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Income Tax > Characteristics and Income Taxation of Business Entities > Flashcards

Characteristics and Income Taxation of Business Entities Flashcards

1
Q

Sole proprietorship

A
  • owner is responsible for operating business on day to day basis
  • business is undistinguished from owners personal affairs for both legal and tax purposes
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2
Q

Sole proprietorship - advantages

A
  • availability of retirement plan (Keogh, SEP)
  • 100% medical insurance premiums deductible by owner
  • no legal formalities
  • conduit of income or losses to owner (sched. C)
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3
Q

Sole proprietorship - disadvantages

A
  • unlimited liability
  • business dies with owner
  • capital structure depends on the owners personal resources
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4
Q

Partnerships (general partnerships)

A
  • an association of two or more owners to operate the business for profits
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5
Q

Partnerships - advantages

A
  • availability of retirement plan (keogh, SEP)
  • 100% medical insurance premiums deductible by partners
  • partnership agreement can be oral
  • conduit of income or losses to owner
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6
Q

Partnerships - disadvantages

A
  • unlimited personal liability for acts of the partnership or partner acting on behalf of the partnership (joint and several liability)
  • partnerships dissolve upon death, bankruptcy, or incapacity of partner
  • capital structure depends on resources of partners
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7
Q

Limited liability company (LLC)

A
  • can be classified for tax purposes as partnership or corporation
  • partnership if no more than two of the following
  • centralization of management - continuity of life - limited liability - free transferability of interests
  • can operate like general partnership (members can be involved in daily operations without losing limited liability status)
  • every member has limited liability for all debts or claims against business
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8
Q

Qualified business income (QBI)

A
  • net income (profit) from a pass through business
  • includes rental income, publicly traded partnerships and REITS
  • can deduct up to 20% of QBI from each business and carry forward loss
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9
Q

2 classes of pass through businesses

A
  • providing personal services: law firms, medical practices, consulting firms, entertainers and athletes
  • all other
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10
Q

3 tiers of business owners (based on taxable income)

A

Tier 1
- single, making less than 182,100 or joint making less than 364,200 for total taxable income may claim full 20% deduction
- doesn’t matter if personal service firm

Tier 2
- single, with more than 232,100, or couples over 464,200 are allowed no deduction if business is personal service firm
- could get limited deduction if they have a different business

Tier 3
- those with incomes between thresholds are eligible for partial benefit
- doesnt matter nature of business
- amount phases out for personal service business

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11
Q

Limited liability partnership (LLP)

A
  • partnership which general partners are not personally liable for malpractice-related claims from misconduct of another general partner
  • useful if want to convert from partnership where one or more partners have unlimited liability
  • some states allow partnership to convert to LLP
  • LLC flexibility preferable to LLP
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12
Q

Regular C corporation

A
  • separate tax entity
  • if distributing after tax earnings to owners the distributed income is taxed a second time at the owner level
  • 21% flat rate tax
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13
Q

Regular C corporation - advantages

A
  • separate tax entity
  • sale of stock to unlimited investors
  • dividend received deduction (50% rule)
  • limited liability
  • continuity of life
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14
Q

Regular C corporation - disadvantages

A
  • corporate formalities
  • dividends paid after tax
  • accumulated earnings beyond certain limits are subject to double taxation
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15
Q

Dividend received deduction

A
  • US corp investing in another US corp receives a deduction for dividends received
  • 50% of dividends received from qualifying corp may be excluded from income if recipient corp owns 20% or less of distributing corp
  • 65% exclusions if ownership between 20% and 80%
  • 100% exclusion if ownership greater than 80%
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16
Q

Section 1244 qualified small business stock

A
  • S or C corp that was initially capitalized with no more than 1 M
  • loss of 100k / yr on a joint return (50K otherwise) is considered to be an ordinary rather than capital loss
17
Q

Personal service corporation (PSC)

A
  • closely held C corp that is owned by certain individuals can be considered PSC
  • any income retained by PSC is taxed at a flat 21%
  • businesses classifying as PSC
    H: health (doctors, dentists)
    A: accounting, architectural, actors
    L: law
    E: engineering
18
Q

Subchapter S corporation

A
  • elects special tax treatment and acts as conduit for items of income, deductions, and tax credits
  • corp becomes S corp by unanimous election of its shareholders
  • S corp status immediately terminated if corporation loses its eligibility
  • files taxes on form 1120 S
19
Q

S corporation - eligibility

A
  • number of shareholders limited to 100
  • can only issue single class of outstanding common stock (can be voting/ nonvoting)
  • must be domestic corporation
  • only individuals, estates, and certain trusts may be shareholders
20
Q

S corporation - advantages

A
  • limited liability
  • conduit of income or loss to owner but limited losses up to basis
  • basis = cash + direct loans made by shareholder to corporation
21
Q

S corporation - disadvantages

A
  • corporate formalities
  • sale of stock limited by eligibility standards
22
Q

Limited partnerships

A
  • any business can operate as this
  • need at least one general partner
  • liable for partnership debt only to extent of the capital contributions
  • role is restricted to passive investor
  • if actively participates, they forfeit limited liability
23
Q

Formation of business taxation

A
  • at formation entity can be tax neutral
  • participants can transfer assets to either partnership or corporation in exchange for ownership interest in the entity without recognition of gain
24
Q

Conduit entities - sole proprietorship

A
  • income or loss reported on sched. C
  • if loss, sched C loss carried to first page of 1040
  • can carry forward loss indefinitely like NOL
  • if owner borrows money for business and pays interest, that debt is deductible on sched. C
25
Q

Conduit entities - partnerships

A
  • partnership files 1065 for information purposes only
  • each partner includes K-1 to report distributive share income or loss
  • losses deductible up to basis
  • basis is cash and loans made to partnership by partner or by someone else
26
Q

Conduit entities - S corportations

A
  • losses deductible up to basis
  • bank loans not included in basis
  • when corp incurs debt, shareholders dont have personal liability for it
  • basis is cash and loans made by shareholder to S corp
27
Q

Conduit entities - LLC

A
  • regardless of number of members, if entity is treated as partnership, only information return is filed
  • income subject to tax will pass through to members
    • basis same as partnership
  • if entitiy makes corporate election, business itself is taxable and files 1120
28
Q

Risk free entity vs risky entity

A

risk free
- sole proprietorship
- partnership

risky
- S corp
- LLC
-limited partnership

29
Q

Corporate accumulated earnings tax

A
  • unless exempt a corp that accumulates earnings and profits to avoid income tax to shareholders is subject to annual accumulated earnings penalty tax equal to 20%
  • in addition to regualr corporate tax
  • can generally accumulate 250k without establishing need
  • need bona fide business need to keep over 250k
30
Q

Distributions

A
  • corporate stockholders may receive return on investment as dividend
  • corp cannot deduct dividend that is distributed
  • double taxation
  • conduit entities avoid double taxation (S corp, LLC, sole pro)
31
Q

Summary of tax forms

A

Corporation
- filing: 1120
- EE: W-2
- distributions: 1099

Self employed
- filing: Sched. C
- EE: Sched. C
- distributions: N/A

Partnership
- filing: 1065
- EE: W-2
- distributions: K-1

S Corporation
- filing: 1120S
- EE: W-2
- distributions: K-1

Income Tax (10 decks)

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