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Course 4: Income Tax Planning > Module 5: Essentials of Business Entity Taxation > Flashcards

Module 5: Essentials of Business Entity Taxation Flashcards

1
Q

Types of Tax Accounting Methods (3)

A
  • Cash Method
  • Accrual Method
  • Hybrid Method
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2
Q

Cash Accounting Method

A

A taxpayer generally reports income when any cash is collected (or the constructive receipt of cash).
- also report expenses when any cash payment is made

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3
Q

Who can use the cash accounting method?

A
  • Taxpayers (other than tax shelters) whose annual average gross receipts DO NOT exceed $26 million for the three prior tax years
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4
Q

List of Taxpayers/Corps who can use the Cash Accounting Method

A
  • individual
  • Sole proprietorships
  • partnerships that do not have C corps as partners ($26 m rules as well)
  • C corps following the $26m rule)
  • qualified personals service corporations in the field of medicine, accounting, architecture, law, or engineering if the use of the method clearly reflects income
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5
Q

Accrual Method of Accounting

A

Requires recognition of taxable income int he same tax year it is reported on the taxpayer’s financial statements when the income is earned in any year and the expenses are reported as they are incurred. Income does not have to be received for it to be considered taxable nor expenses paid to be considered deductible.

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6
Q

Who uses the accrual accounting method?

A

The method is mandatory for any business that maintains inventory if they’re over $26m.

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7
Q

Hybrid Method of Accounting

A
  • A combination of the accrual method and the cash method where the taxpayer may account for some items of income using a different method.
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8
Q

What if a company wants to change their accounting method?

A
  • once an accounting method has been adopted by either an individual or a business, it cannot be changed unless it’s approved by the IRS
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9
Q

Inventory Methods (3)

A
  • FIFO
  • LIFO
  • Specific Identification
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10
Q

Specific Identification Method

A

Required the owner of a small business to keep track of the cost of each specific item in inventory, and to take the cost of each specific item into cost of goods sold as each specific item is sold. This will obviously only work with small businesses.

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11
Q

When is an accounting period (fiscal year) first established?

A
  • When an individual or business files its initial income tax return.
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12
Q

Accounting Periods for flow-through entities (like Partnerships or S-Corps)

A

They must generally use the same accounting period as that of their owners, if they have a different taxable year than that of the business entity, the owner must report their share of the entity’s income in the same taxable year within which the entity’s taxable or fiscal year ends.

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13
Q

Net Operating Loss

A
  • once the taxpayer makes the election to claim an NOL, the election is irrevocable nad generates a tax advantage if the taxpayer was in a low tax bracket in earlier years and expects to be in a higher tax bracket in the carryforward years.
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14
Q

Who receives the Net Operating Loss benefit?

A

Cyclical businesses that might otherwise lose money without receiving any benefit given it’s accounting period are the primary beneficiaries of this tax provision.

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15
Q

Who are NOL’s allowed for?

A
  • individuals
  • regular corporations
  • Estate and trust entities
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16
Q

Who are NOL’s NOT allowed for?

A
  • partnerships, or S-corp flow through entities
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17
Q

What is the NOL’s loss limited to?

A
  • 80% of the total taxable income reported for the carryforward years.
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18
Q

Regular or C Corporation

A

Is regarded as a person (entity) separate from its shareholders/owners for income tax purposes.

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19
Q

How are earnings/profits of a C Corp taxed?

A

They are taxed at special corporate income tax rates, and the distributions, in form of dividends, are then taxed again as taxable income to the recipients.

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20
Q

Dividends Received Deductions

A

Based on the percentage owned of the dividend-paying corporation by the corporation receiving the dividend.
- If the receiving corporation owns less than 20% of the distributing corporation the receiving corporation may deduct 50% of the dividends (if 20% or more they can deduct 65%)

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21
Q

Special Taxes Applicable Only to C Corp

A
  • accumulated earnings tax

- personal holding company (PHC) tax

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22
Q

Accumulated Earnings Tax

A

The tax applies whenever a corporation accumulates earnings beyond its reasonable business needs.

  • it is assessed at 20% of accumulated taxable income for the year beyond the 250,000 floor
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23
Q

What is “reasonable business needs”?

A
  • reasonable accumulation of working capital
  • expansion of business
  • debt retirement
  • acquisition of another business
  • replacement of plant or equipment
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24
Q

A Personal Service Corporation (PSC) Accumulated Earnings Tax

A

A PSC has an accumulation limit of 150k rather than the 250k of a regular C Corp

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25
Q

Dividends Paid Deduction

A

Includes dividends paid during the applicable tax year plus those paid during the first 2.5 months of the following tax year

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26
Q

Personal Service Corporation Tax

A

While a regular S corp is a flow-through entity, PSC income is taxed at the entity level.

