Module 5 Essentials of Business Entity Taxation Flashcards
Lucy files jointly with her spouse, Linus. Linus had no income. Lucy had net earnings from self-employment in 2023 of $220,000. What is her total self-employment tax?
A)
$24,480
B)
$25,757
C)
$19,645
D)
$20,333
b
Lucy’s total self-employment tax is calculated as follows:
Self-employment income $220,000
Less: $220,000 × 0.0765 $16,830
Equals net earnings $203,170
Less: wage base −$160,200
Equals SE income in excess of Social Security wage base subject to Medicare tax $42,970
Multiplied by 0.029 × 0.029
Equals Medicare portion of SE tax $1,246
Add $160,200 × 0.153 +$24,511
Total self-employment tax $25,757
LO 5.3.1
Assume that a single taxpayer has wages of $150,000 for the current tax year. She also has a small business, operated as a sole proprietorship, that generates approximately $75,000 of net income each year. Her taxable income is approximately $185,000. Advantages for incorporating the small business as a C corporation include which of the following?
All business expenses are generally deductible in arriving at net income
Using the dividends-received deduction
earnings of the business are taxed to the regular corporation at special corporate income tax rates
Changing the form of business back to a sole proprietorship with ease once a corporation has been formed
A)
I, III, and IV
B)
I, II, and III
C)
II only
D)
III only
b
There are fewer restrictions on corporate deductions because all business expenses are generally deductible in arriving at net income for a business (except for those specifically limited or disallowed by law, such as bribes or other illegal activities). There are some deductions that are specific to corporations. An important deduction is the dividends-received deduction. The earnings of or profits from the business are taxed to the regular corporation at special corporate income tax rates. Changing a C corporation to other business forms (except for conversion to S status) can be difficult and costly.
LO 5.2.1
To elect S corporation status for the current calendar year, which of the following must be done for a newly incorporated business?
Secure the consent of the board of directors of the corporation.
File the election (IRS Form 2553) before the 15th day of the 3rd month of the tax year the election is to take place.
Issue two classes of stock.
File the election (IRS Form 2553) at any time before the end of the corporation’s tax year.
Elect S corporation status when filing the corporation’s initial tax return.
A)
V only
B)
I, III, and IV
C)
I, II, and IV
D)
II only
d
IRS Form 2553—Election by a Small Business Corporation has to be filed by the 15th day of the 3rd month of the tax year. The shareholders must secure the consent of the IRS to be taxed as an S corporation. In general, only one class of stock is allowed in an S corporation.
LO 5.2.2
ABC Corporation has the following items of income and expense:
Taxable income $300,000
Federal income tax $80,000
Dividends paid (all in current year) $40,000
Accumulated earnings and profits at end of preceding tax year $160,000
Assume that XYZ Corporation is not a personal service corporation and cannot establish a valid business purpose for the excess accumulations. What is the amount, if any, of the accumulated earnings tax payable?
A)
$0
B)
$26,000
C)
$6,000
D)
$18,000
d
Taxable income $300,000
Federal income tax (80,000)
Dividends paid (all in current year) (40,000)
Accumulated earnings credit ($250,000 – $160,000)1 (90,000)
Accumulated taxable income $90,000
20%
Accumulated earnings tax $18,000
1The accumulated earnings credit is the $250,000 accumulation limit minus accumulated earnings and profits at the end of the preceding tax year.
LO 5.2.1
Which of the following statements regarding calculating self-employment (SE) tax is CORRECT?
The method for calculating the deductible employer share of SE tax is to multiply the net SE income by 0.9235 × 0.0765 up to the taxable wage base of $160,200 in 2023.
The shortcut method for calculating total SE tax for SE income at or below the taxable wage base in 2023 is to simply multiply the amount of SE income by 0.1413 (0.9235 × 0.1530).
A)
I only
B)
Neither I nor II
C)
II only
D)
Both I and II
Both statements are correct.
