Tax 2-4 Explain characteristics, advantages, or disadvantages of a business form. Flashcards
Question 6 of 30
Which of the following is a disadvantage of operating as a sole proprietorship?
difficulty in raising capital
unlimited liability
lack of continuity of life
all of the above
(LO 2-4)
all of the above
The difficulty in raising capital, unlimited personal liability, and lack of continuity of business life are all disadvantages of operating as a sole proprietorship.
Question 7 of 30
The partner’s tax basis in his or her interest in a partnership
remains unchanged unless additional capital is contributed or distributions are made.
is increased by his or her share of income reported by the partnership.
remains unchanged until the interest is sold or otherwise disposed of.
(LO 2-4)
is increased by his or her share of income reported by the partnership.
Capital contributions and distributions affect a partner’s tax basis in a partnership interest, as does the partners’ share of income reported.
Example. As mentioned earlier, the partner’s share of recourse and non-recourse financing increases the partner’s basis in the partnership. For example, assume that Mike and Joe form a partnership, J and M Enterprises, and that each partner has a 50% interest in income and capital. J and M is in need of operating funds, and secures a $100,000 loan from a bank. This borrowing at the entity level affects the basis of each partner. Each partner’s basis is increased by $50,000 as a result of the borrowing. As the loan principal is paid down, there is a downward adjustment to each partner’s capital account. During the year, there was $5,000 of principal paid on the loan. Each partner’s basis is decreased by $_, _ _ _ as a result of the loan repayment.
(2-4, pg 31)
Each partner’s basis is decreased by $2,500 as a result of the loan repayment.
Question 8 of 30
One tax advantage of a C corporation is
the ability to have income taxed at potentially lower income tax rates.
the ability to distribute income to shareholders tax free.
the ability to contribute appreciated securities in exchange for stock of an investment company.
(LO 2-4, pg 42)
the ability to have income taxed at potentially lower income tax rates.
A corporation has the ability to take advantage of taxation at potentially lower rates than its shareholders. The first $50,000 of net income of a corporation is taxed at 15%.
Question 12 of 30
Which one of the following forms of business is generally recognized as having the most readily available access to additional capital?
sole proprietorship
general partnership
C corporation
S corporation
(LO 2-4)
C corporation
A C corporation has access to capital from a large number of shareholders and, thus, can generate more capital than any other form of business.
Question 9 of 30
Which one of the following is a characteristic of Section 1244 stock when disposed of by a taxpayer filing a joint return?
Gains on the sale are ordinary income up to $100,000.
Gains on the sale are capital gains up to $100,000 and ordinary thereafter.
Losses on the sale are ordinary losses up to $100,000.
Losses on the sale are capital losses and are limited to $3,000.
(LO 2-4, pg 44)
Losses on the sale are ordinary losses up to $100,000.
A taxpayer filing jointly may claim up to $100,000 of ordinary losses per year under Section 1244.
Question 21 of 30
Which one of the following is a disadvantage of classifying a C corporation as a personal service corporation (PSC)?
employee fringe benefits are disallowed
the corporation may not institute a qualified retirement plan
the benefit of the graduated corporate tax rates is denied
(LO 2-4, pg 45)
the benefit of the graduated corporate tax rates is denied
The benefit of the graduated corporate tax rates is denied. All net income of the PSC is taxed at the highest marginal corporate income tax rate of 35%.
Question 22 of 30
Which one of the following C corporations may be considered a personal service corporation?
an accounting practice
a manufacturing firm
a retail furniture store
(LO 2-4, 45)
an accounting practice
A PSC is a C corporation in which substantially all of the activities involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, veterinary services, or consulting if substantially all of the stock is owned by employees, retired employees, or their estates.
For this purpose, a PSC is defined as a C corporation in which substantially all of the activities involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, veterinary services, or consulting if substantially all of the stock is owned by employees, retired employees, or their estates.
Question 26 of 30
Which one of the following is correct regarding the self-employed health insurance deduction?
The self-employed health insurance deduction may exceed the net income from the business.
The deduction may be taken by a greater-than-2% shareholder in an S corporation, and by a partner in a partnership.
The deduction is treated as a reduction of the net income from the business.
(LO 2-4, pg 26)
The deduction may be taken by a greater-than-2% shareholder in an S corporation, and by a partner in a partnership.
