Bryant - Course 4. Tax Planning. 4. Tax Characteristics of Entities Flashcards

Question

What is the reason for imposing the penalty for Accumulated Earnings Tax (Section 531)?

Answer 1

To discourage companies from retaining excessive amounts of earnings if the funds are invested in non-operating assets. A primary purpose is to force dividend payments of excess earnings.

Answer 2

To prevent closely held companies from converting an operating company into a passive investment company. A primary purpose is to force dividend payments of passive income.

Answer 3

The tax base is taxable income plus or minus certain adjustments. The tax computation is inherently subjective because the accumulated earnings credit (which often reduces the tax base to zero) is based on the retention of earnings for the reasonable needs of the business, which is a subjective determination.

Answer 4

The determination of whether a corporation is a personal holding company and the computation of the penalty tax is a mechanical process. Once the corporation is determined to be a PHC, the tax base is taxable income plus or minus certain adjustments.

Answer 5

Adjustments are made to taxable income for items such as the dividends-received deduction, the dividends-paid deduction, and the federal income tax liability to arrive at undistributed PHC income. The penalty tax (which is in addition to the regular tax liability) is 20% of undistributed PHC income.

Answer 6

Adjustments are made to taxable income for items such as the dividends-received deduction, the dividends-paid deduction, the federal income tax liability, and the accumulated earnings credit. The penalty tax (which is in addition to the regular tax liability) is 20% of accumulated taxable income.

Answer 7

The accumulated earnings tax discourages companies from retaining excessive amounts of earnings if the funds are invested in assets unrelated to business needs. **Thus, a company may avoid the penalty tax if its earnings are reinvested in operating-type assets or retained for the reasonable needs of the business.** If this tax was not imposed, closely held corporations might not pay dividends to their shareholders (thereby avoiding a double tax on the earnings). The retained earnings then could be reinvested in passive investments. Reasonable needs of the business include: * Reasonably anticipated expansion of the business and plant replacement * Acquiring the assets or stock (other than portfolio investments) of another business * Providing working capital for the business * Establishing a sinking fund to retire corporate debt * Making investments in or loans to suppliers or customers

Answer 8

Taxable income: (+) Dividends-received deduction (+) Net operating loss deduction (-) Net capital losses (-) Net long-term capital gains over net short-term capital losses (less federal income tax on such net gains) (-) Federal income tax liability (-) Charitable contributions exceeding the 10% limit (-) Deductions for dividends paid or deemed paid (-) Accumulated earnings credit ** --------------- = Accumulated taxable income

Answer 9

Personal Service Corporations are allowed an accumulated earnings credit of $150,000 while non-personal service corporations are allowed a credit of $250,000.

Answer 10

A company must meet both of the following tests to be classified as a personal holding company: More than 50% of the value of the outstanding stock is owned by five or fewer individuals at some time during the last six months of the tax year; 60% or more of adjusted ordinary gross income is personal holding company income. Personal holding company income consists of passive types of income including dividends, interest, and, under certain circumstances, rental income.

Answer 11

The personal holding company tax is the highest individual tax rate for dividends times undistributed personal holding income. Various adjustments are made to taxable income to arrive at the tax base. These adjustments are similar to those for the accumulated earnings tax.

Answer 12

The personal holding company tax may be avoided** if the company pays all of the undistributed personal holding company income to its shareholders**. Special rules allow personal holding companies to pay these dividends even after the corporation's year-end. The shareholders then pay an income tax levy on the dividend distribution.

Answer 13

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 repayment of debt is a tax-free return of capital.

Answer 14

* The legal form of the instrument and actual adherence to its terms. * Excessive debt-equity ratio. * Proportionality of debt and shareholder's equity interests. * Convertibility of the debt into a stock of the corporation or contingent interest payments based on corporate earnings. Under Section 385, the issuing corporation must characterize the instrument as debt or stock. The shareholders or debt-holders are prohibited from treating the instrument inconsistently with the issuer's characterization unless they disclose the inconsistent treatment on their tax returns. The issuer's characterization is not binding on the IRS.

