Federal Taxation-Entities (28-38%)

Question 1

In forming an entity, what constitutes as having control?

Answer 1

person/persons own at least 80% of voting/nonvoting stock

can be two or more individuals (as long as together they own >80%)

Question 2

What is considered boot, when contributing property?

Answer 2

anything received other than stock

if boot is received, gain recognized by shareholder will be lower of realized gain or FMV of boot received.

Question 3

In forming an entity, what is the basis of contributed property & stock received?

Answer 3

corporation’s basis in the property contributed is the basis the transferor had, plus any gain recognized by the transferor

shareholder’s basis in the stock they receive is the basis of transferred property, plus any gain recognized, less any boot received, less any liabilities assumed by the corporation

Question 4

What are the rules in formation of an entity called?

Answer 4

351 exchange rules - applies to basis and gains recognized

Question 5

What is a liquidating distribution for a corporation?

Answer 5

full payment in exchange for a shareholder’s stock. shareholder will recognize a gain equal to difference of FMV of cash/property received, and shareholder’s basis in the stock (capital gain/loss)

if partial liquidation, then sale/exchange treatment applies (capital gain)

Question 6

What is a liquidating distribution for a partnership?

Answer 6

partner receives a distribution and it terminates the partners interest in the partnership, which can also terminate the entire partnership.

treated as a return of capital to partner. only time there is a gain, is if cash received is more than partner’s basis in partnership.

when cash/property received, partner’s basis reduced by amount of cash, then by any AR/Inv, and then remaining basis of property received.

Question 7

What entities are required to use accrual accounting?

Answer 7

• any regular C Corporation with gross receipts over $25 million (based on average of previous 3 years)
• any Partnership with C Corporation partners with gross receipts over $25 million (based on average of previous 3 years)

Question 8

For reconciling book income to tax income for corporations, when would you use Schedule M-3 vs. Schedule M-1?

Answer 8

Corporations with total assets of $10 million or more are required to file a Schedule M-3, which provides more detail than Schedule M-1

Question 9

How are non-deductible expenses and non-taxable income recorded in regards to book income vs. taxable income?

Answer 9

• non-deductible expenses would be added to book income to arrive at taxable income (ex: LT capital loss, penalties)
• non-taxable income would be subtracted from book income to arrive at taxable income (ex: PPP loan)

Question 10

What are the charitable contribution rules for Corporations?

Answer 10

deduction is limited to 10% of taxable income before contribution

Question 11

What are the rules for net capital losses for Corporations?

Answer 11

cannot offset income, only can offset capital gains

can be carried back 3 years, and forward 5 years

Question 12

What are rules for startup/organization costs for Corporations and Partnerships?

Answer 12

$5,000 can be expensed immediately

$5,000 is reduced by amount of expenses over $50,000

ex: total cost of $53,000, would allow for only $2,000 to be expenses, remainder if amortized over 180 months (53,000-50,000=3,000; 5,000-3,000=2,000)

Question 13

What is a penalty tax on AET (Accumulated Earnings Tax)?

Answer 13

this is when a Corporation accumulates earnings and profits (E&P) for the purpose of avoiding income tax for its shareholders. tax is 20% of accumulated taxable income. any dividends received distributions are added back to income number for purpose of evaluating accumulated earnings.

Question 14

What is the Accumulated Earnings Credit?

Answer 14

given to Corporation when subject to the Accumulated Earnings Tax. credit is greater of: current E&P, OR, $250,000 ($150,000 for service business) less accumulated E&P at the end of preceding year

Question 15

What is the Personal Holding Company Tax? and how is it determined you are a PHC?

Answer 15

20% tax penalizes a Corporation that seems to hold a high level or stock investments

2 tests (must pass both):

• income test: passive income >60% of adjusted ordinary gross income
• ownership test: >50% of corporation’s stock is owned directly/indirectly by 5 or less people during last half of the year

Question 16

What is a deficiency dividend for a PHC (Personal Holding Company)?

Answer 16

dividend paid within 90 days after a PHC penalty has been imposed. this dividend will reduce taxable income.

Question 17

What is a DRD (Dividends Received Deduction)?

