Midterm Exam Flashcards
What is a closely held business?
In general it is a business whose ownership interests are not publicly traded on an established market
How many and how active are owners in a closely held business?
Usually has a much smaller number of owners who tend to take a more active role in the management and operation of the business
Are there more closely held businesses or publicly traded businesses?
Closely held businesses
What types of closely held business organizations exist?
General partnerships, the close corporation, the limited partnership, the LLP, and the LLC
What is a significant problem for closely held businesses that is largely absent in the publicly held setting?
closely held businesses lack a market for their ownership interests. Therefore, there is often a lack of an exit for investors who disagree with the majority will and who would prefer to “cash out” their investment
What is absent in a closely held business
disciplinary effect of the market
What is the Law of Agency?
the law governing the relationships between principles, agents, and third parties
What is the principle in relation to the Law of Agency?
the employer/proprietor
What is the agent in relation to the Law of Agency
the employee
What is a sole proprietorship?
a business owned by a single individual that is not operated as a corporation or other special legal form
What is the major disadvantage of the sole proprietorship?
The owner has unlimited personal liability for the obligations of the business.
Personal assets are at risk in lawsuits arising out of business activities
What is a major advantage of the sole proprietorship?
You can just start doing business… There is no need to file special documents with the state
What is a general partnership?
an association of two or more persons to carry on, as co-owners, a business for profit
How is the general partnership unique?
it can be informally created… so long as two or more persons are carrying on, as co-owners, a business for profit, a general partnership is created
How is the general partnership a rather unstable form of business form?
partners can easily exit the business. A partner’s withdrawal typically causes a buyout of the partner’s interest or the dissolution of the partnership itself
Do all partners in a general partnership have the right to participate in the management of the business?
Yes
What is a corporation?
under all corporation statutes, a corporation is viewed as a separate legal entity whose identity is distinct from that of its owners
What is a downside of the general partnership?
o Like the sole proprietorship however, the primary downside of a general partnership is that the law imposes unlimited personal liability on the partners for the obligations of the partnership
Do shareholders have rights to participate in the management of a corporation’s business?
Generally, NO
What is the most important benefit of a corporation?
it provides its shareholders with limited liability for the obligations of the business
How is the income of a corporation taxed?
It is taxed twice - once at the corporation level and a second time at the shareholder level
Corporation pays taxes on its income, and the shareholders pay taxes on that income again when (and if) the income is distributed to them
What is a state franchise tax?
taxes imposed for the privilege of organizing a business in a state
What is a limited partnership
a partnership comprised of two classes of partners - general and limited
What are the differences between a general and limited partner?
general partners have unlimited personal liability (like a general partnership) whereas limited partners have limited liability (like a corporation)
What is a limited liability partnership (LLP)?
a general partnership that, depending on the relevant statute, provides partners with limited liability for the partnership’s tort obligations or for both its tort and contract obligations
What is a limited liability limited partnership?
a limited partnership that provides LLP-like limited liability protection to some or all of the partners
What is a limited liability corporation?
a business org, formed by a required state filing, that adopts many of the best features of the corporation and partnership forms
Like a corporation, an LLC is a legal entity that is separate and distinct from its owners
What are the owners of an LLC known as?
members
How is an LLC similar to a partnership?
Like a partnership, an LLC is characterized by structural flexibility, restricted transferability of ownership interests, and pass-through taxation
What is a professional corporation (PC) and professional association (PA)
hybrid entities that allow professionals, such as lawyers, accountants, and doctors, to practice in a corporate or corporate-like form.
What is a business trust?
an organization that derives from the conventional common law trust. While once broadly popular, business trusts are now used in a few specialized areas rather than for the operation of businesses generally
As a general rule, what kind of entity is a corporation treated as?
taxpaying entity
What type of entity are most state law partnerships and limited liability companies treated as?
accounting entity
What is a C Corporation?
Corporation treated as a taxpaying entity
What is an S corporation?
Corporation treated as an accounting entity
What type of corporation is more common, S or C?
S Corporations
How often are C corporations taxed?
Twice
C corporations have to pay the 21% corporate tax
The individual income tax is imposed on C corporation income, but not until the corporation distributes its earnings to its shareholders (pays dividends)
What is the tax paid on dividends?
23.8%
Generally taxed at the maximum capital gains rate of 20% and there is a 3.8% Medicare contribution tax rate
What is a pass-through-entity?
partnership and S corporations
Are pass-through-entities subject to the corporate tax or any other entity-level tax?