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27
Q

Personal Service Corporation (PSC)

A

Corporations operating in the professional fields of:

  • health
  • accounting, architecture, and actuarial science
  • law; or
  • engineering or consulting
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28
Q

Personal Service Corporation Tests (2)

A
  • substantially all of the corp’s activities involve the performance of HALE services
  • at least 95% of the corporation’s stock, by value, is owned directly or indirectly by employees performing the services
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29
Q

Personal Holding Company (PHC) Tax

A

Calculated by multiplying the undistributed personal holding company income by a flat rate of 20% in addition to the regular corporate tax.

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30
Q

PHC Ownership Test

A

During the last half of the taxable year, more than 50% of the value of the outstanding stock of the corporation is owned by five or fewer individuals

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31
Q

PHC Ownership Test

A

During the last half of the taxable year, more than 50% of the value of the outstanding stock of the corporation is owned by five or fewer individuals

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32
Q

PHC Passive Income Test

A

At least 60% of the corporation’s adjusted ordinary gross income consists of personal holding company income.

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33
Q

Personal Holding company income

A

Income from securities and other income-producing property.

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34
Q

Section 1244 Stock

A

When a C corp is formed, and the total capital contributions are less than $1m and stock is issued in exchange for investor money (not services) you can sell the stock at a loss of up to $100,000 of an ordinary loss (if married, 50k if single) and can be netted against other gains and carried forward

35
Q

Section 1202 Stock

A

Taxpayers other than C corporations who hold qualified small business stock for more than 5 years may exclude a portion of the gain on the sale of the stock.

36
Q

Maximum Gain Excludible for Sect. 1202 Stock

A
  • 10 times the taxpayer’s basis in the stock; or

- $10m of gain from the stock in that corporation

37
Q

What qualifies as a qualified small business for Sect. 1202 stock?

A

Must nto have aggregate gross assets in excess of $50m when the stock is issued and 80% or more of hte value of corporate assets must be used in the active conduct of one or more of the qualified trades or businesses.

38
Q

Sole Proprietorship

A

Most common pass-through business entities.

39
Q

Sole Proprietorship Losses, Gains and taxability

A
  • Income flows directly to the taxpayer and is reported on schedule C.
  • Self-employment tax applies
  • if losses exceed the limits allowable, the NOL carryforward is allowed
40
Q

Disadvantages of Sole Proprietorships

A
  • Liability is personal
  • difficulty raising capital
  • lack of creditor protection
  • the business will die with the owner
41
Q

General Partnership

A

Treated as a separate entity for its members, but only for limited purposes. Pass-through entities

42
Q

The General Partnership Distinguishable Elements

A
  • Common ownership in the business by more than one owner
  • a sharing of profits and losses of the business
  • General partners are afforded the right to participate in the management and operation of the business. Unlimited personal liability for the acts of the partnership and other partners.
43
Q

How do General Partner Pass-Through’s happen?

A
  • partnerships filed their own return but for information purposes only
  • a k-1 is given to the partner and that is reported on the schedule E of each partner’s IRA form 1040
44
Q

How is a general partners basis calculated?

A

Starts with their original cash or property contribution to the entity, which is then adjusted by earnings or losses.
- the basis can be increased by loans to the partnership, and if losses in excess of the partners actual cash contributed to the partnership it can be deducted.

45
Q

General Partnership Taxation

A

General partners are self-employed for income tax purposes and pay self-employment taxes on net income from self-employment, half of which is a deductible expense by the taxpayer.

46
Q

Limited Partnership

A

A type of partnership in which the partner is liable to the creditors of the partnership only to the extent of that partner’s contribution or promised cash or property.

47
Q

Limited Partnership Formation

A
  • must have an agreement drafted
  • must have a general and limited partner
  • must file with the state giving notice giving notice to others of the limited partnership form.
48
Q

Limited Partnership Taxability

A

Limited partner is only a passive owner for income tax purposes so you cannot deduct any annual losses incurred from the operations of the partnership entity.

49
Q

Family Limited Partnership (FLP)

A

A typed of limited partnership that is typically set up by a senior family member.

50
Q

How does an FLP work?

A

The senior family member transfers business or investment assets to the FLP in exchange for a 1% general partnership interest and a 99% limited partnership interest. Then, over time, the senior family member makes tax-advantaged transfers of the LP interests to younger members of the family.

51
Q

Limited Liability Partnership (LLP)

A

The general partners are not liable for the acts of other partners.
- state created entities and may be formed only in those states that allow the form.

52
Q

S Corp

A

A type of regular corporation that has made a special election to be taxed as a general partnership (to obtain pass through treatment).

