Tax Characteristics of Entities

Question 1

Pros and cons of sole proprietorship

Answer 1

-Ease of formation, no double taxation, autonomy vs full responsibility for all debts and liabilities, no continuity

Question 2

Tax treatment

Answer 2

-Net income and loss are reported on 1040 Schedule C (max rate: 37%), also subject to self-employment tax on net earnings
-May deduct 20% qualified business income for income tax purposes, applies to $182,100 for single and $364,200 for MFJ

If there are are employees or is required to pay federal taxes, then must obtain EIN

Question 3

independent contractor

Answer 3

If the person for whom the services are performed has the right to control or direct only the result of the work and not the means and methods of accomplishing the result.

Question 4

common-law employee

Answer 4

If someone can control what services will be performed and how it will be done, even if the employee has freedom of action.

Question 5

A statutory employee

Answer 5

• driver who is paid on commission or is your agent,
• life insurance sales agent,
• person who works at home on materials or goods that you supply, or
• salesperson who turns in orders for resale from wholesalers, retailers, contractors, or hotel or restaurant establishments. (Social Security and Medicare taxes are withheld if these services are performed on a continuous basis for the same payer and if the worker does not have a substantial investment in the equipment and property used to perform these services.)

Question 6

statutory nonemployee

Answer 6

If all payments for their services are derived from direct sales rather than from the number of hours worked. An example is a licensed real estate agent.

Question 7

corporation

Answer 7

owned by one or more shareholders and is a separate legal entity apart from its owners, formed under rules of state incorporated under

Question 8

Required submissions by corporation to state

Answer 8

-statement listing name and purpose, with directors and organizers
-filing fee
-articles of incorporation
-info on stock to be issued

Question 9

Advantages and disadvantages of C-Corporations

Answer 9

-Shareholders have limited liability, easier to raise additional capital by issuing new stock, special shareholder and employee tax rules, and no restrictions on number/types of shareholders
vs

-creditors may seek payment from shareholders if not properly formed, income is taxed twice, complex computations required for filing consolidated taxablle income

Question 10

Special C-corporation types:

Answer 10

Personal service corporations
Personal holding companies
Professional corporations

Question 11

Personal Service Corporation (PSC)

Answer 11

business that provides personal services toc customers

Question 12

Advantages and disadvantages of PSC

Answer 12

• QSPC is exempt from accrual method of accounting and must use the 21% (2023) max corp rate to calculate liability

vs.

Must use calendar year as tax year

Question 13

Personal Holding Companies (PHCs)

Answer 13

-C-Corporations with certain percentage of income from investments ie interest, dividends and real estate rents

Question 14

PHC tax

Answer 14

Triple taxation:
- Corporate income paid by corporation
-PHC tax paid by corporation
-income tax paid by shareholders when dividend is eventually paid

Purpose is to prevent corporations from accumulating earnings and not distributing them as taxable dividends (which are taxed to noncorporate shareholders at max of 20% + 3.8% NIIT if applicable)

Question 15

Professional corporation/association

Answer 15

Closely held corporation formed by licensed doctors, lawyers, accountants and engineers- provides retirement and other tax advantages available to corporate employees but not self-employed proprietors and partners (although federal tax law now provides similar benefits under both self-employment and corporate retirement plans)

Question 16

Tax-exempt organizations

Answer 16

entity that is “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition or for the prevention of cruelty to children or animals.”
Eg civic leagues, chambers of commerce, real estate boards, and pension funds.

Question 17

T/F: All tax-exempt organizations are non-profit organizations.

Answer 17

False. Non-profit status is a state law concept. Non-profit may make an organization eligible for certain benefits such as state sales, property, and income tax exemptions. Although most federal tax-exempt organizations are non-profit organizations, organizing as a non-profit organization at the state level does not automatically grant the organization exemption from federal income tax.

