CH. 15 - Entities Overview

Question 1

Corporation

Answer 1

business entity recognized as a separate entity from its owners under state law.

Question 2

Limited liability company (LLC)

Answer 2

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.

Question 3

Limited liability companies are generally taxed as ________ for federal income tax ­purposes.

Answer 3

partnerships

Question 4

General partnership (GP)

Answer 4

a partnership with partners who all have unlimited liability with respect to the liabilities of the entity.

Question 5

Limited partnership (LP)

Answer 5

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.

Question 6

Sole proprietorship

Answer 6

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.

Question 7

Articles of incorporation

Answer 7

a document, filed by a corporation’s founders with the state, describing the purpose, place of business, and other details of the corporation.

Question 8

True or false: state laws consider LLCs to be the same legal entity as its owners

Answer 8

False; state law considers LLCs to be separate legal entities from its owners

Question 9

Certificate of organization

Answer 9

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.

Question 10

Articles of organization

Answer 10

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.

Question 11

Partnership agreement

Answer 11

an agreement among the partners in a ­partnership stipulating the partners’ rights and responsibilities in the partnership.

Question 12

Certificate of limited partnership

Answer 12

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.

Question 13

Under state law, ________ is responsible for payment of a corporation’s liabilities

Answer 13

the corporation itself, not the shareholders

Question 14

Who is responsible for an LLCs liabilities?

Answer 14

The LLC itself, not its members

Question 15

For entities formed as partnerships, who is responsible for the liabilities of the partnership?

Answer 15

All general partners are ultimately responsible

Question 16

True or false: limited partners are not responsible for the partnerships liabilities

Answer 16

True!

However, they are not allowed to actively participate in the activities of the business

Question 17

What are the key facts to legal classification and nontax characteristics of business entities?

Answer 17

-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

Question 18

Initial public offering (IPO)

Answer 18

the first sale of stock by a company to the public.

Question 19

True or false: state laws prohibit shareholders from directly amending corporate governance rules and from directly participating in management.

Answer 19

True! they have only the right to vote for corporate directors or officers

Question 20

True or false: LLC members generally do not have the right to amend the LLC operating agreement, provide input, and manage LLC

Answer 20

False–they do have the right.

Question 21

True or false: a business’s legal form is the same as its tax form

Answer 21

False – it can be different

Question 22

For tax purposes, business entities can be classified as either ________ or ________

Answer 22

separate taxpaying entities or flow-through entities

Question 23

Flow-through entities

Answer 23

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.

Question 24

Separate taxpaying entities pay taxes on ___________

Answer 24

their own income

Question 25

True or false: Flow-through entities don’t pay taxes

Answer 25

True, because income from these entities flows through to their business owners, who are responsible for paying tax on the income

Question 26

C corporations

Answer 26

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.

Question 27

Entities that are legal corporations under state law are treated as _________ for tax purposes by default

Answer 27

C Corporations

Question 28

C corporations

Answer 28

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.

Question 29

C corporations report their taxable income to the IRS on Form ______

Answer 29

1120 - “US Corporation Income Tax Return”

Question 30

S corporation

Answer 30

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.

Question 31

For tax purposes, unincorporated entities are considered _________ by default

Answer 31

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

Question 32

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

Answer 32

true!

Question 33

What are the key facts of tax classification of legal entities>?

Answer 33

-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

Question 34

Entities that are not taxed as C or S corporations are treated for tax purposes as __________, ___________ ___________, or _________ __________

Answer 34

partnerships, sole proprietorships, or disregarded entities

Question 35

Disregarded entities

Answer 35

unincorporated entity with one owner that is considered to be the same entity as the owner.

Question 36

Entities with more than one owner are taxed as ___________

Answer 36

partnerships

Question 37

Partnerships report their ooperating results to the IRS on Form ________

Answer 37

1065, “US Return of Partnership Income”

Question 38

Single-member LLC

Answer 38

a limited liability company with only one ­member. Single-member LLCs with individual owners are taxed as sole proprietorships and as disregarded entities otherwise.

Question 39

Entities with only one individual owner such as sole proprietorships and single-member LLCs are taxed as _________ __________

Answer 39

sole proprietorships

Question 40

Income from businesses taxed as sole proprietorships is reported on ____________

Answer 40

Schedule C, “Profit or Loss from Business” of Form 1040, “U.S. Individual Income Tax Return”

Question 41

There are only ______ categories of business entities recognized by the US tax system. What are they?

Answer 41

1. C corporation (separate tax paying entity; income reported on Form 1120)
2. S corporation (flow-through entity; income reported on Form 1120-S)
3. Partnership (flow-through entity; income reported on Form 1065)
4. Sole proprietorship (flow-through entity; income reported on Form 1040, Schedule C)

Question 42

The taxation of a business entity’s income depends on whether the entity is …..

