corporate governance rules and from directly participating in management.
True! they have only the right to vote for corporate directors or officers
True or false: LLC members generally do not have the right to amend the LLC operating agreement, provide input, and manage LLC
False–they do have the right.
True or false: a business’s legal form is the same as its tax form
False – it can be different
For tax purposes, business entities can be classified as either ________ or ________
separate taxpaying entities or flow-through entities
Flow-through entities
legal entities, like partnerships, limited liability companies, and S corporations, that do not pay income tax. Income and losses from flow-through entities are allocated to their owners.
Separate taxpaying entities pay taxes on ___________
their own income
True or false: Flow-through entities don’t pay taxes
True, because income from these entities flows through to their business owners, who are responsible for paying tax on the income
C corporations
a corporate taxpaying entity with income subject to taxation. Such a corporation is termed a “C” corporation because the corporation and its shareholders are subject to the provisions of Subchapter C of the Internal Revenue Code.
Entities that are legal corporations under state law are treated as _________ for tax purposes by default
C Corporations
C corporations
a corporate taxpaying entity with income subject to taxation. Such a corporation is termed a “C” corporation because the corporation and its shareholders are subject to the provisions of Subchapter C of the Internal Revenue Code.
C corporations report their taxable income to the IRS on Form ______
1120 - “US Corporation Income Tax Return”
S corporation
a corporation under state law that has elected to be taxed under the rules provided in Subchapter S of the Internal Revenue Code. Under Subchapter S, an S corporation is taxed as a flow-through entity.
For tax purposes, unincorporated entities are considered _________ by default
Flow through entities; however, owners of an unincorporated entity can still elect to have their business taxed as a C corporation instead of as the default flow-through entity
True or false: owners of an unincorporated entity can elect to have their business taxed as a C corporation instead of as the default flow-through entity
true!
What are the key facts of tax classification of legal entities>?
-Incorporated entities (ie legal corporations) are C corporations for tax purposes unless they make a valid S election
-Unincorporated entities are taxed as partnerships if they have more than one owner
-Unincorporated entities are taxed as sole proprietorships if held by a single individual or as disregarded entities if held by a single entity.
-Unincorporated entities may elect to be treated as C corporations, or they may elect to be taxed as S corporations, if eligible
Entities that are not taxed as C or S corporations are treated for tax purposes as __________, ___________ ___________, or _________ __________
partnerships, sole proprietorships, or disregarded entities
Disregarded entities
unincorporated entity with one owner that is considered to be the same entity as the owner.
Entities with more than one owner are taxed as ___________
partnerships
Partnerships report their ooperating results to the IRS on Form ________
1065, “US Return of Partnership Income”
Single-member LLC
a limited liability company with only one member. Single-member LLCs with individual owners are taxed as sole proprietorships and as disregarded entities otherwise.
Entities with only one individual owner such as sole proprietorships and single-member LLCs are taxed as _________ __________
sole proprietorships
Income from businesses taxed as sole proprietorships is reported on ____________
Schedule C, “Profit or Loss from Business” of Form 1040, “U.S. Individual Income Tax Return”
There are only ______ categories of business entities recognized by the US tax system. What are they?
- C corporation (separate tax paying entity; income reported on Form 1120)
- S corporation (flow-through entity; income reported on Form 1120-S)
- Partnership (flow-through entity; income reported on Form 1065)
- Sole proprietorship (flow-through entity; income reported on Form 1040, Schedule C)
The taxation of a business entity’s income depends on whether the entity is …..
a flow-through entity or a C corporation
True or false: a C corporation’s income is first taxed to the corporation at the corporate tax rate. It is taxed a second time (taxed to shareholders) when the shareholders sell their stock or the corporation distributes the income as a dividend
true!
The tax that flow-through entity owners pay on the entity’s business income depends in large part on the owner’s ___________
marginal income tax rate
Qualified business income (QBI)
ordinary income less ordinary deductions a taxpayers earns from a “qualified trade or business” conducted in the US by the taxpayer
It also includes the distributive share of these amounts from each partnership or S corporation interest held by the taxpayers
True or false: the dedution for QBI is deductible for both individuals and business entities
False; it is deductible by individuals but not by business entities
The QBI deduction is a ______ deduction
from AGI
Taxpayers can deduct _______% of the amount of QBI allocated to them from the business entity reduced by other deductions attributable to the QBI such as the taxpayers self-employment tax deduction, self-employed health insurance deduction, and self-employed retirement plan contribution deductions (ie the QBI deduction before the wage-based limitation is [QBI-self-employment tax deduction - self-employed health insurance deduction -self employment retirement plan contribution] x ____%))
20%
What is the idea behind the QBI deduction?
C corporations are taxed at a flat rate of 21%, but sole proprietors, partnerships, and S corps are flow-through entities, so they are taxed through the individual. To level level the playing field, Congress decided to allow the flow-through entities group the ability to deduct their QBI to make it more in line with the 21% for C corps.
Under the TCJA (Tax Cuts & Jobs Acts of 2017), section 199A, Qualified Business Income, was added to the Internal Revenue Code.
What does it allow?
-It allows up to a 20% deduction on the qualified business income (QBI) of NONcorporate taxpayers (aka sole proprietorships, partnerships, and S corporations)
-It is potentially available to individuals, trusts, and estates
What is the general rule for the QBI deduction? It is the ________ of _________ or ________
It is the lesser of 20% of QBI
OR
20% of modified taxable income
There are _____ limitations on the QBI deduction. What are they?
