Final Exam Review

Question 1

What type of business enterprise typically has the fewest operating formalities?

Answer 1

Sole Proprietorships. Other forms of ownership typically have at least some operating formalities due to co-ownership or state law compliance.

Question 2

Facts about Organizational Forms

Answer 2

A) Unincorporated - corporate tax rates may not be higher than personal tax rates
B) Limited Partnership - General Partner has unlimited liability
C) Corporations are authorized solely by state law and are required to follow certain operating formalities
D) Ownership disputes arise whenever there is more than 1 owner

Question 3

Raising Funds

Answer 3

A) General Partnership - Can only raise funds from other gen partners, who take active biz role
B) Sole Proprietorship- A sole proprietor may personally borrow fund for business use
C) Limited partnerships - One method for organizing to raise substantial funds.
D) A closely held corporation is often limited by practical circumstances of its ownership structure in the amount of fund it can raise.

Question 4

Grace and Cynthia formed a regular commercial partnership last year by contributing the following for their capital interests: Grace $100,000 cash Cynthia Property with fair market value of $100,000 in which her adjusted basis is $40,000 That year the partners each had a distributive share of $75,000, out of which only $40,000 was actually distributed to each partner. Cynthia’s basis in her partnership interest at the end of the year was

Answer 4

$75,000, Initial Basis of $40k + 75k Dis share - $40k Distribution.

Question 5

Surviving Partners at Death of Partner

Answer 5

A) Surviving partners are liquidating trustees , and cannot appoint or avoid this responsibility
B) They have a fiduciary responsibility to the deceased partner’s estate and heirs

Question 6

Section 302 Corporate Stock Redemption

Answer 6

Section 302 corporate stock redemptions are given capital-gain treatment if the redemption meets the requirements for a substantially disproportionate redemption.

Question 7

First Offer Provision of Buy-Sell Agreements

Answer 7

First-offer provision’s primary purpose is to prevent sale to outsiders

Question 8

Desirable Characteristics of Cross-Purchase Buy-Sell

Answer 8

A) The partnership does not hold the insurance policies
B) There is a narrow range of ages
C) The deceased partner’s share will be resold shortly after purchase at stepped-up in basis
D) Partners have comparable size shares of the co.

Question 9

Advantages & Disadvantages of C Corp over S Corp

Answer 9

A) Dis: There is no immunity to accumulated-earning tax
B) Dis: Compensation of shareholder employees is restricted by reasonable compensation test
C) Dis: The owners are not permitted an unlimited deduction of start-up losses
D) Adv: Shareholder-employees may be eligible for more tax favored fringe benefits

Question 10

Sec 162 Bonus Life Insurance Plans

Answer 10

A) Sec 162 are permitted to discriminate
B) The participating employee is the owner of the policy covering his life
C) Bonuses, including Sec 162, are taxable current compensation to the participant
D) The employer can deduct reasonable bonuses paid to employees, regardless

Question 11

A closely held corporate has 2,000 shares outstanding. If 4 directors are to be elected and cumulative voting in effect, how many shares must be held by minority to elect on director.

Shares = Total Votes Shares x N Directors Elected / (Directors Filed +1 ) +1

Answer 11

401

Question 12

Family Limited Partnerships

Answer 12

A) Most states would include investment partnerships as valid partnerships
B) Involved the transfer of senior family member property through gifts of limited interest to successor generations
C) The FLP is potential useful to transfer business or other family investments to the next generation at a discounted transfer tax cost
D) General partnership interest will not qualify for minority discounts

Question 13

Use of Life Insurance to fund NQ DC benefits

Answer 13

A) The benefits are taxable as compensation
B) The premium payments are not deductible since benefits are deductible when paid to the recipient after deferral
C) The policies must be owned by the corporation or subject to claims of general creditors of the corporation
D) Benefits are part of the participant’s estate

Question 14

Business Continuation by Estate Administrator

Answer 14

A) The admin can charge a reasonable fee for services but does not share in profits, even excess ones made as a result of special business skill.
B) The admin takes on personal risk and acts as a sole proprietor
C) The admin may have difficulty getting the consent of all interested parties
D) The heirs have a right to consent to challenge should the admin buy business property from the proprietorship

Question 15

Death of a Majority Shareholder in Closely Held Corporation

Answer 15

A) Surviving minority shareholders cannot force liquidation
B) The corporation has its own continuity and will not be dissolved by operation of law
C) The heirs may be willing to accept the decedent’s stock in lieu of specific bequests.
D) Survivors do not have voting power to control the board, which would be needed for survivor salary increases due to increased responsibility

Question 16

X corp has 100 shares of voting common stock issued and outstanding. Larry owns 80 shares, with the remaining divided between Moe & Curly. At minimum, how many of Larry’s shares must X redeem to qualify the redemption as substantially disproportionate under Sec 302(b)(2).