Question 18

Rules for capital gain and loss taxation

Answer 18

-LTCG vs LTCL
-STCG vs STCL
-NLTCP vs NSTCL
-NLTCL vs NSTCG
-If there’s NLTCG and NSTCG, then taxed as ordinary income
-If there’s NLTCL and NSTCL, can only deduct up to $3,000

Question 19

Dividends-Received deduction

Answer 19

• Deduct 50% if own <20%
• Deduct 65% if own 20-79.99%
• Deduct 100% if own >80%

Question 20

current corporate tax rate

Answer 20

flat 21%

Question 21

Corporate Penalty taxes

Answer 21

-accumulated earnings tax
-personal holding company (PHC) tax

Question 22

Accumulated Earnings Tax

Answer 22

Usually imposed on closely held corporations, on accumulated taxable income (above threshold of $250k/$150k if personal service corporation), to discourage individual taxpayers from using the corporate entity for tax avoidance
20%

Question 23

Personal Holding Company Tax

Answer 23

PHC that passes ownership test (>50% of the value of the outstanding stock is owned by five or fewer individuals during the last half year) and passive income test (at least 60% of adjusted ordinary gross income is personal holding company income/passive income including dividends, interest, and, under certain circumstances, rental income)

Calculated by multiplying undistributed personal holding company income by applicable PHC tax rate of 20%

Question 24

Capitalization of a Corporation

Answer 24

With equity securities (common/preferred stock) and LT debt-issued to shareholders (which is advantageous since interest payments are deductible as opposed to dividends, and repayment of debt is a tax-free return of capital to shareholders as opposed to dividend income treatment of stock redemptions); however can’t be too thinly capitalized or else IRS may recharacterize debt as equity

Question 25

Earnings and profits (E&P)

Answer 25

operating surplus on its capital, distribution would be considered taxable dividend

Question 26

Current year and accumulated earnings and profits (E&P)

Answer 26

distribution to shareholders is deemed to be made first out of current E&P and therefore results in a taxable dividend even if accumulated E&P at the beginning of the year is negative. Accumulated E&P represents the total of all prior years’ undistributed E&P amounts as of the first day of the tax year.

Question 27

Stock Redemption

Answer 27

Treated as:
-A taxable dividend (to the extent of E&P)
-An exchange of the stock, generally resulting in capital gain or loss treatment by the shareholder (subject to 20% max tax rate)
Depends on whether :
-substantially disproportionate to the shareholder’s interest(<80% interest in former common/voting stock).
- equivalent to a dividend (Voting Power, Participation in E&P, Share of Net Assets upon Liquidation)
-a complete termination of the shareholder’s interest (constructive ownership rules waived).

Question 28

Which type of treatment prevents corporations from paying disguised dividends in the form of a stock redemption, taxable as a capital gain?

Answer 28

Taxable dividend treatment prevents corporations from paying disguised dividends in the form of a stock redemption, taxable as a capital gain.

Question 29

What does a complete termination of a shareholder’s stock interest qualify for?

Answer 29

capital gain or loss treatment

Question 30

Special situations for redemption rules

Answer 30

-exchange (rather than dividend) treatment for noncorporate shareholder redemptions in a partial liquidation of the distributing corporation. The distribution must be made pursuant to the termination of an active trade or business of the distributing corporation or be considered not essentially equivalent to a dividend at the corporate level.
-executor of an estate or a beneficiary to have stock in a closely held corporation redeemed, whereby the redemption is treated as an exchange (rather than as a dividend) provided certain conditions are met. The redemption amount is limited to the death taxes imposed and the amount of deductible funeral and administration expenses incurred.

Question 31

Corporate distributions in complete liquidation

Answer 31

• Shareholders decide to terminate corporation’s existence
  -Assets are distributed in kind or sold and converted to cash
  -Once assets are distributed, the liquidated corporation is dissolved under state law

Question 32

Distribution of assets

Answer 32

Liquidation of corporation is treated as if sold at FMV (in case of liability, then the FMV is the greater of the actual FMV or amount of liability)

Question 33

Exception to G/L recognized in a liquidation (IRC 332)

Answer 33

neither the parent nor the subsidiary recognizes gain or loss if a parent corporation liquidates an 80%-owned subsidiary corporation, the subsidiary corporation must do either of the following:

Distribute all its property to the parent corporation in complete liquidation of its stock within a single tax year.
Make a series of liquidating distributions resulting in a complete liquidation over a 3-year period that commences with the close of the tax year in which the first liquidating distribution is made.