No - instead, the income of a pass through entity is taxed immediately to the owners of the enterprise
Is the passed-through-entity or the C corporation more favored?
passed-through-entity is now generally favored over the C corporation at all stages of the business life cycle
what is integration?
the process of adopting a tax system that imposes the same tax burden on the income of a business, irrespective of the legal form in which the business is conducted
This would mean repealing the corporate tax and taxing corporate income directly to the corporation’s shareholders when it is earned (at their individual tax rate)
4 goals for the integration of the tax system
Make the taxation of investment more uniform
Make the taxation of returns earned on debt and equity more uniform
Distort as little as possible the choice between retaining and distributing earnings
Create a system that taxes capital income once
What is the shareholder allocation prototype?
a type of integration which would allocate a corporation’s income among its shareholders as the income is earned. each shareholder would include the amount of corporate income allocated to the shareholder in the shareholder’s gross income. When the corporation distributes its earnings to its shareholders, the distributions would normally be tax-free to the shareholders
What are the 3 ways a corporate can effectuate an acquisition?
Asset Transfer
Stock Transfer
Merger
What is an asset transfer?
Acquire everything that’s inside the target corporation (identify all property in the target and physically transfer all its assets). They would actually have to convey every piece of property
What is a stock transfer?
Instead of dealing with the target corporation, the acquirer can deal directly with the shareholders where they transfer all of their stock to the acquiring corporation
What is a merger?
Acquiring Corp can enter into an agreement with shareholders where target will transfer into acquirer by operation of law. There is no physical transfer of deeds but by virtue of state laws the companies merge together.
What are the tax consequence when the Acquirer buys Target with cash?
There is an immediate tax of 35%
What are the tax consequence when the Acquirer buys Target’s stock?
You can typically avoid a tax if you comply with certain statutory rules
What are the downsides of an acquisition by asset transfer?
Acquirer gets all the liabilities of Target
What are the 2 steps of the stock transfer fiction?
1 - Target’s shareholders sell their stock to Acquirer
2 - Target distributes its assets to Acquirer
The stock transfer fiction results in no tax to Target and no change in the basis of Target’s assets
What are the 2 steps of the asset transfer fiction?
1 - Target sells all its assets to Acquirer
2 - Target distributes the consideration received from Acquirer to its shareholders
The asset transfer fiction taxes Target on the gain in its assets and increases the basis of those assets by a like amount
What are 6 common estate planning objectives
To identify who gets what, when, and under what circumstances
To name fiduciaries who administer assets and make various decisions
To avoid probate (post-death) and guardianship (during life)
Asset protection
Business succession planning
Minimization of transfer taxes
What are the 4 core estate planning documents?
Will
Revocable Trust
Power of Attorney for Healthcare
Power of Attorney for Property
What is Power of Attorney for Health Care?
Allows you to designatre a person to make healthcare decisions for you if you cannot make them yourself
This document also allows you to make a “living will” and provide specific directions about life-sustaining treatment
This avoids the need to petition the court to appoint a guardian to make medical decisions
What is Power of Attorney for Property?
Allows you to designate an agent to act on your behalf on a limited or broad basis regarding your property interests (tangible and intangible property, legal claims, taxation matters)
This avoids the need to petition the court to appoint a guardian/conservator to make financial decisions if you are unable to make them yourself
What is a decent?
an individual who has died
What is an executor
individual that manages and distributes the decedent’s property
What is intestacy?
if you fail to execute a valid will during life
What is probate?
the process by which a court supervises the administration of a decedent’s probate property, whether or not the decedent executed a valid will
Probate administration is typically independent, meaning that court involvement is minimal
What does a will do?
a legal document that does:
Provides for the disposition of property held in the name of the decedent individually (not held by a trustee of a revocable trust or other trust)
Nominates an executor to handle a decedent’s affairs, including payment of debts and taxes, and locating and safeguarding assets
May name guardians for minor children
What are the general requirements of a will?
varies state by state, but usually a will must be in writing, signed by the testator in the presence of witnesses
Is a will the main estate planning document?
commonly thought of as the main estate planning document but is more commonly used as a simple “pour over” into a revocable trust document
Under IL law, what happens during intestacy if the decedent has a spouse and descendants?
decedent’s estate would be distributed 1/2 to spouse 1/2 to descendants
Under IL law, what happens during intestacy if the decedent has a spouse but no descendants?
Entire estate is distributed to spouse
Under IL law, what happens during intestacy if the decedent has no spouse but AT LEAST one descendant?
Estate is distributed “per stirpes” (equally) among descendants
Under IL law, what happens during intestacy if the decedent had neither a spouse nor any descendants
Estate would be distributed equally among decedent’s parents and siblings
(if one parent were deceased, then the surviving parent would receive a double portion and if a sibling were deceased, the sibling’s descendants would receive the deceased sibling’s share)
Under IL, what happens during intestacy if the decedent didn’t have a spouse, descendants, parents or siblings
estate would be distributed 1/2 to the decedent’s maternal grandparents (and their descendant per stirpes)
1/2 to the decedent’s paternal grandparents (and their descendants per stirpes)
What does Per Stirpes mean?
Latin for “by roots” - method of dividing property whereby the descendants of a deceased person take the share their deceased ancestor would have received if living
What are the responsibilities of an executor?
