Study Guide Flashcards
Which type of business organization combines the tax treatment of a partnership with the legal accountability of a corporation?
Limited Liability Companies
Which of the following entities is not considered a flow-through entity? A. C Corp B. S Corp C. LLC D. Partnership
C Corps
Which example demonstrates a disadvantage of being a C corporation?
A) The first $50,000 of income of a C corporation is taxed at 15%
B) Shareholders employed by the corporation are considered employees
C) The C corporation’s earning is taxed to the shareholders when they are distributed as dividends.
D) Shareholder-employees must fund fringe benefits such as life insurance and health plans funded with before tax dollars.
Shareholder-employees must fund fringe benefits such as life insurance and health plans funded with before tax dollars.
Which Court can you get a jury trial? A) US District Court B) Tax Court C) US Court of Claims D) US Court of Appeals
US District Court
Corporations are legally formed
by filing articles of incorporation with the state in which the corporation will be created.
General partnerships may be formed
by written agreement among the partners, called a partnership agreement, or may be formed informally without a written agreement when two or more owners join together in an activity to generate profits.
Limited partnerships are legally formed
by filing a certificate of limited partnership with the state in which the partnership will be organized.
LLC members have
more flexibility than corporate shareholders to alter their legal arrangements with respect to one another, the entity, and with outsiders.
S corporations are
flow-through entities whose income “flows through” to their owners who are responsible for paying tax on the income.
An unincorporated entity with more than one owner is
by default, taxed as a partnership.
file documents with the state to be formally recognized by the state
LLC’s
the least flexible legal arrangement for owners
Corporations
LLCs are legally formed
by filing articles of organization with the state the LLC desires to organize its business in.
LLCs with one single individual owner
follow the same filing guidelines as sole proprietorships. Thus, their income is reported on Form 1040, Schedule C.
are taxed as partnerships and report their income on Form 1065.
LLCs with more than one owner
more restrictive ownership requirements than other entities.
S Corps
subject to self-employment taxes on net income from their sole proprietorships.
Sole proprietors
Shareholders of C corporations receiving property distributions
must recognize dividend income equal to the fair market value of the distributed property if the distributing corporation has sufficient earnings and profits.
The C corporation tax rate is
significantly lower than the top individual marginal tax rate.
Owners who work for entities taxed as a partnership receive guaranteed payments as compensation. The guaranteed payments
are self-employment income.
does not apply to the income of C Corporations
The deduction for qualified business income
C corporations NOL may
not be carried back but may be carried forward indefinitely
qualified business income deduction is
a from AGI deduction but is not an itemized deduction.
a business income allocation from an S corporation distributed to an employee/shareholder
will only be subject to the regular income tax at the shareholder’s marginal ordinary income tax rate.
A C corporation’s losses must
be used at the entity level. That is, the losses don’t flow-through to owners to offset their income from other sources.
Partnerships and their owners
generally don’t recognize any gain during a liquidating distribution, giving them a better tax position than C and S corps
C corporations are most favorable in regards to tax treatment because
There is no limit to the number of owners allowed, no restrictions on what accounting period to use, and all of the gains from selling shares in a C corporation are capital gains.
the only type of entity that has a limit on the maximum number of owners it may have. S corporations may have up to 100 unrelated shareholders.
S Corp
Tax rules allow entities to
be classified differently for tax purposes than they are classified for legal purposes
typically treated as flow-through entities for tax purposes.
Unincorporated entities
C corporations can elect S corporation status to
change the entity to a flow-through entity for tax purposes.
C corporations NOL carried forward
cannot offset 100% of the corporation’s taxable income (before the net operating loss deduction).
is considered to be a disregarded entity. In essence, the entity is treated like a division of its parent company. Thus, its income will be reported on the Form 1120 of its parent corporation.
A single member LLC with one corporate owner
If C corporations retain their after-tax earnings, when will their shareholders who are individuals be taxed on the retained earnings?
Shareholders will be taxed when they sell their shares at a gain.
True or False
If it carries back the NOL and/or carries it forward, it may offset up to 80% of the taxable income (before the NOL deduction) in those years.
False
True or False
regarding the number and type of owners they may have. An S corporation cannot have more than 100 unrelated shareholders. Furthermore, shareholders may not be corporations, partnerships, nonresident aliens, or certain types of trusts.
True
What tax year-end must an unincorporated entity with only one owner adopt?
The entity must adopt the same year-end as its owner.
The excess loss limitation
does not apply to C corporation shareholders because those losses stay at the entity level.
Employers computing taxable income under the accrual method to unrelated taxpayers may
deduct wages accrued as compensation expense in one year and paid in the subsequent year, as long as the company makes the payment within 2½ months after the employer’s year-end.
An unfavorable temporary book-tax difference is
an adjustment that increases taxable income relative to book income.
