Deck 12: The Choice of Business Entity

Question 1

Transfers of equity interests to family members may result in gift tax liability.

Answer 1

True

Question 2

A family partnership can shift taxable income to younger family members without any corresponding shift of cash flow to those family members.

Answer 2

False

Question 3

If a new business organized as a C corporation incurs start-up losses, the tax benefits of those losses will be recognized immediately.

Answer 3

False

Question 4

A family partnership can be used to shift a portion of the income from a capital-intensive manufacturing business to a taxpayer's young children.

Question 5

A family partnership can shift taxable income to younger family members only if these family members own a partnership interest.

Question 6

Typical family-owned businesses are operated as passthrough entities.

Question 7

The net operating losses of a C corporation can be carried forward to reduce its taxable income in future tax years.

Question 8

Limited liability companies (LLCs) provide owners the tax advantages of a passthrough entity and the limited liability protection of corporations.

Question 9

Family partnerships are generally created when the owner of a business makes a gift of an equity interest in the business to a relative.

Question 10

Family partnerships attempt to divide the income of a business among family members in order to decrease the overall tax burden of the family unit.

Question 11

A family partnership can be used to shift a portion of the income from an accounting practice to a taxpayer's young children.

Question 12

Bart owns 100% of an S corporation that had a net operating loss in the current year. If there is sufficient basis in the stock, he will carry this loss back to reduce taxes in a prior S corporation tax year.

Question 13

Following the rate reductions of the Tax Cuts and Jobs Act, it is not possible for after-tax cash flow from a taxable corporation to exceed after-tax cash flow from a passthrough entity.

Question 14

If a business is formed as a regular corporation, the income may be subject to double taxation.

Question 15

After-tax cash flow is minimized when a business operates as a passthrough entity rather than a taxable corporation.

Question 16

Start-up losses of a new business operation can generate immediate tax savings if the business is operated as a corporation.

Question 17

Owners of a small business typically minimize tax costs and maximize cash flow by operating as a passthrough entity.

Question 18

If a business is operated as a passthrough entity, the startup losses of the business may be deducted against the current taxable income of the owner.

Question 19

After-tax cash flow from a passthrough entity will always exceed after-tax cash flow from a taxable corporation.

Question 20

Both individual general partners and S corporation shareholders must pay self-employment tax on their share of the entity's ordinary business income.

Question 21

The accumulated earnings tax is imposed on a partnership formed for or availed of for the purpose of avoiding the income tax with respect to its owners by permitting earnings and profits to accumulate instead of being divided or distributed.

Question 22

Recent tax legislation reducing the individual tax on dividends has made C corporations more attractive than they were prior to the legislation.

Question 23

Because of conflicts of interest, shareholders are usually prohibited by law from serving as corporate officers and executives.

Question 24

When a closely held business is formed as a regular corporation, earnings that are distributed to a shareholder-employee as dividends are taxed only once.

Question 25

Partnerships offer owners the maximum flexibility to tailor their business arrangement to fit their needs.

Question 26

The use of a corporation as a tax shelter is most effective when the corporate tax rate is significantly higher than the individual tax rate.

Question 27

The IRS may recharacterize salary payments to the owners of a closely-held corporation as constructive dividends if it concludes that the amount of the payment is unreasonable in light of the facts and circumstances.

Question 28

The use of a corporation as a tax shelter is most effective when the individual tax rate is significantly higher than the corporate tax rate.

Question 29

One disadvantage of the creation of a family-owned entity is that there is dilution of control with respect to the original business owners.

Question 30

Sunny Daze, Inc., a publicly held company, has $9,000,000 of retained earnings and no financial justification for retaining the earnings. Therefore, it must calculate and pay an accumulated earnings tax on its annual corporate tax return.

Question 31

When a corporation is thinly capitalized, the IRS is more likely to reclassify a portion of the corporation's debt as equity.

Question 32

A personal holding company is a corporation owned by a large number of individual shareholders that has taxable income arising primarily from nonbusiness sources.

Question 33

A partner in a limited liability partnership (LLP) is protected from malpractice-related claims arising from the professional misconduct/negligence of another partner.

Question 34

Following the Tax Cuts and Jobs Act of 2017, it is no longer possible to use a corporation as a tax shelter.

Question 35

The IRS may conclude that a CEO/shareholder of a closely held corporation has been paid a nondeductible constructive dividend rather than a deductible salary.

