Tax Characteristics of Entity

Question 1

Does a Sole Proprietor require a EIN number

Answer 1

only if there are employees in the Sole Proprietor

Question 2

What method of accounting does a Personal Service Corporation use

Answer 2

A qualified personal service corporation (QPSC) is exempt from the rule that generally requires C corporations to use the accrual method of accounting. It may, instead, use the cash method.

Question 3

Compensation Deduction Limitation

Answer 3

A publicly held corporation is denied a deduction for compensation paid to its chief executive officer and its four highest-compensated officers if the compensation amount for any individual exceeds $1 million per year. The following types of compensation are not taken into account for purposes of the $1 million limitation:

remuneration payable on a commission basis
compensation based on individual performance goals (if approved by certain outside directors and shareholders)
payments to a qualified retirement plan, and
tax-free employee benefits, such as employer-provided health care benefits

Question 4

Computation of Tax for Corporations

Answer 4

The corporate income tax rate is a flat 21% of taxable income.

Question 5

Capitalization of a Corporation

Answer 5

A corporation may be capitalized with both equity securities (generally common or preferred stock) and long-term debt issued to the shareholders. Issuance of debt in the capital structure has the following advantages:

The interest payments on the debt are deductible by the corporation, whereas dividends are not deductible.
Redemptions of stock may result in dividend income treatment to the shareholders unless certain requirements are met, whereas a repayment of debt is a tax-free return of capital.
If the corporation is too thinly capitalized (for example, excessive amounts of debt are issued relative to the amount of equity capital), the IRS may attempt to recharacterize the debt as equity and deny an interest deduction to the corporation. IRC Section 385 provides the following guidelines for determining whether debt is recharacterized as equity:

Question 6

How much can an S-Corp owner take in distributions?

Answer 6

The 60/40 rule is a simple approach that helps S corporation owners determine a reasonable salary for themselves. Using this formula, they divide their business income into two parts, with 60% designated as salary and 40% paid as shareholder distributions.

Question 7

What are the criteria to qualify as a S Corp

Answer 7

To qualify as an S corporation, a business must meet the definition of a small business corporation. To meet this definition, the entity must have the following requirements:

1. Must be a domestic (U.S.) corporation rather than a foreign corporation
2. Must not be an ineligible corporation
3. Must not have more than 100 shareholders
4. Must have only individuals, estates, certain kinds of trusts and certain kinds of tax-exempt organizations as shareholders
5. Must not have a nonresident alien as a shareholder
6. Must issue only one class of stock

Question 8

Election after Termination

Answer 8

If an S corporation terminates its election either by ceasing to be a small business corporation or by revocation, the corporation may not re-elect S corporation status for five years unless the IRS consents to an early re-election. For purposes of the five-year rule, tax years beginning before January 1, 1997 are not counted.

Question 9

LIFO Recapture

Answer 9

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 (21%) 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).