LO 5.3.1
Jim is a single taxpayer. During the current year, he sold Section 1244 stock for $40,000. Jim had held the stock for three years. His basis in the stock was $130,000. What is the tax result from the sale of the stock?
A)
Jim has an ordinary loss of $50,000 this year and a carryforward of ordinary loss of $40,000.
B)
Jim has an ordinary loss of $100,000.
C)
Jim has a long-term capital loss of $100,000.
D)
Jim has an ordinary loss of $50,000 and a long-term capital loss of $40,000.
d
The loss on the sale, exchange, or worthlessness of Section 1244 stock may be treated as an ordinary loss up to $100,000 annually on a joint return or $50,000 annually on any other return. Thus, as a single taxpayer, Jim has a $50,000 ordinary loss. Any excess loss is a capital loss—short- or long-term depending on the holding period.
LO 5.1.1
Joe and Carter plan to combine their respective sole proprietorships to enable them to bid on a local automobile plant’s contract to provide uniforms, shoes, and safety equipment to 2,300 employees. Joe currently operates a business that sells uniforms and safety equipment. Carter has a shoe store that specializes in work shoes for many occupations. Joe’s spouse and Carter’s spouse each earn approximately $250,000 per year.
Joe and Carter anticipate operating losses over the first two years of approximately $75,000 per year, to be followed by substantial profits. They would like to be able to use the initial losses from the business against their spouses’ incomes. They plan to share the management responsibilities equally. Both Joe and Carter admit that the business is very risky, as neither one of them has had any experience with such large contracts. They anticipate having the business borrow funds to provide operating funds for the first two years.
Which of the following business forms would be most appropriate for Joe and Carter at this time?
A)
C corporation
B)
Limited liability company (LLC)
C)
General partnership
D)
S corporation
b
The LLC is the only entity that will fulfill all of the requirements of the situation; the S corporation is close, but the corporate borrowing will not establish basis for the shareholders. As a partnership for tax purposes, the LLC borrowing establishes basis for the members. Remember that the taxpayers may only deduct losses from a conduit entity to the extent that they have basis.
LO 5.2.3
Which of the following statements regarding inventory valuation techniques and cost of goods sold (COGS) is CORRECT?
During a period of rising prices, LIFO increases the COGS.
During a period of declining prices, LIFO increases the COGS.
During a period of rising prices, FIFO increases the COGS.
During a period of declining prices, FIFO increases the COGS.
A)
II and III
B)
I and IV
C)
II and IV
D)
I and III
b
During a period of rising prices, the last-in, first-out method (LIFO) treats the higher-priced inventory items as those first sold. This, therefore, increases the cost of goods sold (COGS). Conversely, during a period of declining prices, the first-in, first-out method (FIFO) matches the higher-priced inventory items against income. This naturally increases the COGS.
LO 5.1.1
S corporation shareholders have the ability to deduct losses to the extent of their
A)
adjusted basis in the stock, increased for corporate loans personally guaranteed.
B)
adjusted basis in the stock, increased for funds they have directly loaned to the corporation.
C)
original contribution of capital to the business.
D)
adjusted basis in the stock.
b
A shareholder’s basis and ability to deduct losses from an S corporation are determined by the shareholder’s adjusted basis in the stock, increased by loans she has made to the corporation (basis in debt). Original capital contributions are only one of the items considered in determining basis and ability to deduct losses from an S corporation. A personal guarantee of a corporate loan does not establish basis for purposes of S corporation stock.
LO 5.2.2
Which of the following would be considered self-employment income for purposes of the self-employment tax?
Net income from the rental of a vacation home
Net income from a part-time auto repair business
Fee paid by a nonprofit to a taxpayer for serving on the board of directors
Schedule C net income from a swimming pool care business
A)
II and III
B)
II, III, and IV
C)
I, II, III, and IV
D)
I and IV
b
Statement I is incorrect. Rental income is not self-employment income. For the director’s fee, it makes no difference that the payor is a nonprofit. It is still self-employment income to the director.