Question 34

Tax planning considerations for corporations

Answer 34

Capital structure and Section 1244,
Dividend policy,
Use of losses,
Charitable contributions, and
Dividend-received deduction

Question 35

Non business bad debts

Answer 35

deductible as STCL, $3,000 per year limitation; alternatively shareholders can capitalize the corporation using small business corporation stock, and can deduct up to $50k/$100k joint as ordinary loss

Question 36

Taxation of dividends from E&P

Answer 36

fully taxable to shareholders and are not deductible by the corporation.

Question 37

Use of losses as a tax planning consideration

Answer 37

A corporation should plan to use its net operating loss and capital loss carryovers

Question 38

Charitable Contributions

Answer 38

Owners of closely held corporations prefer to make charitable donations through their controlled corporations since corporations can deduct contributions

Question 39

Dividends-Received Deduction

Answer 39

Corporate shareholders may deduct the dividends received from other corporations in which there is ownership interest.

Question 40

In computing corporate net operating loss (NOL), which of the following is taken into consideration?

Answer 40

In computing a corporation’s NOL, the full dividends-received deduction is allowed. However, no deduction is permitted for an NOL carryover or carryback from a preceding or succeeding year.

Question 41

For purposes of the accumulated earnings tax, what are reasonable needs of the business

Answer 41

reasonably anticipated expansion of the business and plant replacement, acquiring the assets or stock of another business, providing working capital for the business, establishing a sinking fund to retire corporate debt, and making investments or loans to suppliers and customers, not stockholders

Question 42

Partnerships

Answer 42

legal entity owned by two/+ people to operate a business for profit, partners have unlimited personal liability incurred by business and the degree is proportionate to the amount of control a partner has in the partnership

Question 43

Pros/Cons of partnerships

Answer 43

-No restrictions on number/types of partners and not subject to double taxation
vs
GPs do not have LL, cannot choose tax year, and may be altered or destroyed upon death/withdrawal of a partner/transfer of interest

Question 44

General partnership

Answer 44

simplest form of a business organization: each partner has unlimited liability for partnership debts. Thus, these partners are at risk for more than their investment in the partnership.

Question 45

Limited Partnership

Answer 45

Permitted in most states and requires registration: at least one partner must be a limited partner. The general partners are liable for all partnership debts and the limited partners are liable only to the extent of their investment plus any amount they commit to contributing to the partnership if called upon. LPs act more like investors

Question 46

LLPs

Answer 46

registered under the law of one/+ states, attractive to professional service partnerships. Although partners are not considered employees, GPs are subject to self employment tax on share of partnership income

Question 47

Family Limited Partnerships (FLPs)

Answer 47

enables a family to hold and manage its wealth, including the family business, with several generations of family members as partners, can be an effective business entity for estate planning purposes, allowing families to retain control, develop succession plan, transfer assets at lowest cost, reduce income tax liability

Question 48

S Corporations

Answer 48

special corporation treated as flow-through entities, less flexibility than partnerships:
Have no more than 100 shareholders,
Be a domestic corporation,
Have no shareholder who is a nonresident alien, and
Have only one class of stock (S corporations cannot have common and preferred shares, but shares can be voting and non-voting stock).

Question 49

Pros/Cons of S Corporation

Answer 49

-Not subject to double taxation and shareholders have limited liability
vs
-Restrictions on #/types of shareholders, must use calendar year, shareholders owning >2% of stock are not eligible for tax-free fringe employment benefits

Question 50

LLC

Answer 50

Combines the advantages of a C corporation with those of a partnership. All owners called “members” enjoy limited liability, although in some states they are not shielded from liabilities stemming from personal negligence. Unlike an S corporation, an LLC can have an unlimited number of members who can be individuals, corporations, estates, or trusts.
Formed by state registration process similar to corporations.
LLC with 2/+ owners may elect to be taxed as corporation or partnership and must be made within 1st tax year

Question 51

Pros/Cons of LLC

Answer 51

LLCs have a liability advantage similar to corporations and a tax advantage like partnerships. The creation of the entity is more complex and formal than general partnerships. Unlike S Corporations, LLCs do not have limited number of partners.
When taxed as partnership:
Special allocations with the concept of substantial economic effect,
Guaranteed payments,
Self-employment taxes owed by the general partners, and
Recourse and qualifying non-recourse debt for partners as it relates to their basis in the entity.
Members of an LLC that meet the federal income tax definition of a partnership are subject to self-employment tax and can deduct health insurance premiums. An LLC is liable for payroll and excise taxes but avoids double taxation on income.

