CH 16 Business Entity Selection and Taxation

Question 1

Not all entities are separate legal entities for the purposes of taxation

. a. True b. False

Answer 1

. a. True

Question 2

“Piercing the veil” may occur if business owners fail to keep their personal records with their business records.

a. True b. False

Answer 2

b. False

Question 3

Sole proprietorships are never required to register with the state in which they do business.

a. True b. False

Answer 3

b. False

Question 4

One of the major disadvantages of a sole proprietorship is the potential legal liability.

a. True b. False

Answer 4

a. True

Question 5

The ordinary and necessary expenses of a sole proprietorship are reported on Schedule C of the owner’s Form 1040.

a. True b. False

Answer 5

a. True

Question 6

General partnerships are governed by federal law.

a. True b. False

Answer 6

b. False

Question 7

The owners of a general partnership have limited liability from the debts and obligations of the partnership.

a. True b. False

Answer 7

b. False

Question 8

General partnerships are pass-through entities for tax purposes.

a. True b. False

Answer 8

a. True

Question 9

Limited partnerships are generally required to register with the state.

a. True b. False

Answer 9

a. True

Question 10

Limited partnerships offer limited liability for all partners.

a. True b. False

Answer 10

b. False

Question 11

Limited liability partnerships are generally owned by licensed professionals.

a. True b. False

Answer 11

a. True

Question 12

The transferability of an interest in an LLP is the same as for any other type of partnership

. a. True b. False

Answer 12

b. False

Question 13

Only a limited partner can manage a family limited partnership.

a. True b. False

Answer 13

b. False

Question 14

At formation of a family limited partnership, the founder is subject to gift tax on the transfer of the property interest to the family limited partnership.

a. True b. False

Answer 14

b. False

Question 15

There is no limitation on the number of members of a LLC.

a. True b. False

Answer 15

a. True

Question 16

A written operating agreement is an important element of the management of a LLC.

a. True b. False

Answer 16

a. True

Question 17

A corporation’s purpose must be narrowly defined in the articles of incorporation.

a. True b. False

Answer 17

b. False

Question 18

In-kind distributions of appreciated assets by a C corporation are treated as a deemed sale by the corporation.

a. True b. False

Answer 18

a. True

Question 19

The number of S corporation shareholders is limited to 100.

a. True b. False

Answer 19

a. True

Question 20

All payments from an S corporation to an S corporation shareholder will be treated as income subject to payroll taxes.

a. True b. False

Answer 20

b. False

Question 21

Doralee, an architect, performed services for Judy and Violet and, in lieu of her normal fee, accepted a 10 percent interest in a partnership with a fair market value of $10,000. How much income from this arrangement should Doralee report on her income tax return?

a. Doralee does not have any currently taxable income.
b. Doralee has realized $10,000 in capital gains.
c. Doralee must recognize $10,000 in compensation income.
d. Doralee has realized $10,000 in compensation income, but does not have to recognize it until she sells her interest in the partnership.

Answer 21

The correct answer is c.

If a partner contributes services in exchange for a partnership interest, the partner must recognize ordinary compensation income for the value of the services.

In this case, Doralee must currently recognize $10,000 of compensation income

Question 22

An S corporation has the following information for the taxable year:
Net Income (before the items below) $90,000 Warner’s Salary
Other Income Other Expenses
Net Income
($38,000) $29,000
($14,000) $67,000
Warner is a 20 percent owner of the S corporation and he performs services for the business as an employee. What is Warner’s self-employment income?

a. $0.
b. $52,000.
c. $67,000.
d. $90,000.

Answer 22

The correct answer is a.

None of the income from the S corporation (distributed or undistributed) is self-employment income to
Warner.

Income from an S corporation is not considered self-employment income as long as the employee/owner’s compensation is reasonable

Question 23

On August 1, 2023, Elle bought a five percent interest (5 shares) in XYZ, an S corporation that files as a calendar-year taxpayer. In 2023, the S corporation income was $160,000.
How much will be reported to Elle on her 2023 1120-S Schedule K-1?

a. $0.
b. $3,333.
c. $3,353.
d. $8,000.

Answer 23

correct answer is c.

$160,000 x 5% x 153/365 = $3,353.

From August 1 to December 31 is 153 days.

Question 24

At the beginning of the current year, Emmett’s basis in his partnership interest was $100,000. At the end of the year, Emmett received a K-1 from the partnership that showed the following information:

Cash Withdrawn $31,000
Partnership Taxable Income $60,000
Charitable Contribution $1,000

What is Emmett’s basis in his partnership interest at year-end?

a. $128,000.
b. $129,000.
c. $159,000.
d. $160,000.

Answer 24

a. $128,000.

Basis at beginning of current year $100,000

Increases to Basis:
Partnership Taxable Income $60,000

Decreases to Basis:
Cash Withdrawn ($31,000)
Charitable Contribution ($1,000)

Basis at Year-End $128,000

Question 25

Which entity does not have all of the following characteristics?
1. Limited liability.
2. Ability to distribute in-kind appreciated assets to owners without gain recognition.
3. Can have foreign investors.

a. LLC.
b. S corporation.
c. Limited partnership.
d. LLP.