Income that is included in book income, but excluded from taxable income
results in a favorable, permanent book-tax difference.
For a corporation, goodwill created in an asset acquisition generally leads to
temporary book-tax differences.
For tax purposes, a corporation may
deduct corporate capital loss only against capital gains.
A corporation may carry a net capital loss
back 3 years and forward 5 years.
Corporate Net Operating Loss (NOI)
can only offset 80% of taxable income in the carryover year
Accrual-method corporations can deduct charitable contributions before they actually make payment to the charity, only if.
The deduction is allowed in the year authorized by the Board provided the payment is made within 3½ months after year-end.
Corporations may carry excess charitable contributions
forward five years, but they may not carry them back.
when a corporation deducts a charitable contribution carryover.
They generally will report a favorable, temporary book-tax difference
Corporations compute their dividends received deduction by multiplying the dividend amount by
50%, 65%, and 100%, depending on the stock ownership level.
A dividends received deduction is
limited to 50% or 65% of taxable income unless it creates or increases a net operating loss deduction, in which case the full amount is allowed.
Taxable income of C corporations is
subject to a flat 21% tax rate.
Adjusted gross income is
calculated for individual returns, but not for corporate returns.
The dividends received deductions is
a tax only deduction. It creates a favorable permanent book-tax difference.
Temporary book-tax differences
will eventually reverse; if a difference is favorable one year, it will be unfavorable in another. So corporations will eventually recognize the same amount of income for book and tax purposes for income-related temporary book-tax differences.
Corporations cannot deduct
capital losses against ordinary income.
When calculating a current year net operating loss.
Net capital loss carrybacks and net operating loss carryovers are not deductible
The amount deductible for non-cash contributions is
Depending on the nature of the property, the amount deductible for a contribution can be the fair market value of the contributed property.
The current-year charitable contribution deduction is
limited to 10% of the charitable contribution limit modified taxable income. The carryover is any excess of the charitable contribution deduction for the year over the allowable current-year deduction.
Bonuses paid within 2½ months of year-end are
NOT included in employee’s compensation in the year they were earned. Employees only include compensation into income in the year they received it.
Federal income tax expense
generates a permanent book-tax difference for Schedule M-3 purposes.
Net operating losses
generally are treated as deductible temporary differences.
Goodwill impairment in excess of tax goodwill
creates either a permanent difference or an unfavorable temporary book-tax difference.
NOL and capital loss carryovers
are deductible in calculating the charitable contribution limit modified taxable income, while capital loss carrybacks are not.
It is important to distinguish between temporary and permanent book-tax differences for which of the following reasons?
Temporary book-tax differences will reverse in future years whereas permanent differences will not.
Net capital losses
create an unfavorable book-tax difference in the year they occur and a favorable book-tax difference in the year they are applied. These book-tax differences are temporary.
Charitable contribution deductions
are deductible in calculating DRD modified taxable income NOL carryovers, NCL carrybacks, and the DRD itself are not included in the DRD modified taxable income calculation.
A distribution from a corporation to a shareholder
can be treated as a dividend, a return of capital, or gain from sale of the stock, for tax purposes.
Stock distributions can be
taxed as dividend income to shareholders when the distribution has the potential of changing ownership proportions.
The recipient of a tax-free stock distribution
must allocate a portion of the basis from existing stock.
The recipient of a taxable stock distribution
will have a tax basis in the stock equal to the fair market value of the stock received.
Substantially disproportionate stock redemptions
- the redemption decreases the shareholders voting power to less than 50% of corporation’s outstanding stock
- the shareholder’s percentage interest in the voting stock falls to less than 80% of the percentage interest before the redemption; if the stock is nonvoting, then the redemption is treated as a stock sale if the fair market value of the common stock as a percentage of the total stock outstanding falls below 80% of what the stockholder owned previous to the redemption.
A 2-for-1 stock split to all holders of common stock.
would be a stock distribution that was tax-free to the shareholder.
A distribution from a corporation to a shareholder
will only be treated as a dividend for tax purposes if the distribution is paid out of positive and current or accumulated earnings and profits.
The computation of current earnings and profits, includes:
taxable income and deductible expenses, as well as
tax-exempt income and nondeductible expenses.
Earnings and Profit (E&P)
is an after tax computation.
During distributions of property
Losses are not recorded.
the priority of the tax treatment of a distribution from a corporation to a shareholder is
The distribution is a dividend to the extent of the corporation’s earnings and profits, then a return of capital, and finally gain from sale of stock.
Regarding adjustments to taxable income or net loss to compute current E&P
Refunds of prior year taxes ARE included in the computation of current E&P under the cash method of accounting.
Refund of prior year taxes are NOT included in the computation of current E&P under the accrual method of accounting.
When current E&P is negative,
the tax status of the dividend is determined by calculating accumulated E&P on the date of the distribution.