Question 52

features of a partnership

Answer 52

• no restrictions on the number/ types of partners in a partnership.
• can be created informally and profits and losses are divided according to the partnership agreement.
  -defined as a syndicate, group, pool, joint venture or unincorporated organization that carries on any business, financial operation or venture, and a partner is a member who can be an individual, corporation, trust or estate.

Question 53

Dean Accounting did not want to be liable for each partners’ conduct, so it converted to a different flow-through business entity. Identify the most suitable form of flow-through entity for Dean Accounting.

Answer 53

The LLP form limits legal liability. Under state LLP laws, partners are liable for their own acts and the acts of individuals under their direction. LLP partners are not liable for the negligence or misconduct of other partners. This entity is attractive to professional service partnerships, such as public accounting firms.

Question 54

Nonrecognition rule of partnership

Answer 54

Gain/loss upon transfer of property in exchange for partnership interest or subsequent transfers not recognized since change in ownership form; also depreciation recapture rules do not apply; unless partner acts in capacity other than partner/contributes services instead of property/recognizes gain if liabillities transferred exceed basis, or treated as investment company

Question 55

Basis of Partnership Interest

Answer 55

the sum of money contributed plus the adjusted basis of other property transferred to the partnership. services rendered are at FMV

Question 56

Section 752 Adjustment

Answer 56

a partner’s basis in the partnership interest increases by the partner’s share of any changes in the partnership’s liabilities during the year. Made for recourse liabilities and qualifying non-recourse liabilities

Question 57

Items affecting basis of partnership

Answer 57

Items Basis Change
Pass-through of ordinary net income Increase
Pass-through of ordinary loss Decrease
Cash contributions from partners Increase
Cash distribution to partners Decrease
Partnership increases liabilities* Increase
Partnership decreases liabilities* Decrease
Partnership makes charitable contribution Decrease
Partnership has Section 179 expenses Decrease
Pass-through of capital gain Increase
Pass-through of capital loss Decrease
Pass-through of dividend and interest income Increase
Partnership has tax-exempt income Increase
Partnership has nondeductible expenses Decrease

Question 58

Negative Basis Rule

Answer 58

The basis of a partnership interest cannot be negative. Therefore, Section 731 requires recognition of a gain in situations where a negative basis would otherwise occur.

Question 59

Holding Period for Partnership Interest

Answer 59

If a partner contributes only cash to the partnership in exchange for a partnership interest, the holding period begins on the date that the interest is acquired.
If the partner contributes property, the holding period for the partnership interest generally includes the holding period of the contributed property.
If the contributed property is other than a capital asset or Section 1231 property, the holding period begins on the date that the partnership interest is acquired.

Question 60

Erica contributes cash to the XYZ partnership in exchange for a partnership interest. When does the holding period begin for Erica?

Answer 60

If a partner contributes only cash to the partnership in exchange for a partnership interest, the holding period begins on the date the interest is acquired.

Question 61

Basis of Partnership Assets

Answer 61

IRC Section 723 provides a carryover basis rule for property contributed to the partnership.

Partners increase the basis of their partnership interests by their share of tax-exempt income because it ensures that the income will retain its tax-free character when the income is subsequently distributed in the form of cash or the partner’s interest in the partnership is sold or exchanged.

Question 62

Financial Accounting Considerations

Answer 62

Under Generally Accepted Accounting Principles (GAAP), the carryover basis and nonrecognition rules used in taxation do not apply.