Answer 25

The correct answer is b.

S corporations cannot have foreign investors and cannot distribute in-kind appreciated assets to owners
without gain recognition

Question 26

Which of the following statements is/are true?

1. It is necessary to register with the state when forming a proprietorship.
2. It is necessary to register with the state when forming a partnership.

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2.

Answer 26

Neither 1 nor 2.
Rationale

States do not require formal registration of proprietorships or partnerships but do require formal registration of limited partnerships.

Question 27

Rayna owns a partnership which produced net business income of $50,000 this year, and she owns an S corporation which produced net business income of $30,000 this year.

Her total taxable income is $140,000. What is Rayna’s “combined QBI?”

$10,000.
$16,000.
$20,000.
$80,000.

Answer 27

16,000.
Rationale

Rayna’s “deductible QBI” from the
partnership is $10,000 ($50,000 x 20%),
and from the S corporation is $6,000 ($30,000 x 20%).

His “combined QBI” is $10,000 + $6,000 = $16,000.

Question 28

All of the following are attributes of general partnerships, except:

They provide limited liability.
They permit pass-through of income or loss to the partners.
Their formation is usually tax-free.
They are formed by more than one partner.

Answer 28

They provide limited liability.

Rationale

A partnership is an organization of two or more individuals to carry on a trade, business, or financial operation with the intention of producing a profit.
The partnership can be established without any documentation, and, most often, the formation is tax-free.
A feature of partnerships is their function as a conduit to pass income and losses on to the partners.
In contrast to corporations, partnerships do not enjoy the benefit of limited liability.
Consequently, the personal assets of each partner may be legally attached to satisfy any legal liability of the partnership.
Any partnership debts may become the personal responsibility of any one of the partners.

Question 29

Which type of entity could possibly file any of the following forms?

1. Form 1040
2. Form 1065
3. Form 1120-S

Partnership.
Limited partnership.
Proprietorship.
LLC.

Answer 29

LLC.

Rationale

A single member LLC must file a Form 1040, Form 1120 or Form 1120-S.
A multi-member LLC can file a Form 1065, Form 1120, or Form 1120S. A multi-member LLC can file a Form 1065, Form 1120, or Form 1120S.

Question 30

Which of the following statements is/are true?

1. Partnerships offer limited liability protection to partners
2. LLCs offer limited liability protection to members

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2.

Answer 30

2 only.

Rationale

Partnerships are considered general partnerships and general partners have unlimited liability.

Question 31

Which of the following statements is/are true?
1. LLCs offer limited liability protection to members.
2. S corporations offer limited liability protection to owners.

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2.

Answer 31

Both 1 and 2.

Rationale

Both LLCs and S corporations have limited liability.

Question 32

Juliette had net Schedule C net income of $124,000 and would like to make a contribution to a Keogh profit sharing plan.
Which of the following is the maximum contribution she can make this year?

Juliette is not eligible to contribute to a Keogh profit sharing plan.
$21,296.
$23,048.
$31,000.

Answer 32

23,048.

Rationale
The maximum contribution for a self-employed individual is 20% of the adjusted net self-employment income. The contribution is calculated as follows:

Step 1: Calculate the Self-Employment Tax
$124,000 net self-employment income (from Schedule C)
x 0.9235
$114,514
x 0.153 self-employment tax rate (up to the wage base of $160,200 in 2024)
$17,521 self-employment tax

Step 2: Calculate the self-employed individual’s contribution:
$124,000 net self-employment income (from Schedule C)
- 8,761 less ½ of self-employment taxes
$115,239 adjusted net self-employment income
x 0.20 maximum contribution rate for self-employed individuals
$23,048 self-employed individual’s Keogh plan contribution

Question 33

Which entity will meet the following requirements?

1. Disregarded entity
2. Limited liability
3. Self-employment tax on all income

Partnership.
Single-member LLC.
S corporation.
Proprietorship.

Answer 33

Single-member LLC.

Rationale

Both proprietorships and single-member LLCs are disregarded entities, but only the LLC has limited liability.

Question 34

Which entity will meet the following requirements?

1. Unlimited number of owners
2. Limited liability
3. Self-employment tax on all income

Proprietorship.
Partnership.
LLC.
S corporation.

Answer 34

LLC.

Rationale

A S corporation has no self-employment income and proprietorships and partnerships have unlimited liability.

Question 35

Which of the following can file as a corporation or partnership?

LLC and LLP.
LLC only.
LLP only.
LLC and S corporation

Answer 35

LLC and LLP.

Rationale

LLCs and LLPs can file as partnerships or corporations.

Question 36

An S corporation has the following information for the taxable year:

Net Income (before the items below) $90,000
Warner’s Salary ($38,000)
Other Income $29,000
Other Expenses ($14,000)
Net Income $67,000

Warner is a 20 percent owner of the S corporation and he performs services for the business as an employee.

