Essentials of Business Entity Taxation

Question 1

What is the cash method type of tax accounting?

Answer 1

A taxpayer generally reports income when any cash is collected (or constructive receipt) and reports expenses when any cash payment is made.

This method may be used by taxpayers whose annual average gross receipts do not exceed $27M for the three prior tax years.

Question 2

What is the accrual method of tax accounting?

Answer 2

It requires recognition of income and expenses in the years earned or incurred regardless of whether or not cash exchanged hands. Simply, if the business has the right to that income, they can claim it. Same for expenses - the mere obligation to pay is enough to claim the deduction.

It is required for any business that maintains inventory with the exception being if that business has annual average gross receipts of $27M or less or is a service business.

Question 3

What is the hybrid method of tax accounting?

Answer 3

A mix of cash and accrual. Example being a car dealer that may use accrual to report income for new car sales, but cash accounting for service related transactions involving car maintenance and service.

Question 4

When is the FY established for a small business?

Answer 4

Upon the initial tax return for that business.

Question 5

What is a net operating loss and what business entities can claim one?

Answer 5

This is a benefit for small business, self-employed individuals, regular corporations, and estate/trust entities which allows a business to write off losses from previous year(s) onto current tax year gains. The carry forward period is indefinite, but only up to 80% of a businesses income per year, can be written off by a NOL.

Question 6

What are the pros and cons of a C-Corp?

Answer 6

Pros: growth opportunity through endless investors, business is separate entity,
Cons: double taxation (business and dividends)

Question 7

What is a dividends received deduction?

Answer 7

A deduction from business income, the dividends it recieved from another related entity. The amount deducted is dependent on the percentage of ownership of the investing company. Under 20%, the business can deduct 50% of the dividends. Over 20% and the business can deduct 65% of the dividends.

Question 8

What is the accumulated earnings tax?

Answer 8

It is a tax assessed when a small business accumulates more than $250k in retained earnings without an IRS-deemed “reasonable business need.” This forces a small business to hand out dividends.

Question 9

What defines a personal service corporation (PSC)

Answer 9

A PSC is a regular or C corp operating in the fields of…

H-ealth
A-ccounting, architecture, and actuarial science
L-aw
E-ngineering & Consulting

AND

At least 95% of the stock, by value, must be owned by the employees performing the services.

Question 10

How is a Personal Services Corporation (PSC) taxed?

Answer 10

A PSC is taxed at the entity level and at the 21% corporate rate.

Question 11

What is 1244 stock?

Answer 11

If upon forming a C corp, total capital contributions do not exceed $1M, the stock issued is 1244. 1244 stock has favorable tax benefits, particularly with losses; $100k ordinary income for married, $50k for single. 1244 is still eligible for capital gains.

Question 12

What is qualified small business stock (QSBS) or 1202?

Answer 12

1202 stock, if held for more than 5 years, can exclude 100% of the gains from the sale if purchased after Sept 2010.

Question 13

What is the tax rate for a C corp with the TCJA 2018?

Answer 13

21%

Question 14

What are the advantages and disadvantages to a sole proprietorship?

Answer 14

Advantages:
super simple to setup (no paperwork) or to cease.

Disadvantages:
The owner is personal liable for all debts and claims against the business
The business owner is limited in raising capital to personal and bank loans
The business will die with the owner

Question 15

What are the tax characteristics of a general partnership?

Answer 15

Pass through. General partners have joint and several liability and income/losses are reported on the general partners individual tax filings.

Partners are self-employed and pay self-employment taxes

Question 16

What is a limited liability partnership?

Answer 16

Similar to a general partnership except one partner is not liable for the acts of another partner.

Question 17

What is an S Corp?

Answer 17

A type of regular corp which makes a special election to be taxed as a general partnership (flow through). All items of income and loss are reported based on the ownership percentage of each shareholder.

Question 18

What is the percentage allowed to a non-corporate taxpayer, who has a qualified business income from a partnership, S corp, or sole proprietorship?

Answer 18

20%

Question 19

What is built-in gains tax?