Answer 15

Earnings and profits (E&P) measure a corporation's economic ability to pay dividends from its current and accumulated earnings without impairment of capital. This means that the corporation has generated an operating surplus on its capital. If the corporation has no E&P, a distribution represents a tax-free return of capital, and possibly a capital gain, rather than a taxable dividend.

Answer 16

Current year and accumulated earnings and profits (E&P) must be differentiated because the tax code provides specific tracing rules to determine whether a distribution is taxable as a dividend. For example, **a 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. **Distributions are deemed to be made out of accumulated E&P only after the current E&P (if any) is exhausted.**

Answer 17

* 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

Answer 18

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

Answer 19

* The redemption is substantially disproportionate to the shareholder's interest. * The redemption is not essentially equivalent to a dividend. * The redemption results in a complete termination of the shareholder's interest.

Answer 20

Capital gain Loss treatment Under Section 302(b)(3), a complete termination of a shareholder’s stock interest also qualifies for capital gain or loss treatment.

Answer 21

Section 302(b)(4) provides exchange (rather than dividend) treatment for noncorporate shareholder redemptions in a partial liquidation of the distributing corporation. To qualify, 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.

Answer 22

Section 303 permits the 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.

Answer 23

Either distributed in-kind to the shareholders in exchange for their stock or sold and converted to cash in exchange for their stock.

Answer 24

Southern Corporation recognizes $10,000 ($20,000 - $10,000) of ordinary income on the distribution of the inventory, $35,000 ($40,000 - $5,000) of capital gain on the distribution of the land, and $5,000 ($15,000 - $20,000) of capital loss on the distribution of the marketable securities.

Answer 25

John recognizes a $60,000 ($100,000 - $40,000) capital gain. Joan recognizes a $20,000 ($120,000 - $100,000) capital loss. The tax basis of the land received by John is $100,000 (the land's FMV on the distribution date).

Answer 26

The use of long-term debt to capitalize a closely held C corporation is an excellent choice assuming that the corporation is profitable. However, if the corporation is not successful and goes bankrupt, the corporate debt owed to the shareholders becomes worthless and is treated by any non-corporate shareholders as a non-business bad debt. Non-business bad debts are deductible as a short-term capital loss, subject to the $3,000 per year limitation.

Answer 27

As an alternative to using debt, the shareholders could capitalize the corporation using stock (equity). Assuming that the requirements are met, the corporation's stock would be considered as a Section 1244 stock (small business corporation stock). Upon the Section 1244 stock becoming worthless, each shareholder may deduct up to $50,000 ($100,000 on a joint return) as an ordinary loss. The ability to deduct up to $100,000 against ordinary income is superior to the capital loss treatment that applies to non-business bad debts.

Answer 28

False. Non-business bad debts are deductible as a short-term capital loss, subject to the $3,000 per year limitation.

Answer 29

Dividends paid from E&P are fully taxable to shareholders and are not deductible by the corporation. Thus, in a closely held corporation where ownership and management are not separated, the parties may wish to increase salary payments to shareholder-employees rather than increase dividends. A similar type of incentive may be present for a shareholder; he or she may lease property to a corporation instead of transferring it to the corporation as a capital contribution. Even though the increased salary or rental payments are taxable to the shareholders (as are dividends), these payments are deductible as business expenses by the entity as long as the amounts paid are reasonable. This is an important way to avoid the double taxation of corporate income, which occurs if dividends are paid rather than compensation or rent.

Answer 30

A corporation should plan to use its net operating loss and capital loss carryovers. For example, the sale of appreciated business assets may result in recognition of Section 1231 gain that can offset capital loss carryovers because net Section 1231 gains receive capital gain treatment. Alternatively, the sale or disposition of assets may result in the recognition of ordinary income because of the depreciation recapture rules. This ordinary income can offset expiring NOLs.

Answer 31

Many owners of closely held corporations prefer to make charitable donations through their controlled corporations rather than as individuals because the corporations can deduct the contributions. Otherwise, to fund the contributed amounts, the controlled corporation may have to make nondeductible dividend payments to the shareholders. Also, an accrual basis corporation may accelerate a charitable contribution deduction if the board of directors approves the contribution before year-end, and the corporation pays the pledge within 2½ months of the corporation's tax year-end.