The dividend amount
is the fair market value of the land less the liability assumed and the tax basis of the land is the fair market value
The distributing corporation
does not recognize loss on the distribution and reduces E&P by the land’s E&P basis.
the following are subtractions from taxable income in computing current E&P
Federal income taxes paid.
Current charitable contributions in excess of 10 percent limitation.
Current year net capital loss.
Dividends received deduction
is allowed for taxable income but not E&P.
In a redemption treated as an exchange
the company reduces E&P by the lesser of the amount distributed versus the percentage of stock redeemed times E&P at the time of the distribution
liquidation of a corporation
results in a tax deferral to a corporate shareholder owning 80 percent or more of the corporation’s stock before it is liquidated.
The tax basis of property received by a noncorporate shareholder in a complete liquidation
will be the property’s fair market value.
To recognize loss on the distribution of property in a complete liquidation,
the corporation must distribute the property to unrelated persons who are not 80 percent corporate shareholders. Losses can be recognized on distributions to related parties if the distribution is pro rata and the property is not disqualified property.
The concept of E&P
is similar to that of Retained Earnings, the calculation and adjustments made to E&P are very different from those employed in calculating retained earnings.
Gains are
recognized by the distributing corporation on distributions of appreciated property regardless of E&P.
Differences in voting powers are permissible across shares of S corporation stock
as long as the shares have identical distribution and liquidation rights.
All shareholders on the date of the election
must consent to the election of S Corp Status
The shareholders must hold more than 50 percent of the stock
to make a voluntary revocation of their S Corp Status
If more than 50% of the shareholders make a valid S termination election before 2 ½ months of the current year,
the election is valid as of the beginning of the year.
For an S election to be terminated, it must have C corporation earnings and
profits and have passive income in excess of 25 percent of its gross receipts for three consecutive years.
Separately stated items
are tax items that are treated differently for tax purposes as a shareholder’s share of ordinary business income (loss).
S corporations are not entitled to
a dividends received deduction.
For S corporations without earnings and profits from prior C corporation years,
the taxation of cash distributions to the shareholder is very similar to the rules for partnerships.
When an S corporation distributes appreciated property to its shareholders
the S corporation recognizes gain as though it had sold the appreciated property for its fair market value just prior to the distribution.
S corporations are required to recognize
both gains and losses on non-liquidating distributions of property to shareholders.
S corporation distributions of cash
are taxable to the shareholder to the extent of the combined shareholder’s stock and debt basis.
Separately stated items for S corporations include:
DIvidends, interest income, charitable contributions, and investment interest expense.
Stock basis =
original basis + ordinary income allocation - distribution (no gain recognized unless the distribution is greater than the original basis +ordinary income allocation
S corporation shareholders
are not allowed to include any S corporation-level debt in their stock basis.
S corporation allocated losses to a shareholder not deductible due to the tax basis limitation rules
are carried over by the shareholder to future years for potential utilization.
Increase for distributions during the year
decreases an S corporation shareholder’s stock basis
Ordinary loss by shareholders of S corp stock
are deductible but limited to stock basis plus debt basis
Any net increase in basis for the year
first restores the shareholder’s debt basis (up to the outstanding debt amount) and then the shareholder’s stock basis
Net passive income =
passive investment income - (25%)(gross receipts + passive investment income)
The specific identification method and daily allocation method
are methods an S corporation may use to allocate its income across short tax years that result from an involuntary S election termination
S corporations have very little flexibility
in making special profit and loss allocations of operating income.
In general, an S corporation shareholder makes
increasing adjustments to her basis first, followed by adjustments that decrease basis.
Regarding debt, S corporation shareholders
are deemed at risk only for direct loans they make to their S corporation.
S corporations are treated in part like
C corporations and in part like partnerships with respect to tax deductions for qualifying employee fringe benefits.
When an S corporation distributes appreciated property to all of its shareholders pro-rata,
the shareholders who receive the distributed property recognize income on their distributive share of the deemed gain.
outside basis refers
to a partner’s basis in her partnership interest, and the term
inside basis refers
to the partnership’s basis in its assets.
Partners must treat the value of capital interests they receive in exchange for services as
ordinary income.
Most tax elections for a partnership
are made at the partnership level. The requirement that partnerships make most tax elections represents the entity concept.
The least aggregate deferral test
uses the profit percentage of each partner to determine the minimum amount of tax deferral for the partner group as a whole in determining the permissible tax year-end of a partnership.
A partner’s outside basis consists of
the basis of the contributed property less any debt relief the property received plus the portion of debt the partner assumes based upon the partner’s interest in the partnership.
Recourse debt
is debt that is backed by collateral and is allocated from the partnership to each partner that has the ultimate responsibility for paying the debt
Nonrecourse debt
is debt that isnt backed by collateral and is allocated from the partnership to each partner by profit sharing ratios.
