Unit 9 Flashcards
What is the simplest business form
Sole proprietorship - no paperwork to start or dissolve
How does sole proprietorship report tax
Schedule C with Form 1040, it’s the business income statement.
What part of self employment tax do sole props. pay?
Sole proprietors pay self-employment tax, covering both employer’s and employee’s shares of Social Security and Medicare tax.
What is the default business type for someone starting a business w/o choosing an entity?
Sole prop.
What is a major disadvantage of sole proprietorship?
Unlimited liability for the owner. Personal and business assets at risk for owner’s or family’s wrongdoing.
How would you lower your liability as a sole proprietor?
Liability can be lessened with business liability insurance and personal liability protection.
A partnership is formed when?
Formed when two or more individuals do business together without choosing a formal business structure.
Qualifying non-recourse financing means
Qualifying non-recourse financing means debt issued by a bank, pension fund, or governmental agency.
Partnership special allocations
the partners can agree to split items of revenue and expense something other than pro rata ownership percentages.
What can a partner include in their basis?
Partnership debt can be included in partners basis, including recourse or qualifying non-recourse financing.
Special allocations allowed in partnership accounting, as long as
as long as substantial economic effect is maintained.
Partner’s basis benefits from partnership debt in what structure?
Partner’s basis benefits from partnership debt only in a partnership, not in an S-corporation.
Special Economic Effect in partnership
each partner’s capital account and tax basis must reflect these special allocations
How do partnerships compensate partners?
through guaranteed payments, not salaries
Partners pay self employment taxes on what income?
Guaranteed payments, not salary
General Partnership
- Involves two or more partners.
- All partners have unlimited liability for the business.
- Each partner is personally liable for the actions of the other partners.
General Partnership partner liability
Each partner is personally liable for the actions of the other partners.
Partnerships file what form
All partnerships file IRS Form 1065
Individual partners receive what form?
K1 - detailing revenue and expense items for personal Form 1040 reporting
An LLC can choose to be taxed how?
sole proprietor (if single-member), partnership, or corporation.
What taxation method would an LLC typically choose due to favorable accounting features?
Partnership has favorable accounting features
LLC offers liability protection similar to what
similar to corporations
Are all laws the same regarding LLC taxation and liability protection?
No state laws vary
LLCs taxed as partnerships
Face similar tax issues as partnerships, including special allocations with substantial economic effect.
General partners in an LLC taxed as partnerships incur what
General partners Incur guaranteed payments AND self-employment taxes
How does recourse and nonrecourse debt work with an llc taxed as a partnership
Partners Benefit from recourse and qualifying non-recourse debt, enhancing basis in the entity for partners.
LLCs taxed as partnership use what forms
File IRS Form 1065, with individual members receiving Form K-1 detailing revenue and expense items for personal Form 1040 reporting.
C corps file what form
IRS Form 1120
C corp officers, shareholders and directors have liability limited to their what
limited to their investment in the corp
Dividend deduction for C corps
dividend deduction for dividends from investments in other corporations.
C corp Dividend taxation varies based on ownership stake
-Less than 20% ownership: 50% of dividends not taxed.
-20%-80% ownership: 65% of dividends not taxed.
-80% or more ownership: 100% of dividends not taxed, treating the investee as a wholly-owned subsidiary.
What is the biggest drawback of a C corp?
Double taxation: Dividends taxed at entity and individual levels, but recent rate reductions lessen this.
What is the most expensive business form?
C Corp is the most expensive business form, requiring extensive legal documentation.
What does S corp have in common with partnerships and LLCs?
Pass thru entities
Shareholders, officers, and directors have what liability in an S corp
limited
Do S corps have double taxation?
No - they are pass thrus
S-corporations don’t have full tax-deductible benefits or dividend received deductions, what does?
C corp
In an S corp, who has to vote to elect IRC subsection S treatment? (how many votes)
All shareholders (unanimous vote) must agree to elect for IRC subsection S treatment
Who needs to vote for a dissolution of an S corp? (how many votes)
simple majority
To qualify as an S Corp the business must meet the definition of a what?
To qualify as an S-corporation, the business must meet the definition of a small business corporation
S Corp requirements
S-Corporation Requirements:
- Must be a domestic corporation.
- Shareholders must be U.S. citizens or resident aliens.
- Limited to 100 shareholders.
- Shareholders can be individuals, certain trusts, estates, and specific tax-exempt organizations.
- Only allowed one class of stock, but different voting rights permitted.
If an S corp has 100 shareholders and someone gets divorced what could happen
Some shares could go to the spouse so there would now be more than 100 shareholders
How many classes of stock in an s corp?
Only allowed one class of stock, but different voting rights permitted.
The 2004 Job Act Family Election:
- Allows all family members to be treated as one shareholder.
- Family members include a common ancestor, lineal descendants, and spouses or former spouses of lineal descendants.
- The common ancestor must be within six generations of the youngest shareholder at the time of the election.
- The common ancestor doesn’t need to be alive at the time of the election.
S-Corporation Debt and Basis:
- Debt in the S-corporation’s name doesn’t increase shareholders’ basis, unlike in partnerships.
- Direct loans from shareholders to the corporation increase the lender’s basis.
- Repayment of shareholder loans isn’t taxable but reduces the lender’s basis.
- All S-corporations file IRS Form 1120S, with individual shareholders receiving Form K-1 detailing revenue and expense items for personal Form 1040 reporting.
Does debt in S corp’s name increase shareholder basis?
Debt in the S-corporation’s name doesn’t increase shareholders’ basis, but it does in a partnership
What form do S Corps file?