Answer 32

Corporate shareholders may deduct the dividends received from other corporations in which there is ownership interest. This deduction is 100%, 65%, or 50% of taxable income unless the deduction creates or increases a net operating loss (NOL). The specific deductible amount is dependent on the percentage ownership in the other corporation that generated the dividend. Percentage of Stock Ownership - Dividends-Received Deduction Less than 20% = 50% 20% to 79.99% = 65% Greater than 80% = 100% A substantial scale-down of the dividends-received deduction may result if taxable income (other than the dividend income) is negative and if the final result is a small amount of taxable income being reported instead of an NOL. **Therefore, if the limitation is expected to apply, the corporation should either accelerate deductions into the current year or postpone the recognition of income to a later year. Either action can result in the creation of an NOL that prevents the limitation on the dividends-received deduction from applying.**

Answer 33

Making loans to stockholders. Reasonable needs of businesses include: 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.

Answer 34

True When a corporation repurchases (redeems) a portion of its outstanding stock from a shareholder, redemption is 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.

Answer 35

Dividend-received deductions The computation of a corporate net operating loss (NOL) does not involve making adjustments for non-business deductions and capital gains and losses as are required for individuals. 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.

Answer 36

Capital loss of $8,000 NLTCG $16,000 NSTCL $24,000 ------------- First Corporation thus has a net capital loss of $8,000.

Answer 37

The gain realized on the sale or exchange of a capital asset held for one year or less.

Answer 38

The loss realized on the sale or exchange of a capital asset held for one year or less.

Answer 39

The gain realized on the sale or exchange of a capital asset held longer than one year.

Answer 40

The loss realized on the sale or exchange of a capital asset held longer than one year.

Answer 41

In this agreement, the partners set out the terms of how the partnership will operate, how profits and losses are shared, and how income deductions and credits will be allocated to the partners.

Answer 42

A partnership is an entity owned by two or more persons who have joined together to operate a business for profit. It is defined as "a syndicate, group, pool, joint venture, or other unincorporated organization" that carries on any business, financial operation, or venture. A partner is a member and can be an individual, corporation, trust or estate of such syndicate, group, pool, joint venture, or organization.

Answer 43

In general partnerships, each partner has unlimited liability for partnership debts. Thus, these partners are at risk for more than their investment in the partnership. In limited partnerships, 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.

Answer 44

A limited liability partnership (LLP) is typically either a limited partnership or a general partnership that has registered as an LLP under the law of one or more states. However, not all states recognize LLPs. This form of partnership is particularly attractive to professional service partnerships, such as public accounting firms.

Answer 45

* Partners are liable for their own acts and the acts of individuals under their direction however they are typically not liable for the negligence, wrongful acts, or misconduct of other partners. * If the LLP is also a general partnership, each partner has potential liability for partnership liabilities, such as wages owed to employees. * State law may require an LLP to register and pay a fee each year and to carry a certain amount of liability insurance. * The partners are not considered employees. However, general partners are subject to self-employment tax on their share of partnership income. * If the partnership makes guaranteed payments to certain partners for services they perform for the partnership, those payments are taxable to the partners who receive them.

Answer 46

The family limited partnership (FLP) is a financial planning technique that enables a family to hold and manage its wealth, including the family business, with several generations of family members as partners. The usual practice of formation is to establish the senior members of the family, who are likely to be the business owners, as general partners and name other members of the family as limited partners. Because a FLP can transfer the control of the business by appointing successor general partners, it can also be an effective business entity for estate planning purposes

Answer 47

* Conducting a family business, and * Pooling family wealth and managing it in a coherent, structured way.

Answer 48

FLPs allow families to: * Retain the control of the family business or investment assets by senior family members as general partners, * Develop and implement a succession plan for transferring management of the business to the next generation, * Transfer the family business or assets to future generations at the lowest permissible cost in estate and gift taxes, and * Reduce the income tax liability on partnership income when it is allocated to limited partners in a tax bracket lower than the general partners' bracket.

Answer 49

* 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).