LO 5.3.1
Sandy operates a hairstyling sole proprietorship, and performs her business dealings from her home on a part-time basis. She also has a full time job as an esthetician and is paid as a W-2 employee earning $46,000. Her gross income for the current tax year is $71,000. The hairstyling income is $25,000. Due to supply and marketing costs, the business expenses not associated with the home office total $27,275. Expenses associated with the home office total $4,200.
How much of the home office expense, if any, may Sandy deduct for the current year?
A)
$2,000
B)
$0
C)
$4,200
D)
$275
b
The home office expense deduction is limited to the earned income from the business. In other words, the home office expense deduction can generally neither create nor add to a loss. In this situation, the $71,000 of gross income is reduced by the $27,275 of business expenses not associated with the home office. Sandy may claim a loss against ordinary income with her Schedule C; however, none of the home office expenses would be deductible in the current year. Note that the entire $4,200 of home office expenses would be subject to a carryforward.
LO 5.4.1
Which of the following is NOT self-employment income?
Net Schedule C income
The distributive share of income paid to a limited partner
Part-time earnings of an individual (e.g., a professional)
Board of directors fees
A)
II only
B)
I and II
C)
III and IV
D)
I, II, III, and IV
a
The distributive share of income paid to a limited partner is not considered self-employment income, but would be income received under the passive activity rules.
LO 5.3.1
Which of the following statements best describes a weakness of the sole proprietorship form of business?
A)
The owner has too many partners.
B)
The business depends solely on the owner.
C)
The business is in constant danger of bankruptcy.
D)
The owner has no control.
b
A sole proprietorship is owned by one individual who is personally liable for the business and all its operations. Therefore, the business depends solely on the owner.
LO 5.2.3
Which of the following statements regarding accounting periods is CORRECT?
All taxpayers may report taxable income on the basis of a calendar year.
If a partner has a different taxable year than that of the partnership, the partner must report his share of the entity’s income in the same taxable year within which the entity’s taxable or fiscal year begins.
A)
Neither I nor II
B)
Both I and II
C)
I only
D)
II only
c
Statement I is correct. All taxpayers may report taxable income on the basis of a calendar year. Such a year is a 12-month period ending on December 31. Statement II is incorrect. If a partner or S corporation shareholder/owner has a different taxable year than the business entity, the owner must report his share of the entity’s income in the same taxable year within which the entity’s taxable or fiscal year ends.
LO 5.1.1
Gil owns a portfolio of income-producing real estate. Gil retains ownership of the real estate but directs that the rental income be paid to his son, Kevin. The income is paid directly to Kevin, who reports it as part of his taxable income. Gil does not report the income on his tax return.
With which of the following potential tax traps should Gil be most concerned?
A)
Assignment of income
B)
Substance over form
C)
Constructive receipt
D)
Ownership attribution rules
a
The fact that Gil retains ownership of the property and merely assigns the income to someone else is a potential tax trap for him. The assignment of income doctrine serves to tax the person who actually owns the property producing the income. The income cannot merely be assigned to another to generate tax advantages.
LO 5.4.2
Which of the following is subject to the self-employment tax?
Distributive share of limited partnership operating income
Flow-through of S corporation income
Distributive share of general partnership operating income
Interest or dividends from investments
A)
II and III
B)
III only
C)
I, II, III, and IV
D)
I and III
b
The general partnership operating income is self-employment income. By definition, the other items of income are not subject to the self-employment tax.
LO 5.2.3
Yetunde has been selling sports memorabilia online for six years. It is not her primary employment, but she has been doing well with sales. While Yetunde will be itemizing her deductions this year, she believes she can report her income and expenses on Schedule C. Her gross sales from the sports memorabilia this year are $55,000. Her total expenses are $37,600, including cost of goods sold of $28,000. Yetunde has kept detailed records since she began selling memorabilia and can track her profit and loss for each year. In Year 1, she had a loss of $5,000; in Year 2, there was a loss of $2,000; in Year 3, she had a profit of $9,000; in Year 4, Yetunde had another loss of only $500; and Year 5 was a good year with a profit of $12,000. How should Yetunde report her sports memorabilia business for Year 6?
