Ch 2

Question 0

A sole proprietorship is not a separate legal entity but…

Answer 0

A legal extension of its individual owner

Question 1

5 business forms

Answer 1

1 sole proprietorship
2 partnership
3 corporation
4 limited liability company
5 limited liability partnership

Question 2

5 Tax advantages: sole proprietorship

Answer 2

1 not subject to taxation as separate entity
2 marginal tax rate may be lower than that of corporation
3 contribute/withdraw cash/property from business w/out tax consequence
4 money belongs to owner
5 business losses can offset nonbusiness income (int., dividends)

Question 3

Tax disadvantages: sole proprietor 6

Answer 3

1 profits taxed to owner whether or not withdrawn from business
2 corporate tax rates at times are lower
3 must pay full social security taxes b/c not employee of business
4 may not deduct compensation paid to owner employees
5 tax-exempt benefits (group life insurance not available)
6 can’t defer income using fiscal year

Question 4

Partnership

Answer 4

Unincorporated business carried on by 2 or more individuals
Or entities for profit

Tax reporting but not tax paying entity

Question 5

Sole proprietorship

Answer 5

Unincorporated business owned by one individual

Question 6

Limited partnership contains

Answer 6

At least one general partner and one limited partner

Question 7

General partners

Answer 7

Liable for all partnership debts

Can assume managerial rule in partnership

Question 8

Limited partners

Answer 8

Only liable to extent of capital investment in partnership

Can’t assume managerial rule in partnership

Question 9

Tax advantages: partnerships 5

Answer 9

1 partnership pays not tax, (no double taxation)
2 partners tax rate may be lower than corporation’ sat same level
Of taxable income
3 usually no additional taxes for withdrawing money or property
From partnership
4 can use losses to offset income from other sources
5 partner’s basis in partnership increased by his share of partnership

Question 10

Tax disadvantages: partnership 5

Answer 10

1 partnership’s profits taxed to partners when earned, even if
Not distributed
2 partners tax rate could be higher than corporations even at
Same income level
3 partners must pay self employment taxes
4 don’t qualify for many fringe benefits
5 can’t defer income by choosing fiscal year

Question 11

S Corporation

Answer 11

Earnings are accounted for at the corporate level, but taxed only
At the shareholder level

Special rules governing tax treatment found in sub hater as of IRC

Question 12

C corporation

Answer 12

Separate entity taxed on its income at rates ranging from 15% to 39%

Question 13

Tax advantages: C corporations 6

Answer 13

1 corporations marginal tax rates may be lower than owner’s
Marginal tax rates
2 shareholders employed are only liable for half their social
Security taxes
3 shareholder employees entitled to no taxable fringe benefits
4 entitled to ordinary and business deductions
5 can use fiscal year to defer income
6 special rules allow shareholder to exclude 50% of gain realized
On sale or exchange of stock held over 5 years if certain
requirements are met

Question 14

Tax disadvantages: C corporations 4

Answer 14

1 double taxation
2 shareholders can’t withdraw money from corporation without
Recognizing income
3 no tax benefit from NOL in year incurred
4 capital losses can’t offset ordinary income

Question 15

Tax Advantages: S Corporations 6

Answer 15

1 pay no tax, flows through to shareholders who are taxed
2 shareholders marginal tax rates may be lower than C corporations
3 losses flow through and may be used to offset other sources
Of income
4 can offset gains from capital losses against other sources and
Taxed at capital gains rate on capital gains
5 can contribute or withdraw money without recognizing gain
6 basis in S corporation stock is increased by shareholder’s
share of corporate income, basis adjustment reduces shareholder’s
Gain and avoids double taxation

Question 16

Tax Disadvantages: S Corporation 5

Answer 16

1 shareholders taxed on all current year profits whether distributed
Or not
2 marginal tax rate may be higher than C corporation
3 non taxable fringe benefits generally not available
4 share holder employees and employers only pay half of
Social security taxes
5 can’t defer income with fiscal year

Question 17

What can an LLC or LLP elect to be taxed as?

Answer 17

Either a corporation or as a partnership

Question 18

Liability under LLP

Answer 18

Partners are liable for their own acts and omissions as well
As individuals under their direction

Partners aren’t liable for negligence and misconduct of other
Partners

Question 19

What is an LLC analogous to?