Answer 16

1) must be below 50 % ownership and
2) 80 percent of prior holdings

Moe & Curly = 20 - 1 = 19 shares for less than 60%
80-19=61

Question 17

Sec 303 redemption

Answer 17

1) A corporation may retain earnings in the yr of a shareholder’s death for a 303 redemptions without an accumulated earnings penalty.
2) The redemption can be made later than tax payments
3) Closely held biz interest must be 35% or more of adjusted gross estate
4) Redemption limited to estate taxes and funeral expenses

Question 18

Insured Buy-Sell Plan

Answer 18

1) The redemption amounts should be distributed only if the corporation has sufficient surplus
2) The life insurance premiums are not tax deductible to the corporation
3) The policies are part of corporate assets and available to satisfy creditor claims
4) Policies are not statutorily exempt from accumulated earnings, unless for reasonable business purpose

Question 19

Transfer for value exemptions

Answer 19

Closely held corporations where shareholder, partnership where partner

Question 20

Commercial General Partnership

Answer 20

1) The partners own an undivided equal interest as tenancy in partnership
2) The surviving partners do not have to continue operations on death of general partner
3) The partners must consent each other to sell business assets
4) The partners have the authority to dissolve the partnership and liquidate partnership assets at the death of one partner

Question 21

A shareholder in a closely held corporation should leave stock to their heirs only when

Answer 21

the decedent’s estate doesn’t contain other substantial assets. Reason to choose a buy-sell agreement include: minority interest stock, limited stock (vs general where active role

Question 22

Breach of Buy Sell Agreement requires

Answer 22

Specific Performance- the only remedy that gets the non-breaching party the result required by the buy-sell agreement

Question 23

Entity-type Partnership Buy-Sell Agreement

Answer 23

1) Entire payment is included in estate, including goodwill
2) An entity agreement is best when the surviving partner will likely keep the interest
3) The partnership should be the beneficiary
4) An entity agreement is probably more practical where partners have unequal ages and relative interests.

Question 24

A business has an adjusted book value of $500,000 and average annual earnings of $100,000. If the expected return to book value for this business is 15 percent, how much of the average annual earnings may be attributed to goodwill?

Answer 24

1) $25,000
2) $500k * 15% = $75k
3) $100k - $75k = $25k

Question 25

Zero’s basis for his stock in Frigid Corp. is $100,000. Frigid Corp. liquidates and, as part of the plan of liquidation, distributes to Zero property valued at $600,000 that has a basis to Frigid of $300,000. Who pays the tax on the gain?

Answer 25

Frigid must recognize a $300,000 gain

Question 26

The adjusted book value method would be most appropriate for what type of business

Answer 26

A holding company, as it is the least likely to heave hard-to-value intangible assets

Question 27

Transfer of Family Corp through Parent-Owner Will

Answer 27

1) Bequest of stock to active heirs is recommended
2) The marital deduction will not shield the estate from tax if left to children
3) The method is impractical for providing income to inactive surviving spouse; another transfer method is needed

Question 28

Disability Buy-Sell Agreement

Answer 28

1) It provided a method for determining disability, since a definition of disability is needed to determine when the buyout must take place
2) Usually doesn’t take effect immediately upon disability
3) Premium for cross-purchase are not tax-deductible
4) Not usually insured for full purchase price, like buy-sell

Question 29

Risk Management Techniques

Answer 29

1) Speculative risks are uninsurable
2) Loss reduction techniques are designed to reduce the financial impact of losses once they occur
3) Only pure risks are insurable
4) Risk avoidance is not the transfer of risk but the elimination