A)
Only cost of goods sold can be expensed on Schedule C; the rest of the business expenses are miscellaneous itemized deductions.
B)
Because this is not Yetunde’s primary employment, the business is deemed a hobby and she should use hobby rules to report the income and expenses.
C)
Yetunde can use Schedule C to report the expenses of her business but must report the $55,000 as other income on the front of the Form 1040.
D)
Because Yetunde has a profit from the business in three of the last five years, the business is presumed not to be a hobby and she will report income and expenses using Schedule C.
a
Because Yetunde had a profit in Years 3, 5, and 6, the hobby rules do not apply and Yetunde can use Schedule C to report income and expenses from her business.
LO 5.4.2
Which of the following statements regarding business expenses is NOT correct?
A)
For 2023, a self-employed person may deduct 100% of the cost of health insurance as an above-the-line deduction in calculating AGI.
B)
Expenses related to carrying on a taxpayer’s trade or business are deductible in calculating AGI.
C)
Self-employed taxpayers may deduct qualifying home office expenses only as a miscellaneous itemized deduction.
D)
If the taxpayer qualifies for the home office deduction, the deduction cannot exceed the gross income from the taxpayer’s business.
b
Self-employed taxpayers may deduct qualifying home office expenses when calculating AGI. The deduction is taken as a line item on Schedule C. The home office deduction cannot create a loss from the taxpayer’s business. Unused home office expenses may be carried forward.
LO 5.4.1
The Make Work Partnership has four partners; three partners are individuals and one is a C corporation. The partnership’s annual gross receipts for any three-year preceding period do not exceed $29 million. The partnership can use which method of accounting?
Cash method
Accrual method
A)
Both I and II
B)
Neither I nor II
C)
I only
D)
II only
d
Because one of the partners is a C corporation and the partnership’s average annual gross receipts for any three-year preceding period do not exceed $29 million, the partnership must use the accrual method of accounting.
LO 5.1.1
Which of the following incomes is NOT taxed under the Self Employed Contributions Act ?
Rental real estate income
A limited partner’s share of limited partnership net income
Shareholder’s share of an S corporation’s net income
Income of an individual working as an independent contractor
A)
II and IV
B)
I and III
C)
I, II, and III
D)
IV only
c
The income of an individual working as an independent contractor is subject to the self-employment tax. The income in the other situations specifically is not subject to the self-employment tax.
LO 5.3.1
April is an employee of an accounting firm. April has a very successful accounting practice as a side business that is currently operated as a C corporation. She is the sole shareholder and employee of the corporation. She is comfortable in her current salaried position and has rarely drawn any salary or declared any dividends from the accounting practice. Her corporation currently has retained earnings and profits of $400,000.
With which of the following should April be most concerned?
Personal service corporation (PSC) rules
Unreasonable compensation rules
Sham transaction doctrine
Accumulated earnings tax
A)
III and IV
B)
I and II
C)
II and III
D)
I and IV
d
In addition to income tax at the highest corporate rate of 35% for a PSC, corporations are taxed on earnings that are accumulated and not distributed to shareholders when a valid business purpose does not exist for the accumulation. An exemption of $150,000 is allowed to C corporations that are PSCs. An accumulation of $500,000 would potentially subject the corporation to an accumulated earnings tax of 20% on the $250,000 accumulated in excess of the exemption amount. A PSC is a C corporation in which substantially all of the stock is owned by employees, retired employees, or their estates, and where substantially all of the services are provided in one of the listed fields. Accounting is one of the listed fields.
LO 5.2.1
Which of the following statements is an advantage to the S corporation form of business ownership?