Question 36

If a corporation has a high debt-to-equity ratio, the IRS may reclassify deductible interest payments as nondeductible dividends.

Question 37

Glover, Inc. had $350,000 of taxable income, all of which was personal holding company income. The corporation paid a dividend of $350,000 in November. The corporation will owe a personal holding company tax for the year.

Question 38

Partnerships offer more flexibility in allocating income among owners than S corporations.

Question 39

The accumulated earnings tax is assessed at the highest individual marginal tax rate on ordinary income.

Question 40

In today's tax environment, the opportunity for individuals to exploit the difference between the individual and the corporate rate structure is greater than ever.

Question 41

Loretta plans to start a small business, operated through a corporation. In year 0, she expects the corporation to generate a loss of $100,000. Subsequently, she expects the corporation to be profitable, and projects profit of $150,000 in year 1, and $250,000 in year 2. Using Appendix A and a 10% discount rate, calculate the present value of expected tax savings and costs on the business earnings for the first 3 years of operations if the business does not make an S corporation election.

A) $52,910 total tax cost
B) $88,250 total tax cost
C) $94,350 total tax cost
D) $118,800 total tax cost

Question 42

Gwen and Travis organized a new business as an LLC in which they own equal interests. The new business generated a $10,000 operating loss its first year. Travis has no other taxable income for the current year, but expects to have sufficient taxable income in future years to pay tax in the 24% tax bracket. Which of the following statements regarding Travis' tax savings from the current LLC loss is true?

A) Travis can carry his share of LLC loss back two years as a net operating loss, and request an immediate tax refund of $1,200.
B) Travis can carry his share of LLC loss forward, and will get tax savings only when he generates future income.
C) Travis can only use his share of the LLC loss in the current year, and will receive no tax savings.
D) The LLC will reallocate Travis share of the loss to Gwen, who can claim $1,750 of additional tax savings.

Question 43

Bryan Houlberg expects his C corporation to generate a profit of $200,000. What is the effective tax rate on the $200,000 if net income after corporate tax is distributed to him as a dividend and his marginal tax rate on ordinary income is 37%?

A) 21%
B) 58%
C) 36.8%
D) 37%

Question 44

Gwen and Travis organized a new business as an LLC in which they own equal interests. The new business generated a $10,000 operating loss its first year. If Gwen's marginal tax rate is 35%, her tax savings from the first-year LLC loss is:

A) $3,500
B) $1,750
C) $5,000
D) $3,250

Question 45

Which of the following is not exclusively a benefit of a passthrough entity?

A) Avoiding double taxation.
B) Ability to diffuse ownership.
C) Deductibility of start-up losses.
D) All of the above are exclusive benefits of a passthrough entity.

Question 46

A business generates profit of $100,000. The owner has a 37% marginal tax rate. What amount of corporate and individual income tax will be paid on this profit if the business is an S corporation and no income is distributed?

A) Corporate tax, $21,000; individual tax, $37,000
B) Corporate tax, $21,000; individual tax, $0
C) Corporate tax, $0; individual tax, $37,000
D) Corporate tax, $21,000; individual tax, $15,800

Question 47

Which of the following is not a good reason to form a family partnership?

A) Income can be shifted to lower-tax-rate individuals
B) A buy-sell agreement can ensure that all ownership interests are retained in the family
C) No gift tax is due on the transfer
D) Non-voting interests can be given to younger family members to ensure the older generation maintains operational control

Question 48

A business generates profit of $100,000. The owner has a 37% marginal tax rate. What amount of corporate and individual income tax will be paid on this profit if the business is a regular corporation and no income is distributed?

A) Corporate tax, $21,000; individual tax, $37,000
B) Corporate tax, $21,000; individual tax, $0
C) Corporate tax, $0; individual tax, $37,000
D) Corporate tax, $21,000; individual tax, $15,800

Question 49

Which of the following statements regarding S corporations is true?

A) If an S corporation's election terminates, the corporation is forced to liquidate.
B) All states treat the S corporation as a taxable corporation for corporate franchise tax purposes.
C) Generally, the transfer of property by a controlling shareholder to a newly-formed S corporation in exchange for stock is a nontaxable event.
D) The owners of a new business should be indifferent between operating as an S corporation and a partnership.

