CH 2 - Quiz

Question 1

Jennifer and Jamie are starting a business and have asked you for advice about whether they should form a partnership, a corporation, or some other type of entity.
Prepare a list of questions you would ask in helping them decide which type of entity they should choose.

Answer 1

(1) TYPE of business
(2) TYPE of income
(3) AMOUNT of income
(4) LOSSES in Early Years?
(5) WITHDRAW profits from business (or leave them to grow)?

Question 2

Which type of business is beneficial to owners should the business report a loss?

Answer 2

S Corp, Partnership, LLC as they allow the owners to deduct losses from taxable income.

Question 3

[True or False]
In the case of a partnership, an S corporation, or an LLC, owners must pay tax on profits before reinvesting funds back into the business

Answer 3

True

Question 4

Brianna owns:

(1) 40% of the stock of C Corporation
(2) 40% of the stock of S corporation

• Each corporation has operating income of $120,000
• Each corporation has tax-exempt interest income of $8,000.
• Neither pays any dividends during the year.

(1) How will this information will be reported by the corporations?
(2) How will this information will be reported by Brianna?

Answer 4

(1a) C Corp is a taxable entity and will report $120k in taxable income
(1b) S corp is not a taxable entity, and will file an information return detailing $120k of taxable income + $8k of tax-exempt income
(2a) Briana will not report income from C Corp
(2b) Briana will report $48k in business income and $3.2k in tax-exempt income on her FORM1040.

Question 5

Art, an executive with Azure Corporation, plans to start a part-time business selling products on the internet.

He will devote about 15 hours each week to running the
business. Art’s salary from Azure places him in the 35% tax bracket. He projects substantial losses from the new business in each of the first three years and expects
sizable profits thereafter.

Art plans to leave the profits in the business for several years, sell the business, and then retire. Would you advise Art to incorporate the business or operate it as a sole proprietorship? Why?

Answer 5

[First 3 Years] Art should consider operating the business as a sole proprietorship (or a single member LLC)
for the first three years. If he works 15 hours per week in the business, he will exceed the minimum
number of hours required to be a material participant (52 × 15 = 780) under the passive activity loss
rules. [An individual is treated as materially participating in an activity if he or she participates in the
activity for more than 500 hours during the year. Reg. § 1.469–5T(a)(1).] Therefore, he will be able to
deduct the losses against his other income, subject to the § 461(l) limitation on excess business losses.

[Remaining Years] When the business becomes profitable, Art should consider incorporating. If he reinvests the profits in the business, the value of the stock should grow accordingly, and he should be able to sell his stock in the corporation for long-term capital gain.

Question 6

Can a sole proprietor form as a single member limited liability company (LLC)? If so, how would such an LLC be taxed?

Answer 6

Yes.

Under the default rules of the Check-the-box Regulations, a single member LLC is taxed as a sole proprietorship.

Question 7

Assess the validity of this statement:

In the current year, Juanita and Joseph form a two-member LLC and do not file Form 8832 (Entity Classification Election).

As a result, the LLC will be treated as a partnership for Federal income tax purposes.

Answer 7

The statement is correct. Because no Form 8832 was filed, the LLC will be taxed as a partnership, the default classification for multi-member LLCs under the Check-the-box Regulations.

Question 8

Why did the TCJA of 2017 include a deduction for qualified business income?

Answer 8

Given the significant reduction in corporate tax rates in 2018, the TCJA of 2017 included a deduction for qualified business income to provide a tax cut to businesses operating outside of the corporate form.

Question 9

Who can claim the qualified business income (QBI) deduction?

Answer 9

The QBI deduction is available to any non-corporate taxpayer.

Question 10

What are the general rules surrounding the QBI deduction? How is it computed?

Answer 10

In general, the deduction for qualified business income is the lesser of:

1. 20% of qualified business income, or
2. 20% of modified taxable income

Question 11

Define the following term and explain how each is used in determining the QBI deduction:

• Modified taxable income

Answer 11

Modified taxable income is taxable income before the deduction for qualified business income, reduced by any net capital gain (including any qualified dividend income).

Question 12

Define the following term and explain how each is used in determining the QBI deduction:

• Qualified business income

Answer 12

Qualified business income (QBI) is defined as the ordinary income less ordinary deductions a taxpayer earns from a “qualified trade or business” (e.g., from a sole proprietorship, an S corporation, or a partnership) conducted in the United States by the taxpayer.