Question 63

Organizational and Syndication Fees

Answer 63

partnership can deduct up to $5,000 of the costs of organizing the partnership in the year the partnership begins business, limited to the lesser of (1) the amount of organizational expenditures or (2) $5,000, reduced by the amount by which such organizational expenditures exceed $50,000.

Organizational expenditures: attorney’s fees for drafting the partnership agreement, the accountant’s fees for setting up the financial record system, and filing fees.

Syndication fees: need to capitalize but not amortize expenses to promote and market partnership interests (usually associated with tax-sheltered limited partnership interests). Examples of nondeductible syndication fees include brokerage and registration fees, legal fees of the underwriter and issuer, and printing costs associated with the prospectus and promotional materials.

Question 64

Partnership Operations

Answer 64

Certain items like capital gains/losses, charitable contributions and Section 1231 gains/losses are segregated and passed through to partners since tax effects depend on partner’s tax situation

Partnership ordinary income: gross profit, salaries, tax, bad debt/repair expenses, Section 1245 & 1250 depreciation recapture

Question 65

Special allocations

Answer 65

permits partners some latitude to decide how income, deductions, losses, and credits are to be allocated among the individual partners, but also restrict the partners’ freedom to shift tax benefits among individual partners

Question 66

Partnership Allocations

Answer 66

All partners must determine their share of income, deductions, losses and credits if any partner’s interest in partnership changes. Retroactive allocations may not be made to new partners admitted during tax year

Question 67

Basis Adjustments for partnerships

Answer 67

Adjustments are made to original cost basis for ordinary income (or loss) and separately stated items that flow through to the shareholders, as well as additional capital contributions by shareholders and distributions to shareholders.

Question 68

Loss limitations

Answer 68

deductibility of the losses to the partner’s adjusted basis in his or her partnership interest as determined at the end of the partnership’s tax year is limited and carries forward once basis is reduced to 0

Question 69

Passive Activity Loss Limitation

Answer 69

partner may not deduct passive loss against earned or portfolio income, but may deduct the loss only against other passive income.

Question 70

Transactions between Partner and Partnership

Answer 70

-Losses are not allowed on sales/exchanges between a partner and the partnership, or between two partnerships where the partner owns more than a 50% interest
-Gains are treated as ordinary income instead of capital gain if the partner owns more than s 50% interest in the partnership and if the exchanged asset is not a capital asset

Question 71

Partnership Distributions

Answer 71

A distribution of cash or property from the partnership to a partner is generally treated as a tax-free return of capital:
-Liquidating distribution: The partnership may desire to liquidate a partner’s entire interest due to retirement, death or other business reasons. In such cases, the liquidating distribution is treated as a sale or exchange of the partnership interest.
Non-liquidating distribution: Distribution may result in reduction of partner’s capital interest in partnership. Does not result in a taxable gain/loss to partner unless the distribution includes cash/marketable securities in excess of partner’s basis in the partnership interest
-

Question 72

S Corporation requirements

Answer 72

• domestic corporation
• max of 100 shareholders
  -only citizens/resident aliens, estates, certain trusts and certain tax-exempt organizations can be shareholders (cannot be C corporation)
• Only one class of stock may be issued and outstanding. Multiple classes may only be used if the only difference is voting rights
  -cannot maintain special tax statuses
• if it has an 80%/+ owned subsidiary, it cannot file a consolidated tax return with that subsidiary as there are special rules for a QSSS (Qualified subchapter S Subsidiary)

Question 73

S Corporation Election requirements

Answer 73

All shareholders on the S election date must consent and the corporation must file Form 2553. To be effective for the election year, the S election and consent form must be filed on or before the fifteenth day of the third month of the election year.
-IRS can waive the election deadline/grant relief for improper elections if reasonable cause/inadvertent

Question 74

S Corporation Termination Rules

Answer 74

• for voluntary revocation, need consent from shareholders owning >50% of S Corporation’s stock: revocation is effective for the entire year if made on or before the 15th day of the 3rd month of the tax year; otherwise, the termination is effective the 1st day of the next tax year unless a prospective termination date is specified.
• involuntary revocation if S Corporation fails to meet its qualifications or has excessive passive investment income (>25% of gross receipts) in a 3 year period
  -may not re-elect S-Corporations status for 5 yrs

Question 75

S Corporation operating rule with regards to spouses

Answer 75

• Husband and wife are treated as one shareholder, so problematic if there’s a divorce or death and the stock is separated or goes to heirs who do not already own stock

Question 76

Subsidiaries of S Corporations

Answer 76

If stock ownership of C Corporation exceeds 80%, S (parent) and C (Subsidiary) corporation are considered an affiliate group. May not file consolidated return.