Question 30

Business Book Value

Answer 30

1) Book value often inadequately give the true value of assets
2) Book value may be more appropriate than other measures to a liquidating business
3) Book value is actual cash value for property and liability insurance purposes

Question 31

Key Employee Life Insurance

Answer 31

1) The key employee should not name the policy
2) Premiums paid by employer are not taxable to employee
3) Proceeds are typically not in key employees estate
4) The face amount should bear a reasonable relation to the key employee’s worth

Question 32

Valuation of a Key Employee

Answer 32

1) A key employee’s value may be different than their salary
2) Traditional methods for valuing key employees are often incomplete
3) Goodwill can be attributed to brand loyalty, favorable location

Question 33

A business has weighted average annual earnings of $200,000. If the required rate of return on a business of like risk is 12 percent, a buyer is willing to pay which of the following amounts for the business?

Answer 33

200,000/.12 = $1,666,667

Question 34

Three partners have an equal 1/3 interest in a partnership valued at $1.2 million. If a cross-purchase type of buy-sell agreement is selected, how much coverage should each of the partners have on the life of each of the other partners?

Answer 34

Each separate interest is $400k / 2 surviving member = $200k

Question 35

Family Attribution and Section 303 Redemption

Answer 35

1) An estate must be holding closely held corporate stock valued at more than 35% of the adjusted gross estate
2) Family attribution rules do not apply

Question 36

Insured Partnership Entity Buy-Sell Agreement

Answer 36

1) The payments made by the partnership to the estate are treated as liquidation payments for tax purposes
2) Insurance funding tends to inflate the partnership value and should be considered in the valuation provision

Question 37

Insured Stock Redemption Buy-Sell Agreement

Answer 37

1) The corporation is distributing redemption proceeds, thus the survivors get no basis
2) The corporation owns the life insurance policy, pays the premiums and is the beneficiary of each policy

Question 38

Corporate Salary Continuation Plans

Answer 38

1) The plans may discriminate in favor of shareholder employees
2) The insured may be the direct beneficiary without triggering dividend treatment

Question 39

Federal Taxation of Partnerships

Answer 39

1) A written partnership agreement is not binding for federal income tax purposes
2) A partnership pays no income taxes

Question 40

Termination of a Business by Operation of Law

Answer 40

1) The death of a general partner triggers termination
2) The death of a majority shareholder in a closely held corporation does not trigger termination, since corp is separate entity

Question 41

Section 79 Group Term Life Insurance

Answer 41

1) The employee is taxed on premium contributions that exceed a $50,000 death benefit
2) Section 79 has complex nondiscrimination rules

Question 42

Family Attribution rules for Sec 302 redemption

Answer 42

1) An adopted son may be attributed to the shareholder

2) Business partner- brother would not be as siblings are not attributed for 302 purposes

Question 43

Disadvantages of Mandatory Buy-Sell Agreement at Death of Business Owner

Answer 43

1) The heirs may wish to stay in the business

2) The survivors may be unable to finance the sale

Question 44

Valuation of a Corporation for insured stock-redemption buy-sell agreement

Answer 44

1) It is more equitable to consider the value of the insurance in the ultimate purchase price
2) A purchase price given by formula would not typically equal underlying insurance proceeds

Question 45

Are limited partners employees of the firm?

How many general partners must exist in limited partnerships?

Answer 45

1) No

2) At least 1

Question 46

Taxation of S Corps

Answer 46

1) They are not subject to corporate AMT

2) They are not subject to the accumulated earnings penalty

Question 47

Mandatory buy-sell agreement

Answer 47

1) Not an “option” to buy

2) Does not authorize formation of new partnership

Question 48

Corporations

Answer 48

1) Corporate directors do not assume personal responsibility for contracts they negotiate on the corporations behalf
2) Corporations are empowered and regulated by state law, not the Fed Unif Cor Charter Act

Question 49

In what ways do closely held corporations differ from large publicly held corporations?

Answer 49

1) Most owners of closely held corporations are actively involved in business management
2) They are similar in their formalities, as small companies also have stock certificates and board meetings

Question 50

Benefits of a stock-redemption buy-sell agreement

Answer 50

1) The agreement provides survivors with the freedom to operate without unwanted heirs as shareholders
2) The survivors receive no cost basis for the amount of the redemption distribution