Chapter 12 - The Choice of Business Entity

Question 1

Define Accumulated Earnings Tax

Answer 1

A penalty levied on corporation accumulating income beyond the reasonable needs of the business to avoid paying dividends to their shareholders. The tax is levied in addition to the regular income tax.

Question 2

Define Constructive Dividend

Answer 2

A distribution by a corporation to a shareholder that the corporation classifies as salary, interest, rent, or some other type of payment but that the IRS classifies as a dividend.

Question 3

Define Controlled Group

Answer 3

A brother-sister group of corporations owned by the same individual shareholders or a parent subsidiary group of corporations.

Question 4

Define Personal Holding Company

Answer 4

A corporation owned by a small number of individuals that receives taxable income consisting primarily of nonbusiness income such as dividends, interest, rents, and royalties.

Question 5

Define Personal Holding Company Tax

Answer 5

A penalty tax levied on personal holding companies in addition to the regular corporate income tax.

Question 6

Define Thin Capitalization

Answer 6

A corporate capital structure with a high ratio of debt to equity.

Question 7

For family’s that want to shift income via a business, what kinds of businesses can transfer income to kids? Which cannot.

Answer 7

• In a service business kids can’t earn income if they aren’t qualified to provide the service.
• If a business that a kids own a part of has property (rental property, retail store, etc) that produces income, that is ok.

Question 8

When a business is operated as an S corp, how is annual income allocated?

Answer 8

Pro rata to the outstanding shares of corporate stock.

Question 9

In an S Corp, what must be done before any corporate income is allocated to the shareholders?

Answer 9

An owner that work in the business must receive a reasonable salary for any services performed for the corporation.

Question 10

What is the difference between a partnership and an S Corp?

Answer 10

• S Corps require an IRS election, incorporation documents, possible corporate state tax payments.
• Partnership agreements have more flexibility, but require more careful legal drafting.
• Partners (but not S Corp shareholders) receive tax basis for liabilities of the partnership.
• S Corporation shares are transferable. Partnership interests are not - requires new partnership agreement.
• Employee benefit planning favors S Corp.