The S corporation election avoids double taxation of a corporate income upon the payment of dividends.
The S corporation election avoids the problems of a penalty on accumulated earnings as well as the personal holding company tax.
A)
II only
B)
I only
C)
Both I and II
D)
Neither I nor II
Which of the following statements is an advantage to the S corporation form of business ownership?
The S corporation election avoids double taxation of a corporate income upon the payment of dividends.
The S corporation election avoids the problems of a penalty on accumulated earnings as well as the personal holding company tax.
A)
II only
B)
I only
C)
Both I and II
D)
Neither I nor II
Which of the following statements regarding business expenses is CORRECT?
A)
If the taxpayer qualifies for the home office deduction, the deduction cannot exceed the gross income from the taxpayer’s business.
B)
Self-employed taxpayers may not deduct qualifying home office expenses as a miscellaneous itemized deduction.
C)
Expenses related to carrying on a taxpayer’s trade or business are a tax credit.
D)
For 2023, a self-employed person may deduct only 20% of the cost of health insurance as an above-the-line deduction in calculating AGI.
b
Self-employed taxpayers may deduct qualifying home office expenses when calculating AGI. The deduction is taken as a line item on Schedule C. The home office deduction cannot create a loss from the taxpayer’s business. Unused home office expenses may be carried forward.
LO 5.4.1
Gordon, who is married and files jointly with his spouse, purchased Section 1244 stock for $110,000. Seven years later, Gordon sold his shares of the stock for $15,000. What is the character of the loss?
A)
$95,000 Section 1244 loss against ordinary income in the year the stock is sold
B)
$110,000 Section 1244 loss against ordinary income in the year the stock is sold at a loss
C)
$100,000 Section 1244 loss against ordinary income in the year the stock is sold
D)
$95,000 Section 1244 loss deducted against ordinary income at a rate of $3,000 annually as a capital loss beginning in the year the stock is sold
a
Gordon and his spouse have a $95,000 Section 1244 loss ($110,000 purchase price − $15,000 sale price) against ordinary income in the year the stock is sold. If a married investor sells Section 1244 at a loss (or if the stock becomes worthless), up to $100,000 of the loss may be deducted as an ordinary loss and is not subject to the $3,000 loss limitation. Any amount over the $100,000 will be treated as a capital loss subject to the $3,000 annual limitation ($1,500 if married filing separately) under the capital loss rule.
LO 5.2.1
John has the following income for the 2023 tax year:
Schedule C net income: $74,100
Flow-through of general partnership operating income: $20,000
Net income from rental of real estate: $10,000
What is the amount of John’s self-employment tax?
A)
$14,397
B)
$13,296
C)
$10,600
D)
$15,927
b
The items included in the computation of self-employment income are the Schedule C (sole proprietorship) income and the flow-through of general partnership operating income. The total of these items is $94,100. This is then reduced by 7.65% of the $94,100 amount to give us $86,901. (Remember that this subtraction of 7.65% is ALWAYS the first step in the calculation.) This is subject to the full 15.3%, since it is under the wage base of $160,200 for 2023. This equals $13,296. The net income from rental of real estate is generally not subject to the self-employment tax, although the net income from the rental of personalty (e.g., equipment) generally is.
LO 5.3.1
All of the following statements regarding accounting methods are correct except
A)
under the hybrid method of accounting, a taxpayer may account for some items using the accrual method and some items using the cash method.
B)
the cash method of accounting is generally required when the sale of merchandise is an income-producing factor.
C)
once an accounting method has been adopted, it cannot be changed without approval from the IRS.
D)
individuals and sole proprietorships may use the cash method of accounting.
b
The accrual method of accounting is required when the sale of merchandise is an income-producing factor.
LO 5.1.1
Which of the following is subject to the self-employment tax?