Question 50

Kyrsten Haas expects her S corporation to generate a profit of $200,000. Kyrsten's marginal tax rate on ordinary income is 37%. What is Kyrsten's after-tax cash flow from the S corporation if no cash is distributed?

A) $0
B) ($74,000)
C) $126,000
D) ($126,000)

Question 51

Kyrsten Haas expects her S corporation to generate a profit of $200,000. What is the effective tax rate on the $200,000 if no cash is distributed? Kyrsten's marginal tax rate on ordinary income is 37%.

A) 21%
B) 58%
C) 36.8%
D) 37%

Question 52

When the personal holding company tax was originally enacted, its purpose was to discourage individuals from incorporating their investment portfolios.

Question 53

A business generates profits of $150,000. The owner currently has a 32% marginal tax rate. What is the total amount of taxes paid if the business is a regular corporation and $20,000 in dividends is distributed to its sold individual shareholder?

A) Corporate tax, $31,500; individual tax, $3,000
B) Corporate tax, $48,000; individual tax, $6,400
C) Corporate tax, $31,500; individual tax, $6,400
D) Corporate tax, $0; Individual tax, $48,000

Question 54

Loretta plans to start a small business, operated through a corporation. In year 0, she expects the corporation to generate a loss of $100,000. Subsequently, she expects the corporation to be profitable, and projects profit of $150,000 in year 1, and $250,000 in year 2. Loretta's personal marginal tax rate on ordinary income is 37%. Using Appendix A and a 10% discount rate, calculate the present value of expected tax savings and costs on the business earnings for the first 3 years of operations if the business makes an S corporation election. Assume the excess business loss limitation does not apply.

A) $52,910 total tax cost
B) $94,350 total tax cost
C) $99,772 total tax cost
D) $0

Question 55

The personal holding company tax is a penalty tax imposed in addition to the regular income tax.

Question 56

Bryan Houlberg expects his C corporation to generate a profit of $200,000. What is Bryan's after-tax cash flow from the corporation if net income after corporate tax is distributed to him as a dividend and his marginal tax rate on ordinary income is 37%?

A) $120,800
B) $90,188
C) $126,400
D) $158,000

Question 57

Which of the following statements regarding the tax burden imposed on business entities is true?

A) The tax burden imposed on corporate earnings is always lower if the corporation makes an S election.
B) Business owners desiring current cash flow can maximize annual after-tax cash flow by operating as a regular corporation.
C) Current tax cost associated with shareholder cash flow received as dividends may be lower than cash flow received as payments of salary, interest, or rental income.
D) All of the above statements are true.

Question 58

Mr and Mrs Johnson and their two children, Alice and Ben, are the four equal partners in JAB Partnership. This year, JAB generated $40,000 of ordinary income. Compute the tax cost associated with this income if Mr and Mrs Johnson's marginal tax rate is 35%, Alice's marginal tax rate is 24%, and Ben's marginal tax rate is 32%.

A) $12,600
B) $8,800
C) $35,200
D) $0

Question 59

Sandy, Sue, and Shane plan to open Friends, an upscale restaurant. They project that the business will incur a $90,000 operating loss in Year 1, and $75,000 of profit in Year 2. Which of the following statements is true?

A) If the business is a C corporation, it will not owe regular tax liability during the first two years.
B) If the business is a general partnership, it will owe income tax in Year 2.
C) If the business is an S corporation, the Year 1 loss can be allocated entirely to Sandy.
D) If the business is a C corporation, it will owe income tax in Year 2.

Question 60

Which of the following statements regarding the tax treatment of start-up losses is false?

A) Start-up losses of a business organized as a C corporation create NOL carryforwards, deductible in future years when the business generates a profit.
B) Start-up losses of a business organized as a partnership are deductible by the partners, potentially generating immediate tax savings.
C) Start-up losses of a business organized as an S corporation create NOL carryforwards, deductible in future years when the business generates a profit.
D) Start-up losses of a business organized as an S corporation are deductible by the shareholders, potentially generating immediate tax savings.

Question 61

Which of the following items might an IRS agent seek to recharacterize as a constructive dividend?

A) Payment of interest expense to a corporate shareholder, where the loan bears interest at a market rate, has fixed written terms with a repayment required at a defined future point, and the corporation is not thinly capitalized.
B) Payment of salary expense to a corporate shareholder's wife, where the wife performs no services for the corporation.
C) Payment of rental expense to a corporate shareholder, for the use of equipment owned by the shareholder. The equipment is necessary to the corporate business, and the rental cost is similar to that charged by unrelated equipment providers.
D) All of the above payments could reasonably be considered constructive dividends.