Form 1120S, with individual shareholders receiving Form K-1 detailing revenue and expense items for personal Form 1040 reporting.
What happens with repayment of shareholder loans in an S corp? (taxability and basis)
repayment of shareholder loans isn’t taxable but reduces the lender’s basis.
Trust Structure (3 parts)
- Grantor: Creator of the trust.
- Trustee: Holds title to trust assets.
- Beneficiaries: Benefit from the trust.
Association
- Not a legal entity but a group of individuals joined for business or social purposes.
- Formed by submitting Articles of Association at the state level.
Is an association a legal entity?
Not a legal entity but a group of individuals joined for business or social purposes.
Appreciated Securities Exchange (forming a business)
- When an owner exchanges appreciated securities for ownership in a business, it’s treated as if the securities were sold.
- Owner is taxed on the gain, calculated as the fair market value (FMV) minus the basis.
Debt Relief Taxation (forming a business)
- When an owner’s debt obligation is relieved by the new business entity, the entire debt amount becomes taxable income for the owner.
Service Partner Compensation (forming a business)
- When an owner receives an interest in a firm in exchange for services (e.g., building a database), the entire value of the services exchanged is taxed as ordinary income.
S-Corporations, partnerships, and entities taxed as partnerships (LLCs, LLPs, FLPs) aren’t taxed at the entity level because why?
All income and expenses flow through to individual shareholders, partners, and members via Schedule K-1.
Items that flow through from S corps, partnerships and entities taxed as partnerships (LLCs, LLPs, FLPSs) retain what re: their character?
Items retain their original character for reporting purposes (e.g., charitable contributions on Schedule A, dividends on Schedule B, capital gains on Schedule D, etc.).
Entities taxed as partnerships
LLCs, LLPs, FLPs
S corps file what vs Partnerships and entities taxed as partnerships file what
S-Corporations file Form 1120 S.
Partnerships and entities taxed as partnerships file Form 1065.
Pass-through income or loss treatment depends on material participation standards meaning
If one of the 7 material participation standards is met, income is considered active and not subject to passive activity rules.
If an S corp borrows funds in its name, what happens to shareholder basis?
If the S-Corporation borrows funds in its name, shareholder(s) basis remains unchanged.
If a shareholder loans directly to the S corp, what happens?
it increases the SHAREHOLDER’s basis.
Special Allocations in Partnerships
- Permit partnerships to allocate income and expenses as desired.
- Subject to substantial economic effect, ensuring proper accounting in partners’ capital accounts.
Partnership borrowing does what re: partner basis?
Partnership borrowing (recourse or qualifying nonrecourse) increases partner basis.
Retiring debt does what re: partner basis?
Retiring debt reduces partner basis.
Partnership liabilities affect partner’s what
partner’s basis accounts
In flow thru entities positive income does what re:basis?
increases basis for partners, members and shareholders
losses and distributions does what in a flow thru entity re:basis?
reduces basis
In a pass thru entity partnership and LLC debt at entity level does what re:basis
Partnership and LLC debt at entity level increases owners’ basis; repayment reduces basis.
In S corps, direct shareholder loans do what and debt payment does what re: basis?
direct shareholder loans increase basis; debt payment reduces basis.
Can an owner in a pass thru entity use pass thru losses once basis is reduced to zero?
At-risk rules prevent owners from using pass-through losses once basis is reduced to zero.
S corp special taxes only apply when?
S corps that were once C corps - these taxes ARE paid at the entity level
Built in gains tax occurs when a C corp does what
when a C Corporation with appreciated assets converts to an S Corporation.
What is the tax when a C Corp with an appreciated asset converts to an S corp?
IRS imposes a 21% tax on gains from these assets for the first 5 years after the conversion
What is the point of the built in gains tax?
Aimed at preventing tax avoidance by converting to S Corporation for more favorable capital gains rates.
When does LIFO recapture occur?
when a C Corporation using LIFO method switches to S Corporation.
LIFO Recapture
- Occurs when a C Corporation using LIFO method switches to S Corporation.
- In the last year as a C Corporation, the firm must recapture the LIFO reserve.
- If FIFO inventory value is higher, the firm pays tax (21%) on this LIFO recapture in four annual installments.
- First installment due in the last year as a C Corporation; remaining three years as an S Corporation.
Excess Net Passive Income Tax:
- Applies to S Corporations with Accumulated Earnings and Profits (AEP) from C Corporation years.
- If passive investment income exceeds 25% of total receipts, a special tax of 21% (known as “sting tax”) is imposed.
- Passive investment income includes rents, royalties, dividends, interest, annuities, and sales/exchanges of securities.
Does a distribution always reduce an owners basis in an entity?
Yes
Do you pay self employment tax on distributions from S Corps?
No
When might an owner of a partnership or an entity taxed like a partnership such as an LLC owe self employment tax?
if classified as material participants.
Passive activity in a business means what re: distributions, taxable or nontaxable as self employment income?
passive activity in the business means distributions aren’t taxable as self-employment income.
S Corporations and Liquidating Gains
- Gains recognized by the S Corporation from liquidating appreciated property are passed through to shareholders.
- This increases their basis, reducing the taxable gain upon receipt of liquidating dividends in exchange for their stock.
Partnerships and Entities Taxed as Partnerships
- When a partnership is sold or liquidated, the difference between the sales price and partner’s basis is taxed as capital gain.
- Hot assets like disproportionate unrealized receivables, appreciated inventory, and 1245 property subject to recapture are taxed to selling partner(s) as ordinary income.