-QSSS if S Coporation owns 100% of QSSS stock and all assets, liabilities, income, deductions, and credits of the QSSS are treated as those of the parent S corporation.

Question 77

One class of stock for S Corporation

Answer 77

Safe harbor rule provides that straight debt shall not be treated as a second class of stock if interest rate isn’t contingent on profits, debt cannot be convertible to stock and creditor must be either person eligible to be S corporation shareholder or person actively in business of lending.

Treasury: only one class of stock if all outstanding shares of stock confer identical rights to distribution and liquidation proceeds

Question 78

S Corporation Operations

Answer 78

Income, gains, losses, deductions, and credits pass through to the S corporation’s shareholders similar to partnership and allocated on a per-share per day basis:
-ST&LT CG/L
-Section 1231 G/L
-charitable contributions
-credits
-interest on investment indebtedness
-AMT adjustments and tax preference items
-foreign taxes paid/accrued
-dividends and other portfolio income

-organizational expenditures can be amortized over a period of at least 60 months under the general corporate taxation rule; however not entitled to other corporate deductions

Question 79

Basis adjustments for S Corporations

Answer 79

basis for S corporation stock is either the amount paid for the stock or a substituted basis from a nontaxable transaction (e.g., a Sec. 351 tax-free corporate formation transaction). Adjustments are subsequently made for ordinary income (or loss) and separately stated items that flow through to the shareholders, as well as additional capital contributions by shareholders and distributions to shareholders.

Question 80

Passive Activity Loss Limitation for S Corporations

Answer 80

passive losses can only offset other passive activity income. S corporation shareholders who materially participate (that is, participate on a regular, continuous and substantial basis) can avoid the passive activity loss limitations.

Question 81

Losses and Limitations for S Corporations

Answer 81

ordinary loss and any separately stated loss and deduction items of an S corporation are allocated among the shareholders based on the number of shares of stock owned on each day of the S corporation’s tax year.

Question 82

Restoration of Basis for S Corporations

Answer 82

If shareholder’s debt basis in a loan is reduced by a loss deductions, subsequent increases in basis from S Corporation income in a future year increases/restores the debt basis. Excess positive adjustment increases stock basis.
If the debt basis is not fully restored, gain results when loan is repaid: if in the form of a note, then results in a capital gain; if an unsecured advance, then income

Question 83

Other S Corporation Considerations

Answer 83

• LIFO recapture: If a C corporation converts to an S corporation, and had used the LIFO (Last-in-first-out) method of accounting for its inventories while a C corporation, the firm must recapture the LIFO reserve. If the FIFO (First-in-first-out) method of accounting for inventory is higher (usually it would be), the firm must pay tax on this LIFO recapture (the entire reserve) in four annual installments (the first installment is due the last year as a C corporation, and the remaining three as an S corporation).

-Distributions of cash and property to shareholders treated a return of capital is S corporation has no accumulated earnings and profits. The S corporation recognizes gain (but not loss) if it distributes nonmoney property to its shareholders.

-Tax year restrictions,
Treatment of fringe benefits,
Corporate tax on built-in gains, and
Tax on excess net passive income.

Question 84

Tax year restrictions

Answer 84

S corporations must use a calendar year unless a business purpose can be established for choosing a fiscal year-end. Like a partnership, an S corporation may elect a maximum three-month deferral if it agrees to make a special tax payment each year that approximates the deferral benefit.

