Unit 1 Flashcards
What percentage of businesses are sole proprietor ships?
70%
Is a sole proprietorship a legal entity?
No – a sole proprietorship is not a separate legal entity
It is an unincorporated business that is owned and controlled by one person
It may be a single person business or have several employees, but there is only one owner who accepts all the risk and liability of the business
A sole proprietorship – passing onto a new owner
It cannot be passed on to a new owner as the same business entity
Sole proprietorship is sold – it must be operated by the new owner as either
- A different proprietorship.
Or
- A different type of business entity through a sale of assets of the business.
An activity qualifies as a business if…
It’s primary purpose is for profit
And if the taxpayer is involved in the activity with continuity and regularity
So proprietors are required to report on schedule C with a net earnings of
$400
Partnerships
A relationship that exists between two or more taxpayers who join together to carry on a trader business
Each taxpayer contributes money, property, labor, or skill, and expects to share in the profits and losses of the business
Partnerships – filing requirements, paying taxes
Must file an annual information return to report the income, deductions, gains, and losses from its operations
But the partnership itself does not pay income tax
Profits or losses pass through to its partners on a K – one, who are then responsible for reporting their respective shares of the partnerships, income or loss on their own returns
Where is partnership income reported on a 1040
Page 2 of schedule E, supplemental income and loss
CPAR
What does it stand for, what does it mean?
Centralized partnership audit regime
In the event, a partnership tax return is audited – the partnership itself will be subjected to pay income tax if it is determined that it had originally under reported it’s taxable income on the return
A partnership can elect out of CPAR on the 1065 on schedule B-2
CPAR - electing out
A partnership can elect out of the CPAR if it meets all the following requirements
- Must have 100 or fewer partners during the year.
- Has only eligible partners which include:
- Individuals (not LLC’s or trusts)
- C corporations, or foreign entities classified as corporations
- S corporations
- estates of deceased partners, but not bankruptcy estates
Partnerships with just one nonqualified partner cannot opt out of the CPAR
CPAR - partnership representative
The CPAR requires partnerships to designate a partnership representative with the filing of their tax return
Representative is not required to be a partner
Can be an individual or a business entity and must have a substantial presence in the US
Representative has the authority to make decisions for the partnership during the course of an audit
Partnership – how many partners can there be?
A partnership can have an unlimited number of partners
Partners can be foreign or domestic
Must always have at least one general partner, whose actions legally bind the business and who is legally responsible for a partnerships, debts and liabilities
Can be a small business run by a married couple
Can be a complex business organization with thousands of general partners and limited partners
The default legal classification for a partnership
The default is a general partnership where all partners are general partners with each partner, jointly and severally liable for the debts and obligations of the partnership
Joint undertaking or coownership
Not automatically a partnership
Co-owners of a rental property is usually not considered a formal partnership unless the co-owners provide substantial services to the tenants
Are partners employees of the business
No – they should not be issued a form W –2
They would receive a copy of schedule K – 1
The 1065 return must show the name and address of each partner and the partners share of taxable income
The 1065 must be signed by a partner or member
LP - what is it?
A limited partnership
A partnership that has at least one limited partner in addition to its general partner or multiple general partners
A limited partnership allows an investor (the limited partner) to own an interest in a business without assuming personal liability or risk beyond the amount of their investment
LP - application requirement
A limited partnership is a state level entity
In order to form an LP - a certificate of limited partnership or certificate of formation must be filed with the secretary of state where the partnership chooses to do business
LLP - what is it?
A limited liability partnership
An entity that is formed to understate law and generally used for specific professional services such as a law firm or a CPA firm
An LLP allows each partner to actively participate in management affairs, but still provide limited liability protection to each partner
A partner would only be at risk for their own malpractice and or their own interest in the partnerships assets – not for the other partners
Why would a business choose to form an LLP instead of an LLC?
Some states prohibit the formation of an LLC for certain business types
For example, – California and New York – LLC’s cannot provide certain professional services like doctors, CPAs, attorneys, veterinarians, and other license professionals
Married couple businesses and qualified joint ventures – what are they considered?
Often a small business is operated by spouses without incorporating or creating a formal partnership agreement
But the business is still considered a partnership, whether or not there is a formal partnership agreement
QJV - what is it, filing
Qualified joint venture
A business owned by a married couple who both materially participate, and they are the only members
Allows the couple to avoid filing a partnership return
Each spouse would still file their own schedule C and separate schedules SE
Only available to married couples who filed joint tax returns
Only available to businesses owned and operated by spouses as co-owners and not in the name of a state law entity (LLC and LP do not qualify)
MMLLC
Multi member limited liability company
If it is treated as a partnership for tax purposes, must file form 1065
Community property state – qualified joint venture – LLC
If a couple owns a business that they run as a qualified joint venture
And decide to form an LLC for liability protection
As long as they live in a community property state
They can continue to report their income and loss on schedule Cs by making an election to be treated as a qualified joint venture
If they do not live in a community property state – must file form 1065
There are currently nine community property states
C Corporations - what is it, how is it formed, filing?