Answer 50

Rules pertaining to an S corporation are located in Subchapter S of the IRC. Legally, S corporations are the same as other corporations but for tax purposes, they are special corporations treated as flow-through entities. S corporations are not taxed, and** income, deduction, loss, and credit items pass through to the shareholders. **Corporate tax rules will apply unless overridden by the Subchapter S provisions.

Answer 51

LLCs have a limited liability advantage that is similar to corporations. 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.

Answer 52

The members of an LLC will not be subject to self-employment tax. 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.

Answer 53

A sole proprietor has unlimited liability for business debts and judgments. A general partner's business and personal assets are at risk to creditors. All members in an LLC typically enjoy limited liability. Shareholders of an S corporation have limited liability as do members of an LLC. A sole proprietor or a general partner has unlimited personal liability for business debts and judgments.

Answer 54

Profits and losses are shared according to the partnership agreement. A partnership can be created without formality. A partner can be an individual, corporation, trust or estate. An S corporation can only have 100 shareholders or less, but there are no restrictions on the number or types of partners in a partnership. A partnership can be created informally and profits and losses are divided according to the partnership agreement. A partnership is 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.

Answer 55

Limited Liability Partnership 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.

Answer 56

* Basis of a partnership interest, * Holding period for a partnership interest, * Basis of partnership assets, * Financial accounting considerations, and * Organizational and syndication fees.

Answer 57

Section 721 (Nonrecognition Rules) prevents the recognition of gain or loss upon either the transfer of property in exchange for a partnership interest or subsequent transfers of property by the partners in exchange for a pro-rata increase in their partnership interests. Without this nonrecognition provision, gain on a transfer of appreciated property would be recognized and the partners might not have sufficient liquidity (e.g., cash) to pay the tax. In addition, the transfer of property to the partnership represents a mere change in ownership form, which is not a recognition event under the tax laws. Finally, the depreciation recapture rules do not apply if no gain is recognized under Section 721.

Answer 58

* The Section 721 nonrecognition of gain or loss rules do not apply if the partner acts in a capacity other than a partner. For example, if a partner sells property to the partnership in an arms-length transaction, the sale would be taxable. * If a partner contributes services instead of cash or property in exchange for an unrestricted partnership interest, the fair market value (FMV) of the services is taxed as compensation to the contributing partner because services do not qualify as property. This situation will often occur when partnerships are formed without adequate tax advice. If care is not taken at the inception of a partnership, an unanticipated and severe tax consequence will befall the partner who provides the service. * The contributing partner recognizes gain if liabilities transferred to the partnership exceed the partner's basis in the partnership. This is also a situation that can result in an unanticipated tax increase. Good planning can avoid or mitigate the impact of this rule. * The contributing partner recognizes gain if the partnership is treated as an investment company had it been incorporated under Section 351.

Answer 59

If the Section 721 nonrecognition rules apply, **IRC Section 722 provides a substituted basis rule for determining the basis of a partnership interest**. Disregarding the effect of any liabilities, the basis of the contributing partner's partnership interest equals the sum of money contributed plus the adjusted basis of other property transferred to the partnership. If a contributing partner renders services to the partnership in exchange for a partnership interest, **the contributing partner's basis equals the amount of income recognized from rendering the services (i.e., the fair market value (FMV) of the services)**. The FMV basis is permitted because **the partner recognizes ordinary income equal to the FMV of the services**.

Answer 60

$75,000 Disregarding the effect of any liabilities, the basis of the contributing partner’s partnership interest equals the sum of money contributed plus the adjusted basis of other property transferred to the partnership. In Tina's case, the $15,000 in services is added to the adjusted basis of $60,000 to determine her interest. $15,000 + $60,000 = $75,000.

Answer 61

A partner's basis for his or her partnership interest includes the partner's ratable share of partnership liabilities, as well as the basis attributable to any property and services, contributed to the partnership. In addition, the following rules apply if a partnership assumes a partner's liability or if the partner transfers property to the partnership subject to liability: * All partners treat an increase in partnership liabilities as a cash contribution, which increases their bases by their ratable share of the assumed liabilities. * The partnership's assumption of liability is treated as a cash distribution to the partner whose liability is assumed, which decreases his basis in the partnership. Under the general rules of Section 752, 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.