Answer 17

applies to C Corporations only, when they own stock in another company and that company pays dividends. reduction in portion of dividend income is based on percentage of stock owned in other company.

owns <20%, DRD is 50% (also if worded as unaffiliated)
owns 20-79%, DRD is 65%
owns >80%, DRD is 100%

Question 18

How are capital assets (stocks, bonds, real estate) gains and losses accounted for/calculated Corporations?

Answer 18

when capital asset is sold, triggers capital gain or loss (ordinary income). losses can be carried back 3 years, forward 5 years.

• all STCG/STCL netted together
• all LTCG/LTCL netted together
• net ST and LT against each other
• sum takes character of whatever is larger

ex: STCG 5,000; STCL 2,000; LTCG 2,000; LTCL 3,000.
- ST = 5,000 G less 2,000 L = 3,000 G
- LT = 2,000 G less 3,000 L = 1,000 L
- net ST & LT = 2,000 G
- character = ST (3,000 larger than 1,000) = STCG

Question 19

What are the tax effects of a distribution for a Corporation?

Answer 19

accumulated E&P is what matters. distribution is dividend as long as it is made from current or accumulated E&P.

distribution that is larger than accumulated E&P, is a return of capital (lowers shareholders basis) to extent of shareholders basis in stock and is not taxable.

Question 20

What are expenses related to a liquidation for a Corporation? and how are they reported?

Answer 20

• accounting fees
• legal fees
• filing fees
• other expenses

deductible to corporation, expensed immediately

Question 21

What are the 4 main types of Corporate reorganizations?

Answer 21

generally tax free to both shareholders and corporation

• 1: Acquisition/Consolidation - most assets exchanged for stock in acquiring firm (Acq=A acquired B, Cons=A&B combine & become C)
• 2: Acquisition - only stock for stock, acquirer must own 80% of stock after acquisition (Acq=A acquired B, both still exist)
• 3: Acquisition - acquires 90% of assets in exchange for voting stock (Acq=A acquired B, B dissolves, B shareholders not shareholder in A)
• 4: divisive/spin off/split off - corporation divides by transferring assets to a sub in exchange for stock in the sub

Question 22

What determines an affiliated group and when can a consolidated tax return be filed?

Answer 22

when one C Corporation owns at least 80% of the voting power/value of another C Corporation, this is an affiliated group, and can then file a consolidated tax return

Question 23

What are 3 main advantages to filing a consolidated tax return for a Corporation who has control of subsidiary Corporations?

Answer 23

• inter-company dividends are excluded from taxable income
• losses from one-member corporation offset gains of another member
• inter-company profits are deferred until realized

Question 24

What is considered a “domestic” Corporation? What is considered a “foreign” Corporation?

Answer 24

domestic = incorporated in their home state
foreign = incorporated in another state

ex: a FL Corporation is domestic in FL, but foreign in AL

Question 25

What is nexus for state taxes?

Answer 25

nexus is when a business has a relationship with another state to the point that the state has the right to impose taxes on the business (sufficient physical presence)

• sales
• property
• payroll

Question 26

What are the 3 factors included in apportionment?

Answer 26

allocates sales to different states that a business operates in

• sales factor
• property factor
• payroll factor

Question 27

What are the differences in taxation between us US Corporation with a foreign branch and a US Corporation with a foreign subsidiary?

Answer 27

• foreign branch: owes federal taxes on income, just as would with its operations inside the US
• foreign subsidiary: parent does not owe federal taxes on sub’s earnings unless sub sends money to the US Parent in form of dividends

Question 28

What is the FTC (Foreign Tax Credit) for Corporations?

Answer 28

US Corporation that has paid foreign taxes can claim a credit on their federal taxes. credit is lesser of: actual foreign taxes paid, or the foreign tax credit limit.

foreign tax credit cannot be more than this fraction multiplied by US tax liability (taxable income from OS US sources/total taxable income from US/foreign sources

Question 29

What are the elements of an S Corporation?

Answer 29

• no more than 100 shareholders
• only have one class of stock (voting or nonvoting)
• S Corp election can be revoked by majority consensus of shareholders
• S Corp election only effective for current tax year is election is made by 3/15
• tax year is usually calendar year
• shareholders not liable for debt
• shareholders can be employees
• flow-through taxation
• S Corps can own stocks in C Corps
• S Corps can be a partner in Partnership
• S Corp can own 100% of stock of an S Corp subsidiary
• C Corp cannot own 100% of S Corp

Question 30

What are the ways an S Corporation can be terminated?