Question 85

Treatment of Fringe Benefits for S Corporation shareholders

Answer 85

S corporation shareholders who own >2% of the outstanding stock are not eligible for tax-free corporate employee fringe benefits for the following statutory fringe benefits since they are included in the gross income as a guaranteed payment:
The group term life insurance exclusion under Section 79 for premiums paid for a coverage of up to $50,000.
The exclusion from income for premiums paid for accident and health insurance and medical reimbursement plans under Section 105 and Section 106.
The exclusion for cafeteria plan benefits under Section 125.
Employer-provided fringe benefits under Section 132.
Meals and lodging furnished for the convenience of the employer under Section 119.
<2% excluded by shareholder and deductible by corporation

Fringe benefits not subject to a special treatment for >2% shareholder:
Stock options
Qualified fringe benefits
Nonqualified fringe benefits
Compensation for injuries and sickness
Educational assistance programs
Dependent care assistance programs
No additional-cost fringe benefits, qualified employee discounts, working condition fringe benefits, de minimis fringe benefits, and on-premises athletic facilities.

Question 86

Corporate Tax on Built-In Gains

Answer 86

A 21% corporate tax on built-in gains applies if a corporation that previously was a C corporation elects to be an S corporation (if the FMV exceeds it adjusted basis on the first day s election is effective). If the corporation sells an asset with a built-in gain within the five-year period beginning on the effective date for the election, the S corporation is taxed on the built-in gain. Built in losses can be used to reduce built in gains

Question 87

Tax on Excess Net Passive Income

Answer 87

A 21% excess net passive income tax applies when an S corporation has passive investment income for the tax year that exceeds 25% of its gross receipts and, at the close of the tax year, the S corporation has accumulated Subchapter C E&P. Subchapter C E&P is the earnings and profits the corporation earned when it was taxed as a C corporation.

Question 88

Tax Planning Considerations

Answer 88

decision select business organization depends on tax and nontax issues, eg:
-non-tax: corporate may be preferred for limited liability, freedom to transfer ownership interests/ability to raise outside equity capital
-tax issues: partnership/S Corp may be preferred with double taxation. closely held C corporation, payment of compensation or rent by the corporation to the shareholders may reduce or eliminate the double taxation issue

Question 89

Use of Operating Losses

Answer 89

May prefer partnership if expecting operating losses in the initial years of operation (no benefit for C Corporations if it can’t generate enough profits to offset loss carryovers). S corporation’s ability to pass through losses is limited to shareholder’s basis in stock and any shareholder loans. S corporation liabilities such as loans to the corporation are not included in determining shareholder’s loss limitation since shareholders are not liable for such loans.

Partnership may provide >opportunity to deduct losses than S Corporation

Question 90

Optional Basis Adjustment

Answer 90

usually desirable for an incoming partner whose partnership interest costs more than the tax basis of his or her share of the partnership’s assets- all partners must agree

Question 91

What is the basis of each partnership interest adjusted to reflect

Answer 91

partner’s share of income and deduction items.

Question 92

Carl, partner with a $10,000 basis in the ABC Partnership, receives property having a FMV of $20,000 and a basis of $8,000 in a non-liquidating distribution. How much gain does Carl recognize?

Answer 92

0: A partner recognizes gain only when the amount of cash distributed exceeds the basis of the partnership interest.

Question 93

Net Operating Losses (NOLs) generated in 2023 may be carried back ____ years and carried forward _______ years.

Answer 93

You cannot carry back your NOL, but you can carry it forward an indefinite number of years, and NOL can offset only up to 80 percent of your taxable income before your 20 percent Section 199A deduction

Question 94

If a worker is hired for a job and the employer has the right to control or direct only the result of the work and not the means and methods of accomplishing the result, the worker is BEST categorized as a(n)

Answer 94

An independent contractor: If the person for whom the services are performed has the right to control or direct only the result of the work and not the means and methods of accomplishing the result.

Question 95

A qualified personal service corporation (QPSC/accounting, law, health, architecture, and consulting) must use the _____ rate to calculate its tax liability.

Answer 95

21%
May use cash method of accounting, cannot elect alt tax year

Question 96

If a tax-exempt organization has unrelated business taxable income (UBTI) exceeding ______ in 2023, it must pay income tax on that income.