Answer 62

Bank Government agency Retirement or pension fund

Answer 63

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.

Answer 64

Depending on when a partner contributes cash, property, or Section 1231 property, the holding period for partnership interest can vary. For example: * 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.

Answer 65

The date the interest is acquired by Erica. 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.

Answer 66

IRC Section 723 provides a carryover basis rule for property contributed to the partnership. The partnership's basis in the property is the same as that of the transferor partner, even if the contributing partner recognizes gain. Without this rule, partners could increase the basis of their property for depreciation and subsequent sale purposes merely by contributing appreciated property to a partnership. Because the carryover basis rule applies, the partnership's holding period for the property includes the period the property was held by the contributing partner.

Answer 67

Under Generally Accepted Accounting Principles (GAAP), the carryover basis and nonrecognition rules used in taxation do not apply. For instance, if property is contributed to a partnership, its book value is recorded at the contributed property's FMV. This GAAP treatment results in a difference between the tax bases and financial accounting book values of contributed assets.

Answer 68

Anwar contributes cash of $30,000 and Beth contributes land having a $30,000 FMV and a $20,000 adjusted basis to the AB Partnership. Each partner receives a 50% interest in the partnership. For financial accounting purposes, the land is recorded at $30,000. For tax purposes, the carryover basis of the land to the partnership is $20,000. No gain or loss is recorded for financial accounting purposes if the partnership later sells the land for $30,000. However, the partnership recognizes a $10,000 gain under the tax rules because the land's adjusted basis for tax purposes is only $20,000. The $10,000 pre-contribution gain is allocated to Beth.

Answer 69

A partnership can deduct up to $5,000 of the costs of organizing the partnership in the year the partnership begins business. The deduction is 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. Any organizational expenditures exceeding the first year deduction can be deducted ratably over the 180-month period beginning with the month the partnership begins business. Organizational expenditures that qualify for this treatment include items such as the attorney's fees for drafting the partnership agreement, the accountant's fees for setting up the financial record system, and filing fees.

Answer 70

The partnership must capitalize expenses attributable to syndicating the partnership. These expenses, however, are not amortizable. Syndication fees are expenses incurred 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.

Answer 71

Accounting fees Legal fees Filing fees Organizational expenses include legal & accounting fees incident to organizing the partnership, filing fees, and other expenses.

Answer 72

IRC Section 704 permits partners some latitude to decide how income, deductions, losses, and credits are to be allocated among the individual partners. Special allocations are unique to partnerships and permit flexible arrangements among the partners for sharing specific income and loss items. A partner's distributive share of such items is generally determined by the partnership agreement.

Answer 73

If any partner's interest in the partnership changes during the year (e.g., due to the sale of a partnership interest or the entry of a new partner who contributes property to the partnership in exchange for an interest),** all of the partners must determine their distributive share of the partnership income, deductions, losses, and credits according to their varying interests in the partnership during the year.**

Answer 74

Usually, a shareholder's original 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.

Answer 75

A distribution of cash or property from the partnership to a partner is generally treated as a** tax-free return of capital.** This treatment closely parallels the tax-free consequences resulting from a capital contribution of property made in exchange for a partnership interest under Section 721.

Answer 76

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: **A distribution may result in a reduction of a partner's capital interest in the partnership**. Property distributed to a partner in a non-liquidating distribution **does not result in a taxable gain or loss to the partner unless the distribution includes cash or marketable securities in excess of the partner's basis in his or her partnership interest**.

Answer 77

A corporation has nonresident aliens as shareholders. To qualify as an S corporation, the corporation must not have a nonresident alien as a shareholder.

Answer 78

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: * Must be a domestic (U.S.) corporation rather than a foreign corporation. * Must not be an ineligible corporation. * Must not have more than 100 shareholders. * Must have only individuals, estates, certain kinds of trusts, and certain kinds of tax-exempt organizations as shareholders. * Must not have a nonresident alien as a shareholder. * Must issue only one class of stock. All the above requirements must be met for the initial election to be made. Once an election is made, the requirements must be met on every day of each tax year that the S election is in effect. Otherwise, the election terminates.