The deduction may be taken by a greater-than-2% shareholder in an S corporation, and by a partner in a partnership. The deduction may also be used by a sole proprietor.
Question 28 of 30
Which one of the following is generally true with respect to the formation of a partnership?
a. The partnership recognizes gain or loss upon contribution of property by the partner.
b. The partner recognizes gain or loss upon contribution of property to the partnership.
c. No gain or loss is recognized by either the partner or partnership upon contribution of property to the partnership.
(LO 2-4, pg 30)
c. No gain or loss is recognized by either the partner or partnership upon contribution of property to the partnership.
Neither the partner nor partnership recognize gain or loss upon a contribution of property to the partnership.
Corporations (C and S)
Corporations (C and S) offer the advantage of ordinary loss treatment on Section 1244 stock, which is the first $1 million of stock issued after incorporation. There are several requirements to qualify for the special tax treatment. The stock must be held by the original owner, or by an individual who was a partner in a partnership at the time the stock was issued to the partnership. The stock loses its Section 1244 status if the shareholder receiving such stock ever transfers it. Also, the stock must have been issued by a domestic corporation (one incorporated within the United States) for money or other property (but not stock or other securities). In addition, over 50% of the corporation’s income was from business operations.
2-4
Generally, if stock held becomes worthless or is sold at a loss, it is considered a capital loss. With a net capital loss, the taxpayer is limited to offsetting ordinary income at a rate of $3,000 per year. However, a loss from the sale, exchange, or worthlessness of Section 1244 stock is treated as an ordinary loss. Section 1244 losses are deductible up to $50,000 per year against any other sources of income and up to $100,000 per year on a joint return. Any excess loss (above the $50,000 or $100,000) in a given year is treated as a capital loss. Thus, if a married taxpayer filing jointly had $110,000 of loss from the worthlessness of Section 1244 stock during the current year, the result is a fully deductible ordinary loss of $100,000 and a capital loss of $10,000.
Practice Test 1
- Dr. John Smith, a dentist, is contemplating forming a C corporation for his practice. He will be the sole owner and employee of the corporation. Which of the following statements accurately describe the income tax consequences of such an arrangement?
I. The corporation would be considered a personal service corporation.
II. The corporation would not be considered a personal service corporation.
III. The net income of the corporation will be subject to graduated tax rates.
IV. The net income of the corporation will be taxed at John’s individual tax rates.
V. The net income of the corporation will be subject to a flat 35% tax rate.
I and IV only
I and V only
II and III only
II and IV only
(LO 2-4)
I and V only
A C corporation in which substantially all of the services are provided in health, law, engineering, accounting, etc., and substantially all of the stock is held by employees, retired employees, or their estates is considered a personal service corporation (PSC). The result of the PSC classification is the denial of the graduated corporate tax rates, causing a flat 35% tax rate.
Practice Test 1
- Which one of the following is most often considered an advantage of an S corporation?
a. The number of shareholders is limited.
b. Two classes of shareholders are permitted.
c. The business may be a foreign corporation.
d. There is pass-through of ordinary loss.
e. There are no restrictions on who may be a shareholder.
(LO 2-4)
d. There is pass-through of ordinary loss.
The ability to have losses flow through to the shareholders to offset other income is one of the primary advantages of the S corporation. The limitation on the number of shareholders is not considered an advantage. Only one class of stock is permitted, the business must be a domestic corporation, and there are restrictions on who may be a shareholder.
- Which of the following are characteristics of a C corporation but are not characteristics of a sole proprietorship?
I. limited personal liability
II. tax-free formation
III. perpetual life
IV. separate taxable entity
I and IV only
II and III only
I, II, and IV only
I, III, and IV only
The C corporation involves limited personal liability for the shareholders, potential tax-free formation, and perpetual life, and is clearly a separate taxable entity. The sole proprietorship enjoys potential tax-free formation. The other three options are not characteristics of a sole proprietorship. The sole proprietor has unlimited personal liability. The sole proprietorship does not have perpetual life, nor is it a separate taxable entity.
(LO 2–4)
I, III, and IV only
The C corporation involves limited personal liability for the shareholders, potential tax-free formation, and perpetual life, and is clearly a separate taxable entity. The sole proprietorship enjoys potential tax-free formation. The other three options are not characteristics of a sole proprietorship. The sole proprietor has unlimited personal liability. The sole proprietorship does not have perpetual life, nor is it a separate taxable entity.