When forming a corporation – prospective shareholders, provide money, property, or both in exchange for the issuance of stock
A corporation is considered an entity separate from its shareholders and must elect a board of directors responsible for the oversight
Most major companies are organized as C corporations
Can have an unlimited number of shareholders, and maybe either foreign or domestic
Annual tax return on form 1120
After tax profits distributed to shareholders through dividends – resulting in double taxation
C Corporation tax rate
All C corporations are taxed a 21% flat rate, regardless of their size or business activity
S corporation - how is it formed, tax and filing?
It is a distinct form of entity, organized as a corporation for legal purposes
But elected with the IRS for tax purposes
Corporation is generally not subject to tax – it’s income, losses, deductions, and credits are passed through directly to its shareholders, similar to a partnership
On rare occasions, the corporation may be responsible for income tax on certain built-in gains and passive investment income
Required to file an annual income tax return – 1120-S
Reports each shareholders share of income or losses on schedules K – 1
S-corporations must meet the following following requirements
- Be a domestic corporation with 100 or fewer permitted shareholders (partnerships, corporations, and non-resident aliens are not eligible)
- Have only one class of stock – voting and non-voting stock are not considered to be separate classes of stock as long as they have identical rights to distribution and liquidation proceeds.
- Not an eligible type of corporation – certain financial institutions, insurance companies, and domestic international sales corporations are not eligible for S corporation status.
PLLC
Professional service limited liability company
LLCs -
Formed under state law by filing articles of organization
Depending upon whether it has a single owner or multiple owners, an LLC will be treated for federal tax purposes as :
- A disregarded entity.
- A partnership.
- A corporation if the entity elect to be treated as a corporation.
Most LLCs are taxed as partnerships
The benefit of an LLC
An LLC can provide the liability protection of a corporation
With the tax benefits of a partnership
Unlike a partnership, none of the members of an LLC are personally liable for its debts
What determines whether a business qualifies as a farming business
It is based on the nature of the activity
Not the entity type
Includes crop production, animal, production, forestry, and logging, fishing
Tax exempt organizations- nonprofits - what type of entity can they be and NOT be?
Nonprofit organizations may be created as corporations, trusts, or unincorporated associations
But never as partnerships or soul proprietorships
Tax exempt organizations - requesting status and filing requirements
Most charitable organizations must request tax exempt status by filing form 1023 – application for recognition of exemption
Churches are treated as tax exempt by default and do not have to apply for formal exemption
Most nonprofits must annually file form 990, return of organization, exempt from income tax to report its income and losses
Form 990 is an informational return only, but maybe taxed on unrelated business activities on a separate form (form 990-T)
Small organizations can file either a form 990 – EZ or the 990 – N
Entity classification election
Certain business entities may choose how they will be classified for tax purposes by filing form 8832
Once a business entity makes an election to change its classification, it cannot change the election again within five years or 60 months
How long should businesses keep records?
At least three years from when tax return was due or was filed whichever is later
If a business has employees, it must keep all employment tax records for at least four years
Records related to property must be kept until the statute of limitations expires for the year in which the property is sold or otherwise disposed of
Records related to the basis of property may need to be kept for even longer in determining the basis of replacement property
A business must apply for an EIN if any of the following apply
- The business pays employees.
- The entity operates as a corporation, exempt organization, trust, estate, or partnership.
- The business files any of these tax returns (employment, taxes, or payroll, taxes, excise, tax, alcohol, tobacco, and firearms)
- The business withhold taxes paid to a non-resident alien.
- The business establishes a pension, profit, sharing, retirement plan.
A new EN is required for any of the following changes
- When a sole proprietor or partnership decides to incorporate, or when a sole proprietor, takes on a partner and becomes a partnership.
- When a partnership becomes a sole proprietorship – example one partner dies
- When a sole proprietor files for bankruptcy under chapter 7 or chapter 11.
- When taxpayer terminates one partnership and begins another partnership.
- When a business establishes a pension, profit-sharing, or retirement plan.
- the individual owner dies, and the business is taken over by the estate – the new EIN would be the EIN of the estate
A business does not need to apply for a new EN in the following instances
- Merely to change the name or address of a business.
- To change the location or add more business locations.
- If a sole proprietor operates multiple businesses.