Answer 79

200 The S corporation could have as many as 200 shareholders if the group consisted of 100 married couples.

Answer 80

Although an S corporation may not have a corporate shareholder, it may own stock of a C corporation. If this stock ownership equals or exceeds 80%, however, the S corporation (parent) and the C corporation (subsidiary) are considered as an affiliated group under IRC Section 1504. Starting in 1997, being a member of an affiliated group no longer terminates the S election. Nevertheless, an S corporation may not file a consolidated return with its 80%-owned subsidiaries.

Answer 81

In addition, an S corporation may have a Qualified Subchapter S Subsidiary (QSSS). **The subsidiary is a QSSS if the parent S corporation owns 100% of the QSSS stock and elects to treat the QSSS as such**. Under this election, **the QSSS is not treated as a separate corporation for income tax purposes. Instead, all assets, liabilities, income, deductions, and credits of the QSSS are treated as those of the parent S corporation**.

Answer 82

True. Treasury regulations allow that a corporation is treated as having only one class of stock if all outstanding shares of stock confer identical rights to distribution and liquidation proceeds.

Answer 83

Election Requirements: * File- All shareholders who own stock on the date the S election is filed must consent to the election. The election and consent are filed with the IRS on Form 2553. * Consent - Shareholders who own stock during any part of the tax year must consent to the election if they own stock on any day preceding the election date. * Election- A corporation may make the election in the tax year preceding the election year or on or before the fifteenth day of the third month of the election year.

Answer 84

Revocation of S corporation status, Involuntary and inadvertent terminations, and Election after termination.

Answer 85

An S election may be terminated either voluntarily by the shareholders or involuntarily if the corporation fails to continue to meet the requirements for a small business corporation (e.g., if on any day in any year the S corporation has more than 100 shareholders or issues a second class of stock). Voluntary revocation is permitted if consent is obtained from shareholders owning more than 50% of the corporation's stock.

Answer 86

An S corporation may involuntarily lose its special tax status and revert to being a C corporation if it fails to meet the small business corporation requirements or if it has excessive (i.e., more than 25% of gross receipts) amounts of passive (investment) income for each year in a three-year period. However, if the IRS deems that the termination was inadvertent and the S corporation or its shareholders take the necessary steps within a reasonable time period to restore its small business corporation status, the S corporation status is considered to have been continuously in effect.

Answer 87

5 years If an S corporation terminates its election, 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.

Answer 88

* Short-term and long-term capital gains and losses * Section 1231 gains and losses * Charitable contributions * Credits * Interest on investment indebtedness * AMT adjustments and tax preference items * Foreign taxes paid or accrued * Dividends and other portfolio income

Answer 89

Neither I nor II In the case of an S corporation, the income must be allocated based on percentage of stock owned on a daily basis. Partners have much greater flexibility. The partnership agreement serves as the basis for allocation, with special allocations being permitted. No special allocations are permitted for an S corporation.

Answer 90

Under IRC Section 705, the basis of each partnership interest is adjusted to reflect the partner's share of income and deduction items. This basis adjustment is necessary to ensure a single level of taxation of partnerships. Basis adjustments for income and deduction items are made currently regardless of whether an actual distribution is made to the partners. In addition, each partner's basis in the partnership interest is adjusted for capital contributions, withdrawals, and changes in liabilities that occur during the year. Each partner's basis is increased by the partner's distributive share of partnership ordinary income and separately stated income and gain items. The basis of the partnership interest is increased whether the income is taxable to the partners or is tax-exempt. A partner's basis is decreased (but not below zero) by partnership distributions and by the partner's distributive share of partnership ordinary loss, separately stated losses and deductions, and expenditures that are nondeductible in computing partnership ordinary income or loss (e.g., charitable contributions made by the partnership).