3
- There is a overall limitation based on modified taxable income–basically, as long as you are below a certain point, you’re good
- Another that applies to high-income taxpayers
- A third that applies to certain types of service businesses
In all cases, the 199A deduction may not exceed 20% of the taxpayers modified taxable income
What is modified taxable income?
Modified taxable income is taxable income before the deduction for QBI, reduced by any net capital gain
(what do we mean by net capital gain? It is the excess of a long-term capital gain over a short-term capital loss plus and any qualified dividend income)
Formula: Taxable income (NOT including QBI) –LTCG –Qualified dividends = modified taxable income
QBI does not include certain types of investment income. What are they?
-Capital gains or capital losses
-Dividends
-Interest Income (unless “properly allocable” to a trade or business, such as lending) or
-Certain other investment items
-“Reasonable compensation” paid to he taxpayer with respect to any qualified trade or business or
-guaranteed payments made to a partner for services rendered
True or false: the QBI business deduction is deductible by taxpayers even if they claim the standard deduction instead of itemizing deductions
True!
Specified service trade or business
any trade or business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities. Architecture and engineering services (their services build things) are specifically excluded from the definition of specified service trade or business.
True or false: a taxpayer is allowed to claim the QBI deduction even if the business is from a specified trade or business if their taxable income is les than $170,050 (340,100 MFJ) in 2022.
True!
The specified service requirement is completely phased out for the QBI deduction for taxpayers with a taxable income before the QBI deduction of at least ______________
220,050 (440,100 MFJ)
Under the wage-based limitation, the QBI deduction cannot exceed the greater of __________ or _______________
(1) 50% of the wages paid with respect to the qualified trade or business
or
(2) the sum of 25% of the wages with respect to the qualified trade or business plus 2.5% of the unadjusted basis of all qualified property used in the qualified trade or business immediately after acquisition
(Qualified property is generally tangible, depreciable property used in a qualified trade or business during the year)
In 2022, the wage-based limitation for the QBI deduction only applies to taxpayers with taxable income in excess of ___________
$170,050 (340,100 MFJ)
The wage-based limitation is completely phased in for taxpayers with taxable income before the QBI deduction of at least ____________
$220,050 ($440,100 MFJ)
True or false: a distribution from a through-through entity reduces the owner’s basis in their ownership interest and is therefore treated as a nontaxable return of capital rather than a taxable distribution of income.
True!
The tax that flow-through entity owners pay on the entity’s business income depends in large part on _____________
the owner’s marginal income tax rate
True or false: QBI includes these following types of investment income:
-capital gains or losses
-dividends
-interest income
False–it does not
True or false: QBI does not include “reasonable compensation” paid to the taxpayer with respect to any qualified trade or business or
guaranteed payments made to a partner for services rendered
True!
The QBI deduction is a _________ (for/from) AGI deduction
from
True or false: taxpayers can take the QBI deduction even if they claim standard deduction instead of itemized deductions
true!
Passive owners of flow-through entities ________ (may/not not) be required to pay net investment income tax on income allocated to them from the business
They may, because passive income is considered to be investment income for purposes of the net investment income tax
The net investment income tax rate is _____% of the ________ (lesser/greater) of ____________ or ____________________
The net investment income tax rate is 3.8% of the lesser of net investment income (gross investment income minus investment expenses) or (2) AGI in excess of a threshold amount
The threshold amount is $250,00 for MFJ and surviving spouses, $125,000 for MFS, and $200,000 for all others
Net earnings from self-employment
the amount of earnings subject to self-employment income taxes. The amount is 92.35 percent of a taxpayer’s self-employment income.
Social security wage base limitation
limit on the amount of employee compensation and/or net earnings from self-employment subject to the social security tax. The amount is provided annually and is indexed for inflation.
Taxpayers can deduct ________% of the self-employment tax paid as _______ (for/from) AGI deduction
Taxpayers can deduct 50% of the self-employment tax paid as a for AGI deduction
True or false: self-employment tax is computed together for each spouse if filing MFJ
False
self-employment tax is computed separately for each spouse even if a married couple files a joint return
What is the tax rate for Medicare tax for business owners who are allocated self-employment income from their businesses?
.9%
For medicare taxes, what is the tax base?
the sum of the taxpayers (and spouse if MFJ) net earnings from self-employment (from all sources) and compensation earned as an employee minus a threshold amount
Institutional shareholder
an entity such as an investment company, mutual fund, brokerage, insurance company, pension fund, investment bank, and endowment fund, with large amounts to invest in corporate stock.
The tax rate on dividends to individual taxpayers depends on the…..
individuals taxable income
Shareholders that are C corporations are taxed on dividends at _____%
21%–the same rate as other income
Dividends-received deduction (DRD)
a corporate deduction for part or all of a dividend received from another corporation.
True or false: tax-exempt organizations suchas as charitable organizations, churches, universities, and political organizations are exempt from tax on their investment income, including dividend income from investments in corporate stock
true!
True or false: tax exempt organizations are not required to pay tax on unrelated business income (UBI) they generate
False; they may be
This tax is called unrelated business income tax (UBIT)
Unrelated business income
income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis of the organization’s exemption.
UBIT is taxed at ____%
21%
Double taxation
the tax burden when an entity’s income is subject to two levels of tax. Income of C corporations is subject to double taxation. The first level of tax is at the corporate level, and the second level of tax on corporate income occurs at the shareholder level.
Personal holding companies
closely held corporations generating primarily investment income.
Personal holding company tax
penalty tax on the undistributed income of a personal holding company.
Accumulated earnings tax
a tax assessed on C corporations that retain earnings without a business reason to do so.
Net operating loss (NOL)
the excess of allowable deductions over gross income.