Question 62

Mr Allen, whose marginal tax rate is 37%, owns an office building that generates $100,000 annual taxable income. He plans to create a family partnership by giving each of his three children a 15% interest in the building. Mr Allen will retain a 55% interest. Mr Allen will manage the building, and receive a guaranteed payment of $20,000. If Mr Allen's children are in the 12% tax bracket, compute the annual tax savings from this income-shifting arrangement.

A) $11,250
B) $9,000
C) $5,000
D) $0

Question 63

Marcia is a shareholder in an S corporation and also works for the corporation. This year, her share of ordinary income was $250,000 and her compensation was $100,000. Which of the following accurately describes her tax consequences from these earnings?

A) Both the ordinary income and the compensation are subject to income tax and self-employment tax.
B) Both the ordinary income and the compensation are subject to income tax and the compensation is subject to payroll tax.
C) Both the ordinary income and the compensation are subject to income tax and the compensation is subject to self-employment tax.
D )The ordinary income is subject to income and self-employment tax; the compensation is subject to income and payroll tax.

Question 64

Gerry is the sole shareholder and president of Garmon Corporation. He also owns the office building that serves as the corporation's headquarters. Last year, Garmon paid Gerry $250,000 for the use of the building. Garmon's MTR was 21% and Gerry's was 37%. The revenue agent who audited Garmon's return has concluded that the fair rental value of the office building was $200,000. What is the net impact of this audit conclusion on Gerry and Garmon's combined income tax liability?

A) $10,500 net increase
B) $8,500 net decrease
C) $2,000 net increase
D) $2,000 net decrease

Question 65

Mrs Jansen is the sole shareholder of Mimeo Corporation. She also owns the office building that serves as corporate headquarters. Last year, Mimeo paid $200,000 annual rent to Mrs Jansen for use of the building. Mimeo's marginal tax rate was 21% and Mrs Jansen's marginal tax rate on ordinary income was 37%. The revenue agent who audited Mimeo's return concluded that the fair rental value of the office building was $150,000. Compute the net impact of this audit conclusion on Mrs Jansen's income tax liability.

A) $8,500 increase
B) $10,500 decrease
C) $10,500 increase
D) $8,500 decrease

Question 66

Which of the following is a consequence of establishing a family partnership or a family-owned S corporation?

A) The original owners will have their control of the business diluted.
B) For the structure of the family business to be honored, the transfers to the younger family members must be complete and legally binding.
C) The transfers to the younger family members must be irrevocable.
D) All of the above are consequences of establishing a family partnership or a family-owned S corporation.

Question 67

Chad is the president and sole shareholder of Greenfield, Inc., a regular corporation. The corporation reported taxable income of $575,000 after deducting his $900,000 salary. If the IRS disallowed $550,000 as unreasonable compensation, Chad's taxable income will:

A) Increase by $550,000
B) Decrease by $550,000
C) Increase by $900,000
D) Stay the same

Question 68

Which of the following would not be a successful means of avoiding double tax on the earnings of a closely-held corporation?

A) Having a shareholder lend money to the corporation at a reasonable rate of interest.
B) Having a shareholder lease warehouse space to the corporation at a reasonable rental rate.
C) Having the corporation pay the shareholder a fixed percentage of the par value of the stock the shareholder owns.
D) Having the corporation employ the shareholder at a reasonable compensation.

Question 69

Which of the following statements regarding alternative business forms is true?

A) If an S corporation's election terminates, the corporation is forced to liquidate.
B) Some states treat S corporations as taxable corporations for purposes of corporate franchise taxes.
C) Generally, the transfer of property to a new partnership in exchange for a partnership interest is a taxable event.
D) The owners of a new business should be indifferent between operating as an S corporation and a partnership.

Question 70

Cathy is the President and sole shareholder of Boxer, Inc., a regular corporation. The corporation reported taxable income of $435,000 after deducting Cathy's $800,000 salary. If the IRS disallowed $550,000 of the salary as unreasonable compensation, the corporation's regular income tax will change by a:

A) $115,500 increase
B) $175,000 increase
C) $175,000 decrease
D) $115,500 decrease

Question 71

Which of the following is NOT one of the characteristics of a constructive dividend?