Answer 30

• majority vote of the shareholders
• if >50% of owners change, then new owners must agree to keep status
• involuntary terminated if passive income exceeds 25% of gross receipts for 3 years in a row
• if any eligibility rules are broken, IRS can terminate status

*if an S Corporation terminates, it must wait 5 years before it can re-elect to be an S Corporation again.

Question 31

What are separately stated items in regards to S Corporations and Partnerships?

Answer 31

• charitable contributions
• interest income
• dividend income from investments
• rental activities
• sec 179 deductions
• capital gains/losses
• tax credits
• foreign taxes

Question 32

What affects a shareholders basis?

Answer 32

increased by income (including tax exempt income) items

decreased by distributions and flow-though deductions

*loss by S Corp is deductible by shareholders to extent of their basis. if exceed basis, can be carried forward to use in another year with basis to use it

Question 33

What is the built-in gains tax?

Answer 33

When C Corp converts to S Corp, appreciated property owned is subject to built-in gains tax if that property is sold within the recognition period (21% - recognition period = 5 years). built-in losses can offset built-in gains.

Question 34

What is a general partner in a Partnership?

Answer 34

participates in day-to-day running of the business and has joint liability for the partnership’s obligations

Question 35

What is a limited partner in a Partnership?

Answer 35

cannot participate in day-to-day running of the business and has liability up to amount their investment in partnership

Question 36

What affects a partners basis?

Answer 36

increased by:

• contributions of property
• proportionate share of income
• proportionate share of increases in liabilities

decreased by:

• distributions
• proportionate share of expenses, losses, decreases in liabilities

*partnership takes same basis in contributed property that the partner had

Question 37

Why would a large partnership (over 100 partners) want to elect to be an ELP (electing large partnerships)?

Answer 37

• makes tax reporting more straightforward
• can combine more items at partnership level and pass-through net amounts to partners
• main items that can be combined with ordinary business income, include deductions, passive activity income/losses and charitable contributions
• capital gains are netted at partnership level instead of being separately reported

Question 38

How does built-in gains on contributed property work for partnerships?

Answer 38

when partner’s contributed property has built-in gain (basis less than FMV), and partnership sells that property, gain is allocated back to contributing partner up to FMV at time of contribution. remaining gain is distributed among partners like any other income/gain. (rule has 5 year limit for contributing partner)

Question 39

What is considered the at-risk amount for partnerships?

Answer 39

usually the partners basis less their proportion of any non-recourse debt. this is because non-recourse debt by definition makes the partner not ultimately liable for the debt, so a partners share of that debt is not at-risk.

when partnership has loss for year, each partner can only deduct their share of loss to extent of their basis, or their at-risk amount if it is less.

Question 40

When does a partnership terminate? What is involved in a termination of a partnership?

Answer 40

terminates when no part of business operates or is carried out by any partner as the partnership

requires closing partnership tax year (ex: Aug 3rd instead of Dec 31st)

Question 41

How does division of partnerships work?

Answer 41

if divides into 2 or more partnerships, original partnership continues in whichever partnership has a partner that controlled 50%+ of original partnership

Question 42

What happens when a partner sells their interest in a partnership?

Answer 42

is like selling any other property - gain/loss will be difference between cash received and partners basis in partnership. if buyer assumes partners share of partnership liabilities, that adds to the gain for partner (capital gain).

ex:
partner basis = 20,000
sells interest = 25,000
liabilities share = 6,000
partner gain = 11,000 (25-20=5; 5+6=11)

Question 43

What are the different ways an LLC can be classified?

Answer 43

• C Corporation (Form 8832 filed)
• S Corporation (Form 2553 filed)
• Partnership (more than one member, no election needed)
• Single-member LLC or Disregarded Entity (one member, does not elect S or C Corp treatment. Similar to being a Sole Proprietor.

Question 44

What is a trust?

Answer 44

Legal entity setup by a grantor to transfer property/income to a beneficiary

Question 45

What are the types of trusts?