Answer 19

Analogous to an LLP with no general partners

Question 20

Check-the-box regulations

Answer 20

Incorporated business’s with 2 or more owners is treated by
Default as a partnership for tax purposes

Unless it elects to be taxed as a corporation

Question 21

4 general legal requirements for forming a corporation

Answer 21

1 investing minimum amount of capital
2 filing articles of incorporation
3 issuing stock
4 paying state incorporation fees

Question 22

If section 351 applies to formation of corporation than…

Answer 22

Any gain or loss realized on the exchange may be deferred

Question 23

Section 351: transferors recognize no gain or loss

Answer 23

No gain or loss recognized by transferors when the transfer
Property to corporation solely in exchange for corp’s stock

Provided immediately after exchange transferors are in control

Question 24

Basis when exchanging stock for property under section 351 2 calculations

Answer 24

Stock basis = (basis of property transferred) - (liabilities assumed by corporation) Stock basis = FMV of qualified stock received - deferred gain/loss

Question 25

Section 351: 3 requirements for deferral of gain/loss

Answer 25

1 transferors must transfer property to corporation 2 transferors must receive stock of transferee corporation in Exchange for their property 3 transferors must immediately control corporation after exchange

Question 26

What is excluded from property in section 351, 3 things

Answer 26

1 services 2 indebtedness of transferee corporation not evidenced by a Security 3 interest on transferee corporation debt accrued after beginning Of transferor's holding period

Question 27

Section 351 control requirement

Answer 27

Transferors must control 80% of corporations voting stock immediately after the transfer

Question 28

Is a gain realized when cash is contributed to ownership of stock?

Answer 28

No gain is realized when cash is contributed

Question 29

Section 351 control requirement: services

Answer 29

Because services don't qualify as property, stock received by A person who exclusively provided services doesn't count Toward ownership

Question 30

Section 351: when transferor provides both property and services in exchange for corporations stock... What value must the property have when exchanged with services?

Answer 30

The stock received in exchange for services is counted towards 80% ownership The property must be at least 10% the value of the stock

Question 31

Section 351: existing corporations

Answer 31

Same rules that apply to newly created corporations Property must be transferred in exchange for stock, property Transferors must be in control of corporation immediately after Exchange

Question 32

Section 351: how can existing majority owning shareholders help smaller transferor shareholders meet the requirement for section 351

Answer 32

Existing majority shareholders can transfer property for additional Stock Must be at least 10% value of stock already owned

Question 33

Section 351: immediate control after exchange 3 things

Answer 33

1 Exchanges must be agreed upon before hand 2 But can be executed on different days and still qualify 3 Won't count as control if it was prearranged to immediately sell Stock after the transfer

Question 34

Section 351: preferred shares received in exchange, stock rights, stock warrants

Answer 34

Treated as boot

Question 35

Boot

Answer 35

Cash, notes, securities in another corporation, non voting stock

Question 36

Gain recognition of boot of transferor Loss recognition of transferor?

Answer 36

Transferor recognizes gain to extent of lesser of transferor's Realized gain or FMV of boot property received transferor never recognizes loss in an exchange qualifying under Section 351 whether or not boot is received

Question 37

Section 351: character of recognized gain

Answer 37

Depends on type of property transferred: 1 if shareholder transfers capital asset (ex. Stock of another co.) It's recognized as a capital gain 2 if shareholder transfers sec. 1231 property (ex. Equipment, inventory, Building) it's recognized as ordinary income to extent of Depreciation recapture

Question 38

Section 351: when does depreciation recapture occur?

Answer 38

Depreciation recapture occurs when transferor receives boot | And recognizes gain on depreciated property transferred

Question 39

Section 351: Computing gains on several assets transferred

Answer 39

The gain and loss realized and recognized is computed separately For each property transferred

Question 40

Transferors basis in boot property

Answer 40

Equals FMV of boot property received

Question 41

Share holders basis AKA adjusted basis of stock received equation

Answer 41

Shareholder's basis = (Adjusted basis of property transferred to corporation) + (gain recognized by transferor) - (FMV boot received from corporation and liabilities assumed by corporation)

Question 42

Section 351: Basis among more than one class of qualified stock received

Answer 42

Basis must be allocated

Question 43

Section 351: Transferor's holding period for any stock received in exchange for a capital asset or Sec. 1231 property

Answer 43

Includes Holding period before transfer

Question 44

Section 351: holding period for boot and inventory

Answer 44

Begins day after transfer

Question 45

Section 351: gain or loss recognized by transferee corporation

Answer 45

Corporations recognize no gain or loss when they issue their Own stock or debt in exchange for property or services Recognize a gain but not a loss when they transfer appreciated Property to transferor as part of Section 351 exchange

Question 46

Section 351: if the corporation reduces a property's basis to its FMV under the loss property limitation rule, what happens to the property's holding period .