Applying for an EIN
Most taxpayers can apply for an EIN online or paper file form SS –4, application for employer identification number
IRS e-file mandate
Any business filing 10 or more returns or statements will be required to file the forms electronically
The mandate includes form 1099 and W – 2
If an employee fails to complete a form, W-4…
The employer must withhold federal income taxes from wages as if they were single and taking the standard deduction
Businesses need to issue a form 1099 – NEC
Report non-employment compensation of $600 or more paid during the year to certain independent contractors
Amounts reported on the 1099 – MISC include
$600 or more for rent, prizes and awards, crop proceeds, and certain medical and healthcare payments
Royalties over $10
Gross proceeds paid to an attorneys office, when the total amount is $600 or more
Form 1099-k
Payment card and third-party network transactions
Like PayPal, square and stripe
Reporting requirement is $600 ($5,000 phased in in 2024)
Issuing a form 1099 – INT
A business not in a line of a business that pays interest as part of its regular activities – must report interest paid to any single individual taxpayer when the total is $600 or more for the year
For banks and similar institutions, the reporting requirement threshold is $10 or more per year
Form 8300, report of cash transactions over $10,000
When a business receives a cash payment of more than $10,000 from one transaction, it must file for 8300, report of cash payments over $10,000 received in a trader business, within 15 days after they receive the cash
This type of transaction is also called a designated reporting transaction
Business must also provide a written statement to each person or customer named on any form 8300 that is filed
The statement must be provided to the customer no later than January 31 of the following year
Businesses receiving over $10,000 in cash during two or more related transactions must also treat the transactions as a single transaction and file form 8300
cash includes coins and currency, cashiers checks, bank, transfers, travelers checks, as well as cash and a foreign currency
Does not include bank wire, transfers, credit card transactions, ACH transactions, or amounts paid with personal checks
Purpose of the form 8300 is to assist law-enforcement and its anti-money laundering efforts
The IRS evaluates three primary characteristics to determine the relationship between a business and workers it pays for services
- Behavioral control – covers whether the business has a right to direct or control. However, the work is done.
- Financial control whether the business has a right to direct or control the financial and business aspect of the workers job. Factors include how the worker is paid whether expenses are reimbursed, and whether tools and supplies are provided.
- type of relationship – the worker and the business owner perceive their relationship, such as whether there are written contracts or employee type benefits, such as vacation pay or a retirement plan
Form SS-8
Determination of worker status for purposes of federal, employment, taxes, and income tax withholding
Maybe filed by either of the business or the worker
The IRS will review the case to officially determine the worker status
Back Up withholding
If a business does not request a SSN or taxpayer identification number for a payee
It must withhold federal income taxes, 24% rate
For nonresident aliens, they are subject to withholding rate of 30% unless they lower tax trading rate applies
Statutory Employees
Issued a w-2, but report wages on schedule C
Statutory employee in box 13 on form W – two is checked
Statutory employees are usually sales people or other employees who work on commission
Not required to pay self-employment tax, because their employers must treat them as employees for Social Security tax purposes
Statutory non-employees
Direct sellers
Licensed real estate agents
Certain companion sitters
Treated as self-employed for federal tax purposes If:
- Payments for services are directly related to sales rather than the number of hours worked
- Services performed under a written contract, providing that they will not be treated as an employee for federal tax purposes.
- Companion sitters, not employees of a companion sitting placement service treated as self-employed.
Compensation reported on form 1099 – NEC
Taxpayer reports income on schedule, see and pay self-employment tax
Employing family members – a child working for a parent
If the parents business is a sole proprietorship or a spousal partnership…
So if the child is under 18, wages are not subject to Social Security and Medicare taxes
If the child is under 21 payments are not subject to FUTA tax
All payments are subject to income tax withholding
These special rules for children do not apply if the business is organized as either a C corporation or an S corporation… would be required to pay Social Security tax, Medicare tax, and FUTA tax
Spouse employed by a spouse
Wages are not subject to FUTA tax if the business is a sole proprietorship
But does not apply for a corporation or partnership
Social Security wage limit in 2024
168,600
FUTA tax rate
6% for up to 7,000 for EACH employee
Self-employment tax for general partners versus limited partners
General partners report their income on schedule, C and our subject to self-employment tax and additional Medicare tax
Limited partners considered passive activity income and is generally not subject to self-employment tax or the additional Medicare tax
TFRP
Trust fund recovery penalty
Trust fund taxes, referred to amounts withheld from employees wages (Social Security, Medicare, and income tax) by employers and held in trust until they are remitted to the treasury
This penalty is also called the 100% penalty
If a business does not deposit it trust fund taxes in a timely manner, the IRS may assess a trust fund recovery penalty
The amount of the penalty is equal to the unpaid balance of the taxes
The TRP may be assessed against any person who
1. is responsible for collecting or pain, withheld income and employment taxes, or for paying collected, excise taxes, and
2. Will fully fails to collect or pay them.
How many shareholders can an S corporation have?
And S corporation cannot have an unlimited number of shareholders. Only a C corporation can.
NS corporation is generally limited to know more than 100 shareholders
Self-employment – when are you required to file an income tax return and a schedule SE
When net earnings from self-employment are $400 or more
Net earnings not gross profit