Answer 96

$1,000

Question 97

Each of the following facts provides evidence of the degree of control and independence of a hired worker EXCEPT:

Answer 97

Form of Compensation

Evidence of degree of control and independence fall under:
-Behavioral: Does the company have the right to control what the worker does and how the worker does his job?
-Financial: Are the business aspects of the worker’s job controlled by the payer?
-Type of Relationship: Are there written contracts or employee benefits? Will the relationship continue and is the work performed a key aspect of the business?

Question 98

The accumulated earnings tax rate is ____ on excess accumulated earnings above a specified threshold.

Answer 98

The accumulated earnings tax rate is 20% on excess accumulated earnings above a specified threshold of $250,000 ($150,000 for a personal service corporation)

Question 99

Under IRC Section 731 basis of a partnership interest

Answer 99

cannot be negative

Question 100

Each of the following facts provides evidence of the degree of control and independence of a hired worker:

Answer 100

-Behavioral: Does the company have the right to control what the worker does and how the worker does his job?
-Financial: Are the business aspects of the worker’s job controlled by the payer?
-Type of Relationship: Are there written contracts or employee benefits? Will the relationship continue and is the work performed a key aspect of the business?

Question 101

If a tax-exempt organization has unrelated business taxable income (UBTI) exceeding ______ in 2023, it must pay income tax on that income.

Answer 101

$1,000

Question 102

Net Operating Losses (NOLs) generated in 2023 may be carried back ____ years and carried forward _______ years.

Answer 102

You cannot carry back your NOL, but you can carry it forward an indefinite number of years, and
Your NOL can offset only up to 80 percent of your taxable income before your 20 percent Section 199A deduction.

Question 103

In the current year, B and C form BC Partnership. The partners will each own 50% of the partnership capital, profits, and losses. B contributes $140,000 and C contributes property with a FMV of $140,000 and an adjusted basis of $60,000. This year, the partnership generates $200,000 of taxable losses.

Calculate the losses that Partner C can take this year.

Answer 103

Losses are deductible for members of a partnership to the extent of their tax basis in the partnership. Partner B has a beginning basis of $140,000 and Partner C has a beginning basis of $60,000.

Since the capital, profits, and losses are split 50% / 50%, Partner B would be able to fully deduct the $100,000 of allocated losses while Partner C would only be able to deduct $60,000, with the additional $40,000 of loss suspended to a future year in which his basis becomes positive again.

At the end of the first year of operations, Partner B’s basis has been reduced to $40,000 and Partner C’s basis has been reduced to $0.

Question 104

The accumulated earnings tax rate is ____ on excess accumulated earnings above a specified threshold.

Answer 104

The accumulated earnings tax is imposed on a corporation’s accumulated taxable income for a particular year. The accumulated earnings tax rate is 20% on excess accumulated earnings above a specified threshold of $250,000 ($150,000 for a personal service corporation).

Question 105

In a liquidation of an S Corporation, the event is taxable at

Answer 105

corporate level and taxable at the shareholder level through a passthrough of corporate tax items.

Question 106

Dean Accounting did not want to be liable for each partners’ conduct, so it converted to a different flow-through business entity. Identify the most suitable form of flow-through entity for Dean Accounting.

Answer 106

The Limited Liability Partnership (LLP) entity limits legal liability. Under state LLP laws, partners are liable for their own acts and the acts of individuals under their direction. LLP partners are not liable for the negligence or misconduct of other partners. This entity is attractive to professional service partnerships, such as public accounting firms.

Question 107

In a liquidation of a C Corporation, the event is taxable to __

Answer 107

both the corporation and the shareholders.

Question 108

Which of the following MUST have restrictions on participation in management within the tax entity?
S Corporation shareholders
General Partners in a partnership
Limited Partners in a partnership
Members of a Limited Liability Corporation

Answer 108

Limited Partners in a partnership:
Within a partnership, generally, there are no restrictions on management participation, except participation by limited partners must be restricted in order to preserve limited liability.

Question 109

Each of the following permits the deduction of the tax entity’s losses to the extent of their tax bases, including their allocable share of debt for which they are liable, EXCEPT:

Answer 109

C Corporation shareholders may not deduct any of the corporation’s losses.