A) Payment between a corporation and a shareholder
B) Original payment treated as deductible by the corporation
C) Original payment treated as made to the shareholder in some capacity other than as an owner of the corporation
D) All of the above are common characteristics of constructive dividends.

Question 72

Mr and Mrs Maxwell are equal partners in Family partnership. The Maxwell's marginal tax rate is 35%. Next year, the partnership is expected to generate $200,000 of ordinary income. The Maxwells are considering transferring 20% interests in the partnership to each of their children. Their daughter, Melissa, has a 12% marginal tax rate. Their son, Mark, has a 22% marginal tax rate. Calculate the expected annual tax savings to the family from the proposed transfer of partnership interests.

A) $14,000
B) $28,000
C) $14,400
D) $16,000

Question 73

Which of the following statements concerning the differences in operating a business as a partnership or as an S corporation is true?

A) The S corporation form offers greater flexibility in allocating the income or loss among the owners.
B) The owners of an S corporation have unlimited personal liability for the debts of the business.
C) The owners of a general partnership have unlimited personal liability for the debts of the business.
D) All of the above are true statements.

Question 74

Homer currently operates a successful S corporation. He would like to bring his two teenage children into the business. If he gives each child 10% of the stock, which of the following statements is true?

A) Since the children did not pay for the stock, Homer will still be taxed on the full income of the corporation under the assignment of income doctrine.
B) Homer must receive a reasonable salary for any time he spends working on behalf of the business.
C) Both statements are true.
D) Neither statement is true.

Question 75

The three Crosby children intend to form a business. The business will borrow $900,000 from a local bank. Which of the following statements is true?

A) Regardless of whether the business is a partnership or an S corporation, the owners will include the bank debt in the tax basis of their ownership interests.
B) From a liability standpoint, the owners should be indifferent as to whether they are a general partnership or an S corporation.
C) If the business is an S corporation, the owners can allocate income and losses in any reasonable manner.
D) If the business is a partnership the owners can allocate income and losses in any reasonable manner.

Question 76

Which of the following entities does not provide all the owners with limited liability for debts incurred by the entity?

A) C corporation
B) S corporation
C) Limited partnership
D) LLC

Question 77

The IRS agent who audited the Form 1120 filed by Alano Inc. concluded that $300,000 of the salary that Alano paid to its CEO and sole shareholder was a constructive dividend. As a result:

A) The CEO/shareholder's taxable income increases by $300,000.
B) Alano must distribute an additional $300,000 cash to the CEO/shareholder
C) Alano must distribute an additional $300,000 cash to the CEO/shareholder.
D) Alano's taxable income increases by $300,000.

Question 78

Platte River Corporation is a calendar year S corporation. At the beginning of the year, Mr Reeves owned 100% of Platte River's outstanding stock. On June 30 of the current year, he gave 25% of the stock to his son Mark and 10% of the stock to his daughter Megan. Platte River's ordinary income for the year was $220,000. What portion of this income must each shareholder report?

A) Mr. Reeves, $220,000; Mark, $0; Megan, $0
B) Mr. Reeves, $143,000; Mark, $55,000; Megan, $22,000
C) Mr. Reeves, $181,500; Mark, $27,500; Megan, $11,000
D) Mr. Reeves, $73,333; Mark, $73,333; Megan, $73,333

Question 79

Mrs Jansen is the sole shareholder of Mimeo Corporation. She also owns the office building that serves as corporate headquarters. Last year, Mimeo paid $200,000 annual rent to Mrs Jansen for use of the building. Mimeo's marginal tax rate was 21% and Mrs Jansen's marginal tax rate on ordinary income was 37%. The revenue agent who audited Mimeo's return concluded that the fair rental value of the office building was $150,000. Compute the net impact of this audit conclusion on Mimeo's income tax liability.

A) $10,500 increase
B) $10,500 decrease
C) $8,500 increase
D) $8,500 decrease

Question 80

Which of the following statements regarding partnerships versus S corporations is false?

A) Ordinary income allocated from both types of passthrough entities is subject to self-employment tax.
B) Partners are not permitted to be employees of their partnerships, but S corporation shareholders can be employees of their S corporation.
C) S corporation shareholders are not liable for entity debts, but general partners are liable for partnership debts.
D) Partnerships have more flexibility than S corporations in the manner in which items are allocated to the owners.