Answer 45

• living trust
• testamentary trust
• revocable trust
• irrevocable trust
• simple trust
• complex trust

Question 46

What is a living trust?

Answer 46

trust setup while alive and immediately becomes effective

Question 47

What is a testamentary trust?

Answer 47

trust that does not become effective until you die

Question 48

What is a revocable trust?

Answer 48

trust that retains ownership and control of assets in the trust and can change terms, beneficiaries and trustees

Question 49

What is a irrevocable trust?

Answer 49

trust you give ownership and control to a trustee, and you no longer are able to make changes

Question 50

What is a simple trust?

Answer 50

trust that is required to distribute all annual income to beneficiaries, which cannot be charitable organizations. income from trust is taxable to recipient and corpus/principal must remain in trust. capital gains stay within trust and become part of corpus/principal

Question 51

What is a complex trust?

Answer 51

trust considered complex if it does any one of the following:

• retains income in trust
• distributes corpus/principal
• distributions go to charitable organizations

Question 52

What is the trust tax formula?

Answer 52

gross income
less: interest/expenses/charitable contributions
less: distributions of DNI (distributable net income) to beneficiaries
less: personal deduction ($300 for trusts)
= taxable income
taxable income X applicable tax rate
= gross tax
less: any credits
= trust tax payable

Question 53

What are the types a tax exempt organization can be?

Answer 53

corporation, trust, or association

• charitable organization
• religious organization
• social welfare organization
• labor organization
• employee benefit associations or funds
• veterans organizations
• political organizations

Question 54

What information form does a tax exempt organization file?

Answer 54

Form 990 (if gross receipts exceed $50,000), files Form 990-T (if gross receipts under $50,000)

Churches do NOT have to file a Form 990

Question 55

How does obtaining and maintaining tax exempt status work?

Answer 55

organization must apply for and receive tax exempt status to become a 501(c)(3) by using Form 1023

organization must be organized/operated exclusively for exempt purposes. no part of earnings can benefit the private interests of any shareholder/individual

if organization fails to file required returns 3 years in a row, it automatically loses its exempt status. if lost, have 15 months to re-apply and can have status retroactively re-instated to date of revocation.

Question 56

What is UBTI (unrelated business taxable income) for a tax exempt organization?

Answer 56

if exempt organization has business income from activities unrelated to exempt purpose, it is taxed on that income (only if over $1,000). would be taxed at normal corporate rate if setup as corporation, or trust rates if setup as trust.

Question 57

What are the rules related to business interest expense for Corporations?

Answer 57

limited to businesses adjusted taxable income

subject to average receipts test (not exceeding 26,000,000)

Question 58

What is Section 1244 stock?

Answer 58

permits shareholders to deduct an ordinary loss on sale or worthlessness of stock, allowed when:

(1) the shareholder must be the original holder of stock, and an individual or partnership
(2) the stock can be common or preferred, voting or nonvoting
(3) the amount of ordinary loss is limited to $50,000 ($100,000 on joint return)
(4) the corporation during the 5-year period before the year of loss received less than 50% of its total gross receipts from royalties, rents, dividends, interest, annuities, and gains from sales or exchanges of stock or securities
(5) the corporation’s aggregate amount of money and adjusted basis of other property received for stock as a contribution to capital and paid-in surplus does not exceed $1,000,000

Question 59

A portion of an unused foreign tax credit can be used how (CB/CFWD)?

Answer 59

can be carried back 1 year and carried forward 10 years

Question 60

Which of the following credits is a combination of several tax credits to provide uniform rules for the current and carryback-carryover years?

Answer 60

General business credit?

Question 61

A portion of an unused general business credit can be used how (CB/CFWD)?

Answer 61

can be carried back 1 year and carried forward 20 years

Question 62

How does dividend received deduction (DRD) work for ownership in foreign corporations?

Answer 62

100% dividend received deduction may be claimed for a dividend received from a foreign corporation in which ownership exceeds 10% and the stock was owned for more than 365 days.

Question 63

What are the limitations on charitable contributions for C Corps in 2020?

Answer 63

limited to 25% of taxable income

i.e. $100,000 taxable income = $20,000 charitable contribution max allowed for 2020