Answer 46

The holding period will begin the day after the exchange date Because no part of the new basis references the transferor's Basis

Question 47

Gene rule section 357: the transferee corporation's assumption of liabilities in section 351 exchange, how is it treated 2 exceptions

Answer 47

Not treated as boot for a gain recognition Exception 1) treated as boot when used for tax avoidance Exception 2) treated as boot when total amount of liabilities Assumed by transferee corporation exceeds total basis of Property transferred

Question 48

Assignment of income doctrine

Answer 48

Holds that income is taxable to person who earned it and it may Not be assigned to another person for tax purposes Expenses deductible only by party that incurred those liabilities

Question 49

What does the deductibility of interest payments create an incentive for the corporation to do?

Answer 49

Deductibility of interest payments creates an incentive for | Corporations to incur as much debt as possible

Question 50

Tax implications for dividends paid with an equity instrument of the payor corporation

Answer 50

Not tax deductible by the payor corporation

Question 51

Section 351: transferor transfers appreciated property in exchange for the issuance of corporate debt

Answer 51

The debt received will be treated as boot possibly leading to Gain recognition

Question 52

Extinguishment of debt: tax treatment

Answer 52

Generally the retirement of debt is not a taxable event

Question 53

Tax advantages: debt in corporation's capital structure 2

Answer 53

1 corporation can deduct interest paid on debt obligation 2 shareholders don't recognize income in debt retirement as They would in stock redemption

Question 54

Tax disadvantages: using debt in corporation's capital structure 2

Answer 54

1 when shareholder makes capital contribution and receives Debt instrument it is treated as boot (taxable if a gain) 2 if debt becomes worthless, it's treated as a capital loss, not as an ordinary loss

Question 55

Tax advantages: using equity in corporation's capital structure 6

Answer 55

1 70%, 80%, or 100% dividends received deduction available To corporate shareholder who receives dividends 2 can receive common/preferred stock in tax-free corporate Formation 3 can be distributed to shareholders as dividends tax free 4 common/preferred stock that shareholder sells or exchanges That becomes worthless is eligible for ordinary loss treatment 5 section 1202 excludes 50%-100% capital gains realized on sale Or exchange of qualified C corporation small business stock 6 qualified dividends are taxed at capital gains rate

Question 56

3 tax disadvantages: using equity in corporation's capital structure

Answer 56

1 dividends aren't deductible in corporation's taxable income 2 redemption of common or preferred shares is generally Taxable to shareholder's as dividend 3 possible for dividend of preferred stock to be treated as Ordinary income

Question 57

Capital contributions by non shareholders

Answer 57

1 excluded from corporation's gross income 2 given basis of $0 by IRC 3 financial accounting rules report donated capital at FMV 4 can't take depreciation expense for tax purposes because Basis is 0

Question 58

3 instances when securities can be sold for ordinary losses

Answer 58

1 securities that are noncapital assets 2 affiliated corporations (own over 80% of voting stock) 3 section 1244 stock (qualifying small business)

Question 59

What qualifies a stock as section 1244, 2 requirements

Answer 59

1 receives $1million or less for aggregate stock 2 derived more than 50% of gross receipts from a active sources of income (other than dividends, royalties, rents, interest, capital gains)

Question 60

Nonbusiness bad debt

Answer 60

Unpaid loan not evidenced by a security Treated less favorable than business bad debts (evidenced by Security), deductible as short term capital losses up to $3k/yr.

Question 61

Business bad debts

Answer 61

Deductible as ordinary losses without limitation when partially Or totally worthless

Question 62

Loans from shareholder to corporation in connection with stock investment, how are they treated?

Answer 62

Generally Treated as nonbusiness loan Business loan if protects employment, so depends on nature of loan

Question 63

Recognizing losses on corporate transfers, when basis exceeds fair value

Answer 63

1 have transferors own less than 80% of company 2 no shareholder can own over 50% of company