What is Warner’s self-employment income?

Answer 36

$0.
Rationale

None of the income from the S corporation (distributed or undistributed) is self-employment income to Warner.

Income from an S corporation is not considered self-employment income as long as the employee/owner’s compensation is reasonable

Question 37

Excess distributed income over reasonable compensation:

1. is treated as self-employment income in a LLC.
2. is treated as dividend income in a S corporation.

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2.

Answer 37

Both 1 and 2.
Rationale

S corporations do not have self-employment income.

Question 38

Which entity will meet the following requirements?

1. Availability of preferred returns for certain investors
2. Considers loans from third parties in basis of owners
3. Limited liability

Partnership.
LLC.
S corporation.
C corporation.

Answer 38

LLC.
Rationale

S corporations cannot have preferred returns for certain investors;

partnerships do not have limited liability;

and corporations do not consider loans from third parties to be part of basis.

Question 39

Which entity will meet the following requirements?

1. Flow-through entity
2. Limited liability
3. Can have foreign investors

Proprietorship.
Partnership.
LLC.
S corporation.

Answer 39

LLC.
Rationale

Proprietorships and partnerships have unlimited liability. S corporations cannot have foreign investors.

Question 40

UPDATED FOR 2024:

Cobalt, a calendar-year S corporation, was incorporated in 2020. The company had the following taxable income and distributions each year:
Taxable Income
Distributions
2020 $0 $0
2021 ($20,000) $0
2022 ($30,000) $0
2023 $150,000 $60,000
2024 $400,000 $175,000

Cobalt has a single shareholder, Beibei. Beibei’s original basis in the stock was $150,000.

What is Beibei’s basis at the end of 2024?

$150,000.
$250,000.
$415,000.
$650,000.

Answer 40

$415,000.

Rationale

Beibei’s basis was $415,000 at the end of 2024.
Taxable
Income
Basis beginning of 2020 $150,000
Net 2021 ($20,000)
Net 2022
($30,000)
Net 2023
$90,000
Net 2024
$225,000
Year-End 2024 Basis $415,000

Question 41

Which of the following statements is/are true?

1. Partnerships require registration with the state.
2. Limited partnerships require registration with the state.

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2.

Answer 41

2 only.
Rationale

Limited partnerships, but not general partnerships, require formal registration with the state.

Question 42

Gunner, who is single, is an owner and engineer in a partnership with one other owner. Gunner’s share of partnership income is $40,000 and his total taxable income (excluding the QBI deduction) is $82,000, placing him in the 22% marginal rate bracket.

What is Gunner’s net tax rate on the partnership income factoring in the Section 199A qualified business income deduction?

4.4%.
17.16%.
17.6%.
22.0%.

Answer 42

17.6%.

Rationale

Gunner is in the 22% bracket, and his income is below the phaseout range.

The net effect of the qualified business income deduction will reduce the tax rate on his business income to 17.6% (22% x (1 - 0.20)).

Question 43

Which of the following, if any, correctly characterize the check-the-box Regulations?

A. A one-owner business becomes a sole proprietorship if default (no election is made) occurs.

B. A one-owner business cannot elect to be taxed as a corporation.

C. If default (no election is made) occurs, a limited liability
company is taxed as a corporation.

D. The check-the-box Regulations apply to all entities that are already incorporated under state law.

E. None of the choices

Answer 43

Solution: The correct answer is A.

A one-owner business can elect to be taxed as a corporation. If default occurs, (no election is made), a limited liability company is taxed as a partnership. The check-the-box Regulations do not apply to entities that are incorporated under state law.

Question 44

Which of the following, if any, do not describe the status or nature of limited liability companies?

A. Cannot elect partnership tax status if incorporated under state law.

B. One of the main reasons why the check-the-box Regulations were issued.

C. Can elect to be taxed as a corporation.

D. Statutes creating these entities have been adopted by only a minority of the states.

E. None of the choices.

Answer 44

Solution: The correct answer is D.

A limited liability company cannot elect partnership status if incorporated under state law .

The confusion regarding the tax status of limited liability companies was one of the main reasons why the check-the-box Regulations were issued.

Limited liability companies can elect to be taxed as corporations.

All states have enacted laws permitting the use of limited liability companies.

Question 45

Kayci would like to establish a business with her business partner Nathan. They would like to have an entity that provides for limited liability. They would like the flexibility to allocate profits and losses in a percentage differing from their ownership interest. They expect losses in the first few years.

Which entity should they establish?

A. Partnership
B. LLC taxed as a partnership
C. S-Corporation
D. C-Corporation

Answer 45

Solution: The correct answer is B.

The partnership does not allow for limited liability.
The S-corporation does not allow for the allocation of profits.
The C-Corporation does not allow for the allocation of profits or the flow through of losses.

The LLC taxed as a partnership meets all of their requirements.