Answer 19

Tax from when the S corp disposes of an asset it held when it was a C corp. The tax applies to any unrealized gain attributable to the appreciation in the value of an asset while held by the C corp.

Question 20

What is the QBI (pass-through business) deduction?

Answer 20

The TCJA provides an overall tax deduction on business income of 20% for all taxpayers other than C corp (21% tax rate). This means only 80% of business income is taxed.

Must be a Section 162 trade or business.

Question 21

What makes up QBI?

Answer 21

QBI is defined as the net amount of income, gain, deduction, and loss.

Other deductions include 1/2 self employment tax, self-employment health insurance, the Keogh deduction.

Question 22

What is the the basic rule for QBI deduction under the phaseout threshold?

Answer 22

The lesser of:
20% of the QBI
20% of the taxable income in excess of net capital gains

Question 23

The Personal Holding Company (PHC) tax is only applicable to which corp?

Answer 23

C corp - in order to prevent closely held corporate owners from using the separate corporate entity as an investment shell

Question 24

What is the self employment tax and what is it’s break-down?

Answer 24

12. 4% for social security
13. 9% for Medicare

Business pays half, but under self-employment, owner pays all, but can deduct half from tax liability.

Question 25

How do you calculate the self-employment tax?

Answer 25

Under the threshold

Net income x .9235 x .153

Question 26

How do you calculate SE tax when the SE income is above the wage base cap of $147,000?

Answer 26

1. SE income x .9235
2. Results of 1, minus wage base
3. Results of 2 x .029 = Medicare portion of tax
4. Wage base x .153
5. Sum 3+4 = total SE tax

Question 27

How much health insurance costs can be deducted by a sole proprietor?

Answer 27

100%. This includes costs of health care for their family

Question 28

What income is considered SE income?

Answer 28

• Net Schedule C income
• Board of directors fees
• K-1 income (distributive share from general partner)
• Part time earnings

Question 29

What are the three main rules of thumb in order to take the home office deduction?

Answer 29

1. You must be self-employed
2. In taking the deduction in addition to the rest of the home-related tax deductions, you cannot create a loss for the business.
3. Under the simplified version of the deduction, the taxpayer cannot claim more than 300sqft or $1500 deduction

Question 30

What are the special taxes to a C Corp?

Answer 30

Accumulated earnings tax: encourages to pay dividends

Personal holding company tax: discourages C Corp shell for 21% flat tax

Question 31

Given the type of corp, name where (or at what level) it is taxed.
C Corp
S Corp
Sole proprietorship 
FLP
LLC

Answer 31

C Corp is taxed at the entity level. All others are taxed at the owner/shareholder level on Schedule C of the 1040.

Question 32

Where are taxes reported for a general partnership?

Answer 32

Taxes pass through to the general partners on schedule K of form 1065. The general partners then report that on their Schedule E of their 1040

Question 33

What are the special taxes an S Corp could be required to pay?

Answer 33

LIFO recapture tax
Built-in gains
Excess net passive income tax

Question 34

What tax is avoided when a taxpayer incorporates (S or C corp)?

Answer 34

SE Tax. The significance is that any SE income-related questions cannot include income from a S or C corp.

Question 35

What is the criteria for determining a hobby vs a business, thus being able to itemized deductions on schedule C?

Answer 35

The taxpayer must have turned a profit in 3 of the last 5 years.

Question 36

MNO Corporation has the following items of income and expense:

Taxable income: $330,000
Federal income tax: $100,000
Dividends paid in current year: $20,000
Accumulated earnings and profits at the end of the preceding tax year: $60,000
Assume MNO is not a service corporation and cannot establish a valid business purpose for its excess accumulations.

What is the amount of accumulated earnings tax payable?

Answer 36

$330,000 - $100,000 - $20,000 = $210,000

As a non-PSC, they take their accumulation limit of $250,000 - $60,000 from last year and subtract the resulting $190,000 from $210,000.

20% of the resulting $20,000 taxable income is $4,000

(Note: a PSC only has a limit of $150,000)

Question 37

What tax form is filed by a C corp?

Answer 37

Form 1120