Net income from rental of personalty
Net income from the rental of realty
$350 net income from a sole proprietorship
Flow-through of income from an S corporation
A)
I, II, III, and IV
B)
I only
C)
I and III
D)
II and III
b
Net income from the rental of realty and flow-through S corporation income are both excluded from the self-employment tax. Less than $400 of self-employment income is not subject to the self-employment tax.
LO 5.3.1
Christopher, who has an interest in multiple businesses, has the following income for 2023:
Net Schedule C income: $80,000
Dividends and interest: $11,000
General partnership K-1 income: $10,000
S corporation K-1 income: $29,000
What is Christopher’s total self-employment tax for 2023 (round up to the nearest dollar)?
A)
$6,359
B)
$12,717
C)
$11,304
D)
$16,955
b
Christopher’s self-employment income is $90,000. The dividends, interest, and K-1 distributions from the S corporation are not self-employment income. The self-employment tax is calculated as follows: $90,000 × 0.9235 = $83,115 net self-employment earnings. Total self-employment tax is $12,717 ($83,115 × 0.1530).
LO 5.3.1
Your client, Mary, and her neighbor, Phil, are developing an idea for a business. Phil is convinced that a C corporation is the best form of business for their new venture. Mary is not very familiar with the C corporation form of business. What can you accurately tell Mary about the characteristics of a C corporation?
The number of shareholders is limited.
The bankruptcy of shareholders has no effect on the business form.
Shareholder liability is limited.
Capital structure is dependent upon the resources of the shareholders.
A)
III and IV
B)
I and II
C)
I and IV
D)
II and III
d
Statements II and III are accurate. The number of shareholders is limited in an S corporation, not a C corporation. Capital may be raised by sale of stock and borrowing.
LO 5.2.3
In 2023, which of the following is a method of calculating total self-employment tax where net income from self-employment is below the taxable wage base?
Calculate self-employment income; multiply by 0.9235 (1 − 0.0765); and multiply the result by 15.3%.
Calculate self-employment income; multiply by 15.3%; and subtract 7.65%.
Calculate self-employment income; subtract 7.65%; and multiply the result by 15.3%.
Calculate self-employment income; multiply by 15.3%.
A)
I and III
B)
I and II
C)
II and IV
D)
III only
a
To calculate the self-employment tax in 2023 where net income from self-employment is below the taxable wage base, use the following steps:
Step 1: Calculate self-employment income.
Step 2: Subtract 7.65% or multiply by 0.9235 (1 − 0.0765).
Step 3: Multiply the resulting product by 15.3%.
LO 5.3.1
Home office deductions are allowed if the residence or portion of the residence falls within any of the following categories of use except
A)
the self-employed taxpayer may use either the simplified method or the regular method to calculate home office expenses.
B)
the home office is used exclusively and regularly as the principal business place of the self-employed taxpayer for the business under consideration.
C)
the home office is separate from the main home (an office, studio, garage, greenhouse, darkroom, or therapy room) and used exclusively and regularly in connection with the self-employed taxpayer’s trade or business.
D)
the home office is sometimes used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of the taxpayer’s trade or business.
d
To fulfill the deduction requirement using this category, the home office must be used exclusively and regularly by patients, clients, or customers meeting or dealing with the self-employed taxpayer in the normal course of the taxpayer’s trade or business.
LO 5.4.1
Which of the following statements regarding common tax traps is NOT accurate?
A)
Tax traps may result in the unexpected recognition of income.
B)
A transaction is based solely on its economic form.
C)
Tax traps are of particular concern to owners of closely held businesses.
D)
A transaction must be based on economic reality as well as economic form.
b
A transaction cannot be based solely on form; it must also be based on economic reality.
LO 5.4.2
Claudia will begin a private tutoring business for students for whom English is a second language and who need assistance preparing for the SAT. She will be using a room at the university library for the tutoring sessions, and except for some small initial costs for materials, she does not expect any expenses. If Claudia receives $9,000 in tutoring income this year, how does she account for it on her income tax return?