File decedent’s will with probate court
Notify decedent’s heirs and legatees
Provide notice to creditors
Gather decedent’s assets (appraisal of assets)
Pay decedent’s final debt and expenses
Transfer title of decedent’s property to beneficiaries
Pay expenses of administration
What is a grantor or settlor in relation to a trust?
creator of a trust
What is a donor?
anyone who makes a gift to a trust (or to an individual)
What is a trustee?
individual that holds title to the trust property and administers the trust
The person or person for whose benefit the trustee holds the trust property are called?
beneficiary or beneficiaries
What is a current beneficiaries v. remainder beneficiaries?
Current beneficiaries may receive distributions from the trust now
Remainder beneficiaries will not receive distributions from the trust until later, often when the trust terminates or when a senior-generation beneficiary has died
What is an inter vivos trust v. testamentary trust?
intervivos trust is one that is established during the grantor’s life
testamentary trust - one that is established at the time of the grantor’s death by the grantor’s will
What is an irrevocable trust?
When the grantor cannot amend or revoke the trust
What is a revocable trust?
a legal relationship between a grantor/settlor and a trustee regarding the administration of property
What is a grantor trust?
A trust where the grantor/settlor is treated as owning the trust property for federal income tax purposes
May be revocable or irrevocable
What are Powers of Appointment?
powers which can be given to another person (typically a beneficiary) to determine the ultimate takers of property from a defined group of permissible takers
When can a revocable trust be funded?
life or death
life: often funded with all or substantially all of a grantor’s assets during lifetime in order to avoid probate
death: typically funded by a “pour over” will which distributes all property to the trust
What is a generation-skipping-transfer tax
tax on all transfers that skip over members of one younger generation to a still younger one
what is the current estate tax exemption?
11.8 million and 22 million for spouses
What is the IL Estate Tax?
IL has a $4 million estate tax exemption (no gift tax, but lifetime gifts are factored into calculation)
What is an Outright Gift?
gifts of property made directly to family members (or to a trust for their benefit) during life
What is a Credit Shelter Trust?
This trust is created upon the decedent’s death pursuant to the terms of the decedent’s revocable trust
It makes use of the applicable federal estate tax exemption amount of the first spouse to die
On the death of the first spouse, assets in the amount equal to the first spouse’s remaining estate tax exemption is placed into trust for the surviving spouse and/or descendants
What are the sources of Federal Tax Law?
Internal Revenue Code
United States Constitution
Treasury Regulations
IRS Materials
What is income?
gross income can generally be said to encompass any economic benefit that increases the taxpayer’s wealth, unless the Code specifically excludes the item from gross income
What is return of capital?
When an individual receives a return of his money
What happens when an apartment increases in value? Are you taxed on this increase in value?
No - not until you sell the home… Known as a realization event
What is a realization event?
Event in which you are taxed on the increases in property value when it is sold or exchanged
Heather purchases a home for 200k and then sells it for 300k. What is Heather’s basis in the home? What amount is she taxed on?
Basis is 200k (what she bought it for/the cost)
She is taxed 100k (difference between sale price and basis)
What kind of interest payments can be deducted from your gross income?
Interest payments incurred in trade or business activities or investment activities may be deducted by the taxpayer
Interest paid for money borrowed for personal use generally cannot be deducted by the taxpayer (car loans/CC debt)
what is an annual tax on the value of real property?
real estate tax
What is secured debt?
1 - makes your ownership in a qualified home security for payment of the debt
2 - provides, in case of default, that your home could satisfy the debt
3 - record or is otherwise perfected under any state or local law that applies
i.e = your loan is a secured debt if you put your home up as collateral to protect the interests of the lender
What is home acquisition debt?
loan taken out to buy, build, or substantially improve a qualified home (main or 2nd). It also must be secured by that home
What is the home acquisition debt limit?
750k
if you sell your home at a significant profit and the home you sold counts as your main home, how much of the gains are not taxable?
First 250k
500k if married and filing jointly
What is the Eligibility Test for determining if your home qualifies for certain tax breaks when you sell it?
Sale qualifies for exclusion of 250k gain (500k if married filling jointly) if you owned the home and used it as your main home during at least 2 of the last 5 years before the date of sale
How do you determine if a home is an individual’s main home?
there is a “facts and circumstances” test - most important factor is where your spend the most time
How do improvements and repairs affect a home’s basis
Improvements materially add to the value of your home. You cannot deduct these costs.
Repairs do not add value to your home
What does a Taxable Asset Transfer look like?
See drawing
What does a “C” reorganization look like?
See drawing
What does a Triangular “C” reorganization look like?
See drawing
What does a Taxable Stock Transfer look like?
See drawing
What does a B organization look like?
See drawing
What does a Triangular “B” Reorganization look like?
See drawing
What does a Taxable merger look like?
See drawing
What does a Forward Triangular “A” Reorganization look like?
See drawing