Question 13

Define the following term and explain how each is used in determining the QBI deduction:

• Qualified trade or business

Answer 13

A qualified trade or business includes any trade or business other than a trade or business of providing services as an employee.

Question 14

Define the following term and explain how each is used in determining the QBI deduction:

• “specified services”

Answer 14

A “specified services” trade or business includes those involving:
- The performance of services in certain fields, including health, law, accounting, actuarial science

“specified services” trade or business is not a
qualified trade or business.

Question 15

Which of the following taxpayers may claim a deduction for qualified business income?

1. A driver for Uber or Lyft.
2. A veterinarian operating as an S corporation.
3. A CPA operating as an LLC taxed as a sole proprietorship.
4. Same as part (c), except that the CPA has taxable income of $200,000.
5. A real estate salesperson.
6. A pet sitter/dog walker.
7. A sole proprietor software developer.
8. An individual wage earner who derives $60,000 of rental income from a duplex she owns.

Answer 15

1. Yes.
2. Yes.
3. Yes since Sole Proprietorship.
4. Yes
5. Yes
6. Yes
7. Yes
8. No for individual wages, Yes for rental income.

Question 16

Meghann, a single taxpayer, has QBI of $110,000 and modified taxable income of $78,000 (this is also her taxable income before the QBI deduction).

Given this information, what is Meghann’s QBI deduction?

Answer 16

Since Meghann’s taxable income before the QBI deduction is less than the threshold amount for single taxpayers ($164,900), her QBI deduction is $15,600, the lesser of:
1. 20% of qualified business income ($110,000 × 20%), or $22,000

2. 20% of modified taxable income ($78,000 × 20%) $15,600

Question 17

Charlotte is a partner in, and sales manager for, CD Partners, a domestic business that is not a “specified services” business.

(1) During the tax year, she receives guaranteed payments of $250,000 from CD Partners for her services to the partnership as its sales
manager.

(2) In addition, her distributive share of CD Partners’ ordinary income was $175,000.

What is Charlotte’s qualified business income?

Answer 17

Charlotte’s qualified business income from CD Partners is $175,000. Her guaranteed payments do not qualify as QBI.

Question 18

• Robert is the sole shareholder and CEO of ABC, Inc., an S corporation that is a qualified trade or business.
• During the current year, ABC has net income of $325,000 after deducting Robert’s $100,000 salary.
• In addition to his compensation, ABC pays Robert dividends of $250,000
  (1) What is Robert’s qualified business income?
  (2) Would your answer to part (a) change if you determined that reasonable compensation for someone with Robert’s experience and responsibilities is $200,000? Why or why not?

Answer 18

(1) Robert’s qualified business income from ABC, Inc., is $325,000
(2) Yes. This would reduce ABC’s net income from $325,000 to $225,000, and Robert’s qualified business income would be $225,000.

Question 19

• Maria and Javier are the equal partners in MarJa, a partnership that is a qualified trade or business.
• In the current year, MarJa had $350,000 of ordinary income after reporting $500,000 in guaranteed payments to Maria and Javier for their services to
  MarJa ($250,000 each).

1. What is Maria’s and Javier’s qualified business income?

Answer 19

1. Maria and Javier each have $175,000 of QBI ($350,000 of ordinary income split equally between the equal partners). The guaranteed payments Maria and Javier receive are not QBI.

Question 20

• Ellie and YiLing are equal owners in Otter Enterprises, a calendar year business.
• During the current year, Otter Enterprises has $320,000 of gross income and $210,000 of operating expenses.
• In addition, Otter has a long-term capital gain of $15,000 and makes distributions to Ellie and YiLing of $25,000 each.

Discuss the impact of this information
on the taxable income of Otter, Ellie, and YiLing if Otter is:
1. A partnership.
2. An S corporation.
3. A C corporation.

Answer 20

Net Income = $110k
L.T. Gain = $15k
Distribution = $50k

(1) If Partnership, Net Income and L.T. Gain flow to owners. Distribution would not impact taxable income, but would reduce basis.
(2) If S Corp, Net Income and L.T. Gain flow to owners. Distribution would not impact taxable income, but would reduce basis.
(3) If C Corp, Corp reports income of $125k. Both would report a dividend of $25k each.