A)
Because the tutoring is similar to the teaching she does at the university, Claudia is required to report it to the university, which will put the income on her W-2.
B)
Because her expenses are negligible, Claudia is not allowed to deduct the expenses from her tutoring income.
C)
Claudia must report the tutoring income and expenses on Schedule C of Form 1040.
D)
Until Claudia can prove the tutoring is not a hobby (achieve a profit in three of the next five years), she will report gross tutoring income on the front of Form 1040.
c
The tutoring business is engaged in for profit, not as a hobby. The income and expenses are reported on Schedule C of Form 1040.
LO 5.4.2
A taxpayer has Schedule C net income of $60,000. What is the taxpayer’s total self-employment tax? Round your answer to the nearest dollar.
A)
$4,239
B)
$9,180
C)
$3,825
D)
$8,478
d
The total self-employment tax is $8,478 ($60,000 × 0.9235 = $55,410; $55,410 × 0.1530 = $8,478).
LO 5.3.1
Which of the following incomes is not taxed under Social Security self-employment tax?
Rental real estate income
Small part-time repair shop income
Shareholder’s share of S corporation’s income in excess of salary
Income of an individual working as an independent contractor
A)
II and IV
B)
I, II, III, and IV
C)
I and III
D)
I, II, and III
c
Income from rental property is not subject to Social Security tax, nor are dividends to S corporation shareholders/employees as long as the employees’ compensation is considered reasonable.
LO 5.3.1
Which of the following statements regarding S corporations is CORRECT?
A)
An S corporation must pay self-employment tax on its ordinary income.
B)
The maximum number of shareholders an S corporation may have is 100.
C)
An S corporation may have more than one class of stock.
D)
Any individual, estate, corporation, or trust may be an S corporation shareholder.
b
Only certain types of trusts, individuals, and estates may be shareholders of an S corporation. They are limited to one class of stock, and neither the corporation nor its owners pay self-employment tax. The maximum number of shareholders is 100.
LO 5.2.2
Sam had the following items of income during the 2023 tax year:
Sole proprietorship net income: $30,000
Interest income: $2,000
Flow-through of S corporation income: $10,000
What is the amount of self-employment tax Sam owes?
A)
$6,120
B)
$4,590
C)
$4,400
D)
$4,239
d
The equation is $30,000 - 7.65% = $27,705 × 15.3% = $4,239. Remember that the first step in computing the self-employment tax is always the 7.65% subtraction. The flow-through of income from an S corporation (or limited partnership income to a limited partner) is not considered to be self-employment income.
LO 5.3.1
How much of the self-employment tax is deductible by a taxpayer on her income tax return whose income is below the taxable wage base?
A)
15.3%
B)
2.90%
C)
6.20%
D)
7.65%
d
The deductible share of the self-employment tax is 7.65%.
LO 5.3.1
Only certain types of trusts, individuals, and estates may be shareholders of an S corporation. They are limited to one class of stock, and neither the corporation nor its owners pay self-employment tax. The maximum number of shareholders is 100.
LO 5.2.2
d
Multiple ownership of an unincorporated business is characteristic of a general partnership. More than one owner personally liable indicates a general partnership business form. Common shareholders, preferred shareholders, and limited partners do not have personal property at risk; only their investment in the company is at risk.
LO 5.2.3
Which of the following statements regarding LLCs is CORRECT?
A)
LLCs may not be liquidated without the adverse tax consequences of a C corporation if that tax form is chosen by the LLC.
B)
They are permitted in only a few states.
C)
They offer the advantage of not being subject to some of the tax rules and restrictions that apply to S corporations.
D)
They are incorporated legal entities owned by one or more members.
c
LLCs are unincorporated legal entities owned by one or more members and are created by filing Articles of Organization with the state. LLCs may be liquidated without the adverse tax consequences of a C corporation, even when choosing to be taxed as a C corporation. They are now permitted in all 50 states and the District of Columbia.