Answer 42

a flow-through entity or a C corporation

Question 43

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

Answer 43

true!

Question 44

The tax that flow-through entity owners pay on the entity’s business income depends in large part on the owner’s ___________

Answer 44

marginal income tax rate

Question 45

Qualified business income (QBI)

Answer 45

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

Question 46

True or false: the dedution for QBI is deductible for both individuals and business entities

Answer 46

False; it is deductible by individuals but not by business entities

Question 47

The QBI deduction is a ______ deduction

Answer 47

from AGI

Question 48

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 ____%))

Answer 48

20%

Question 49

What is the idea behind the QBI deduction?

Answer 49

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.

Question 50

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?

Answer 50

-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

Question 51

What is the general rule for the QBI deduction? It is the ________ of _________ or ________

Answer 51

It is the lesser of 20% of QBI
OR
20% of modified taxable income

Question 52

There are _____ limitations on the QBI deduction. What are they?

Answer 52

3

1. There is a overall limitation based on modified taxable income–basically, as long as you are below a certain point, you’re good
2. Another that applies to high-income taxpayers
3. 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

Question 53

What is modified taxable income?

Answer 53

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

Question 54

QBI does not include certain types of investment income. What are they?

Answer 54

-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

Question 55

True or false: the QBI business deduction is deductible by taxpayers even if they claim the standard deduction instead of itemizing deductions

Answer 55

True!

Question 56

Specified service trade or business

Answer 56

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.

Question 57

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.

Answer 57

True!

Question 58

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 ______________

Answer 58

220,050 (440,100 MFJ)

Question 59

Under the wage-based limitation, the QBI deduction cannot exceed the greater of __________ or _______________

Answer 59

(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)

Question 60

In 2022, the wage-based limitation for the QBI deduction only applies to taxpayers with taxable income in excess of ___________

Answer 60

$170,050 (340,100 MFJ)

Question 61

The wage-based limitation is completely phased in for taxpayers with taxable income before the QBI deduction of at least ____________

Answer 61

$220,050 ($440,100 MFJ)

Question 62

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.

Answer 62

True!

Question 63

The tax that flow-through entity owners pay on the entity’s business income depends in large part on _____________

Answer 63

the owner’s marginal income tax rate

Question 64

True or false: QBI includes these following types of investment income:
-capital gains or losses
-dividends
-interest income

Answer 64

False–it does not

Question 65

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

Answer 65

True!

Question 66

The QBI deduction is a _________ (for/from) AGI deduction

Answer 66

from

Question 67

True or false: taxpayers can take the QBI deduction even if they claim standard deduction instead of itemized deductions

Answer 67

true!

Question 68

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

Answer 68

They may, because passive income is considered to be investment income for purposes of the net investment income tax

Question 69

The net investment income tax rate is _____% of the ________ (lesser/greater) of ____________ or ____________________

Answer 69

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

Question 70

Net earnings from self-employment

Answer 70

the amount of earnings subject to self-employment income taxes. The amount is 92.35 percent of a ­taxpayer’s self-employment income.

Question 71

Social security wage base limitation

Answer 71

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.

Question 72

Taxpayers can deduct ________% of the self-employment tax paid as _______ (for/from) AGI deduction

Answer 72

Taxpayers can deduct 50% of the self-employment tax paid as a for AGI deduction

Question 73

True or false: self-employment tax is computed together for each spouse if filing MFJ

Answer 73

False

self-employment tax is computed separately for each spouse even if a married couple files a joint return

Question 74

What is the tax rate for Medicare tax for business owners who are allocated self-employment income from their businesses?

Answer 74

.9%

Question 75

For medicare taxes, what is the tax base?

Answer 75

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

Question 76

Institutional shareholder

Answer 76

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.

Question 77

The tax rate on dividends to individual taxpayers depends on the…..

Answer 77

individuals taxable income

Question 78

Shareholders that are C corporations are taxed on dividends at _____%

Answer 78

21%–the same rate as other income

Question 79

Dividends-received deduction (DRD)

Answer 79

a corporate deduction for part or all of a dividend received from another corporation.

Question 80

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

Answer 80

true!

Question 81

True or false: tax exempt organizations are not required to pay tax on unrelated business income (UBI) they generate

Answer 81

False; they may be

This tax is called unrelated business income tax (UBIT)

Question 82

Unrelated business income

Answer 82

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.

Question 83

UBIT is taxed at ____%

Answer 83

21%

Question 84

Double taxation

Answer 84

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.

Question 85

Personal holding companies

Answer 85

closely held corporations generating ­primarily investment income.

Question 86

Personal holding company tax

Answer 86

penalty tax on the undistributed ­income of a personal holding company.

Question 87

Accumulated earnings tax

Answer 87

a tax assessed on C corporations that retain earnings without a business reason to do so.

Question 88

Net operating loss (NOL)

Answer 88

the excess of allowable deductions over gross income.