Answer 91

* A positive basis adjustment is made to the stock basis for ordinary income or separately stated income or gain items accruing during the year before the ordinary losses and separately stated loss and deduction items are used to reduce the stock basis. * The shareholder's deduction for pass-through losses is limited to the stock basis after the above positive adjustments and after distributions but before negative adjustments for losses and deductions and the shareholder's debt basis. * A shareholder's pass-through loss first reduces the shareholder's stock basis (but not below zero). * If the loss exceeds the stock basis, the remaining pass-through loss then reduces the shareholder's debt basis (but not below zero). * If the loss exceeds both the stock and debt basis, the shareholder carries over the excess loss and deducts it in a subsequent year when the shareholder again has basis in stock or debt. The carryover basis is indefinite but does not transfer to another taxpayer if the shareholder disposes of all of the stock or if the shareholder dies. Furthermore, if the S election is terminated, the loss must be used against any basis of the former S corporation stock by the end of a one-year post-termination transition period.

Answer 92

If a shareholder's debt basis in a loan made to the S corporation is reduced by a loss deduction, subsequent increases in basis resulting from S corporation income in a future year initially increase the debt basis until that basis reduction is fully restored. Any excess positive adjustment then increases the shareholder's stock basis. If the debt basis is not fully restored, gain results when the loan is repaid. If the loan is in the form of a note, the repayment results in a capital gain because the note constitutes a capital asset. However, ordinary income results if the loan is an unsecured advance.

Answer 93

The passive activity loss limitations apply to partners who do not materially participate in the business of the partnership. The passive activity loss rules are applied at the partner level, that is, each partner must determine whether he or she materially participates in the partnership. If a loss is determined to be passive, a partner may not deduct the loss against either earned income or portfolio income but may deduct the loss only against other passive income. These rules are highly significant and play a major role in determining the deductibility of partnership losses by partners.

Answer 94

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).

Answer 95

Money or property distribution made by an S corporation to its shareholders is treated as a return of capital if the S corporation has no accumulated earnings and profits from pre-S corporation years. As such, the amount of money or FMV of the nonmoney property distributed to a shareholder reduces the basis of the shareholder's S corporation stock. If distributions exceed the shareholder's stock basis, the excess is treated as a capital gain if the stock is a capital asset. The S corporation recognizes gain (but not loss) if it distributes nonmoney property to its shareholders. The distribution is treated as if the corporation sold the property to the shareholders at its FMV. The gain then passes through to the shareholders whose basis for their S corporation stock is increased. The distributed property's FMV reduces the shareholders' S corporation stock basis.

Answer 96

The S corporation recognizes an $80,000 capital gain, which passes through to Sue and increases the basis of her Austin stock. The basis of the land to Sue is $90,000 (its fair market value).

Answer 97

S corporations must use a calendar year unless a business purpose can be established for choosing a fiscal year-end. These year-end restrictions prevent shareholders from deferring pass-through income for up to 11 months (e.g., if a January 31 fiscal year-end was permitted). Also, 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.

Answer 98

3 months An S corporation may elect a maximum 3-month deferral if it agrees to make a special tax payment each year that approximates the deferral benefit.

Answer 99

S corporation shareholders who own more than 2% of the outstanding stock are not eligible for tax-free corporate employee fringe benefits for the following statutory fringe benefits: * 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. The fringe benefits listed above are included in the gross income of a more than 2% shareholder as a guaranteed payment. The amount of the payment is deductible by the corporation. Amounts received by a shareholder owning 2% or less of the S corporation's stock are excluded by the shareholder and deductible by the corporation as they would be for employees of a C corporation.

Answer 100

* 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.

Answer 101

A 21% corporate tax on built-in gains applies if a corporation that previously was a C corporation elects to be an S corporation. The built-in gains tax does not apply to a corporation that always has been an S corporation or that elected S corporation status before 1987. A built-in gain exists if the FMV of an asset exceeds its adjusted basis on the first day the 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 existing on the first day of the S election period can be used to reduce built-in gains. Any appreciation on the asset that occurs after conversion from a C corporation to an S corporation is subject to the regular S corporation pass-through rules but is not taxed under the built-in gains tax. Any asset not held on the first day of the S corporation election period is also exempt from the built-in gains tax.

Answer 102

The first $150,000 of post-conversion appreciation is subject to the built-in gains tax at the corporate level and flows through to the shareholders. The remaining $25,000 of post-conversion appreciation also is subject to the regular S corporation pass-through rules but is not subject to the built-in gains tax. In addition, the built-in gains tax that is paid by the corporation flows through as a loss to the shareholders.