LO 5.2.2c
Landry has been baking pies and cakes for several years that are very popular when he sells them locally. He works full-time in the oil field and baking has become a hobby he enjoys. He is meeting with his new financial planner, Richard, to review his plans for retirement in 10 years. He explains that he will continue his baking after retirement but not necessarily full time. Richard has asked for as much documentation as possible about his current and prior years’ sales and expenses for this hobby. Landry is confused about why it matters. What should Richard do for Landry as his planner?
Richard should review Landry’s previous income tax returns to ascertain if the hobby income was reported.
When reviewing the documentation for the hobby, Richard is also determining whether or not the hobby could be classified as a business.
Landry should file amended returns and deduct all of his hobby expenses from the hobby income before it is entered on his Form 1040 if Landry has not previously reported the hobby.
A)
I and II
B)
II and III
C)
I, II, and III
D)
I only
a
Statement III is incorrect. If Landry has not previously reported the hobby income and expenses, Richard should advise him to file amended returns, reporting the income on the front of the Form 1040. Hobby expenses are not deductible except for allocated property taxes and mortgage interest.
LO 5.4.2
Which of the following forms of business would file a Schedule C to report the income or loss from the business?
A)
C corporation
B)
S corporation
C)
Limited partnership
D)
Sole proprietorship
d
The sole proprietorship is the business that files a Schedule C with the individual’s Form 1040. The limited partnership files a Form 1065, and the C corporation files a Form 1120. The S corporation files an 1120-S.
Note that a single-member LLC would also file a Schedule C, as it would be treated as a disregarded entity for income tax purposes.
LO 5.2.2
Which of the following statements comparing a C corporation and a general partnership is CORRECT?
Both a C corporation and general partnership can have more than one owner.
Both a C corporation and general partnership are regarded as distinct entities for tax purposes.
Profits are divided equally in both business forms.
Neither a C corporation nor general partnership pays federal tax on income.
A)
I and III
B)
II only
C)
I only
D)
I and IV
c
One similarity of a partnership and a C corporation is that they may both have more than one owner. However, only a C corporation is regarded as a distinct, separate entity for tax purposes. Partnerships are flow-through entities. C corporations may retain profits. Partnerships are not required to distribute profits equally. C corporations pay tax on income.
LO 5.2.3
Which of the following forms of business has to meet the fewest legal requirements to be established as a business?
A)
Limited partnership
B)
S corporation
C)
Sole proprietorship
D)
C corporation
c
To be established as a business, the sole proprietorship certainly has to meet the fewest legal requirements. The C corporation and the S corporation are required to file articles of incorporation, at a minimum, with the secretary of state. The limited partnership also is subject to certain state registration requirements. The sole proprietorship is the only business entity that essentially does not have to meet any legal requirements to be established as a business.
LO 5.2.3
Chris has been actively buying and selling science fiction memorabilia for many years. He has a booth at several conventions he attends each year. His tax professional has been tracking his profit and loss and reports that Chris made a profit in four of the last five years. Which of the following statements regarding Chris’s profit and loss is CORRECT?
The IRS will presume that Chris’s activity is a hobby.
If the hobby rules do not apply, Chris can use Schedule C to report the income and expenses from this activity.
A)
Neither I nor II
B)
II only
C)
I only
D)
Both I and II
b
Statement I is incorrect. An activity is presumed not to be a hobby if there are profits from the activity in any three of five consecutive tax years ending with the tax year in question (unless the IRS proves otherwise). Statement II is correct; if the hobby rules do not apply, Chris can report his income and expenses on Schedule C.
LO 5.4.2
For purposes of the accumulated earnings tax (AET), what amount may a regular corporation retain in accumulated earnings before having to prove a reasonable business need for the retained funds?
A)
$25,000
B)
$250,000
C)
15% of the current year’s earnings
D)
None of these
b
Every regular corporation can accumulate up to $250,000 in retained earnings without having to prove a reasonable business need.
LO 5.2.1