Answer 103

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.

Answer 104

The corporate form may be preferred due to the availability of nontax attributes such as limited liability, the relative freedom to transfer ownership interests, and the ability to raise outside equity capital.

Answer 105

If the owners expect operating losses in the initial years of operation, they may prefer the partnership form to either the C corporation or the S corporation form of organization. In a C corporation, the operating losses do not benefit the shareholders directly and may be of no benefit if the corporation cannot generate sufficient profits in future years to offset the loss carryovers. In a partnership, the losses pass through to the partners, limited by their basis for the partnership interest. The basis of a partner's interest, however, includes his or her share of partnership liabilities. In contrast, an S corporation's ability to pass through losses is limited to the shareholder's basis in the stock and any shareholder loans. Other S corporation liabilities, such as loans to the corporation, are not included in determining the shareholder's loss limitation because the shareholders are not liable for such loans. Thus, the partnership form may provide its owners a greater opportunity to deduct losses than the S corporation form.

Answer 106

An optional basis adjustment election under Section 754 is 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. The excess amount is added to the new partner's basis for his or her interest in the partnership's assets. If the partnership made a Section 754 election in a prior year, the election continues in effect and automatically applies to the current year. However, if the election was not previously made, all of the partners must agree to make the election because it is made at the partnership level rather than by the individual partner. Therefore, before a sale is consummated, an incoming partner should attempt to obtain assurances from the remaining partners that the partnership will agree to make the election in the current year if the election is not already in effect. Attaching a statement to a timely filed tax return for the year the transaction occurs constitutes the election.

Answer 107

The consulting company's debt is part of Joel's personal debt. The consulting company's creditors may place liens on his property. The publishing company's debt may have increased Joel's share of debt. Both the consulting company and the publishing company's debt effects Joel's personal debt obligations. It is likely that creditors require some sort of collateral from Joel's personal property to secure loans for his business. An increase of borrowing by the partnership will result in an additional share of the debt for Joel.

Answer 108

Partner's share of income and deduction items Under Section 705, the basis of each partnership interest is adjusted to reflect the partner's share of income and deduction items.

Answer 109

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

Answer 110

True The tax year is restricted to a calendar year unless the corporation establishes a business purpose (e.g., a natural business cycle) for a fiscal year. Other special rules allow a tax year resulting in a maximum three-month deferral.

Answer 111

Sole Proprietor - Individual will be personally liable for repayment of the debt Corporation - A shareholder's investment has no effect on their basis Partnership - The basis for all or some of the partners will increase by their share of the debt

Answer 112

zero; unlimited If you choose to carry back your NOL from 2023: **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.**

Answer 113

20% 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).

Answer 114

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

Answer 115

Limited liability Limited number of owners C Corporation: * Double taxation * Multiple-Class Shares * Separate entity * Limited liability S Corporation: * Earnings Taxed Once * Limited number of owners * Separate Entity * Limited liability

Answer 116

Facts that provide evidence of the degree of control and independence fall into three categories: * 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? The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

Answer 117

independent contractor 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. The employer is not required to furnish an independent contractor with workers’ compensation coverage or fringe benefits.

Answer 118

There are no restrictions on the number or types of shareholders that can own stock in a C corporation. This is one of the key advantages of a C corporation.

Answer 119

21% A qualified personal service corporation (QPSC) must use the 21% (2023) maximum corporate tax rate to calculate its tax liability.

Answer 120

Social Security Number (SSN) Employer Identification Number (EIN) If a sole proprietorship has employees or is required to pay federal excise taxes, it must obtain an employer identification number (EIN) from the IRS. Otherwise, sole proprietors use their Social Security number (SSN) as their tax identification number.

Answer 121

$1000 If a tax-exempt organization has unrelated business taxable income (UBTI) exceeding $1,000 in 2023, it must pay income tax on that income. UBTI is defined as income from a business activity unrelated to the organization’s tax-exempt purpose.

Bryant - Course 4. Tax Planning. 4. Tax Characteristics of Entities Flashcards

(145 cards)