53
Q

S Corp Rules

A
  • Organized under state law
  • shareholders must be US citizens, estates, certain trusts, or certain tax-exempt organizations
  • No partnerships or C corps can be shareholders
  • Only have one class of outstanding stock and no more than 100 shareholders.
54
Q

S Corp Set Up

A
  • Must obtain consent from all shareholders by the 15th day of the third month in the year they want it to take place
  • can be terminated either by a majority vote OR a disqualifying event
55
Q

S Corp Taxation for individuals

A

Treated like a partnership with K-1 distributions that pass through but there are no special advantages of implementing special allocations of profits and losses. All items of income and loss are reported based on the ownership percentage of each shareholder.
- Lastly, the basis of an S corporation is calculated differently than that of a general partner, they can only count the basis of what they’ve actually put into the partnership.

56
Q

Pass-Through Deduction

A

20% deduction allowed to a noncorporate taxpayer who has QBI from a partnership, S Corp, or sole proprietor

57
Q

S corp Entity taxation

A
  • Built-in Gains
  • LIFO Recapture
  • Net Passive Income Penalty Tax
58
Q

Built-in Gains Tax

A

Applies when the S corp disposes of an asset, held at the time of conversion to S status, in a taxable disposition within five years after conversion. The tax applies to any unrealized gain attributable to the appreciation in the value of an asset while held by the C corp.

59
Q

How is Built-In Tax Gain Calculated

A

The highest corproate tax rate applies to the lesser of:

  • the recognized built-in gains of the S corp for the taxable year OR
  • the amount of “taxable income” of the corporation if it were a C corp
60
Q

LIFO Recapture Tax

A

If a C corp used the LIFO method of inventory valuation for its last year before making an S corp election, it must include in income the amount of excess found when comparing the inventory’s value under FIFO. Payable in four installments, with the first payment due on or before the due date for the final C corp return

61
Q

Net passive income penalty tax

A

the s corp must have accumulated earnings and profits as a C corp from prior periods, and more than 25% of the S corps gross receipts must be from passive investment income. 21% tac rate.

62
Q

Limited Liability Company (LLC)

A

Hybrid business entity that combines the limited liability associated with either a C or S corp and the pass-through tax treatment of a general partnership.

63
Q

How to form an LLC

A
  • owners must file an article of organization with the state.
64
Q

LLC taxation

A

the LLC Must declare how it wishes to be taxed, and it can be taxed as one of the following

  • Sole proprietorship
  • partnership
  • C corp
  • S corp
65
Q

Qualified Business Income (Pass-Through Business) Deduction

A

20% deduction of Qualified Business Income from pass-through business when calculating their personal income tax.

66
Q

QBI Definition

A

The net amount of income, gain, deduction and loss with respect to the trade or business. Most investment income is not included as QBI

67
Q

QBI does not include

A
  • capital gains or loss
  • dividend income
  • interest income other than interest income that is properly allocable to the trade or business
  • any amount received from an annuity that is not received in connection with the trade or business
  • gains and losses from commodity transactions or foreign currency transactions
68
Q

QBI AGI Deductions

A
  • 1/2 of the self-employment tax
  • the self-employment health insurance deduction
  • The keogh deduction
    • available to taxpayers who take the standard deduction, because the deduction is take after AGI
69
Q

QBI Deduction Calculation

A

Lesser of:

  • 20% of the qualified business income
  • 20% of taxable income in excess of net capital gains
70
Q

Over QBI Threshold Problems

A

The deductibility of QBI once you are over the income threshold comes down to the type of business that you’re in, either a Specified Service Trade or Business or other business.

SSTB does not get the QBI deduction, but other business get a deduction at:

  • 20% of QBI or
  • the greater of 50% of the taxpayers allocable share of W-2 wages paid by the business OR 25% of the taxpayer’s allocable share of the W-2 wages paid by the business, plus 2.5% of the taxpayer’s allocable share of the unadjusted basis of all qualified property of the business.
71
Q

Within Phaseout Range

A
  1. Calculate Percentage of How far over the range they are
  2. find the QBI deduction for both the 10% of QBI and the 50% of wages paid, find the difference between those two, and multiply it by step 1.
  3. Subtract that from 20% of the QBI
72
Q

What is the Self Employment Tax?

A

15.3% of Self-Employment Income

73
Q

Self-Employment Tax Deduction

A

There is an above-the-line deduction that’s afforded to the self-employed individual for the deductible share of the self-employment tax due. This deduction is simply half of the self-employment tax.

74
Q

How to calculate self-employment tax (below the wage base)

A
  1. determine what constitutes self-employment income
  2. Deduct self-employment taxes paid for their employees but not the Social Security tax they paid for themselves (subtract 7.65%)
  3. multiply the resulting product by 15.3%
75
Q

What constitutes self-employment income?

A
  • Net Schedule C Income
  • the distributive share of income paid to a general partner
  • part-time earnings of an individual; and
  • board of director fees
76
Q

What does NOT constitute self-employment income?

A
  • dividends or interest on investments
  • real estate rental income
  • the distributive share of income paid to a limited partner
  • wages paid to an S corp shareholder
  • the distributive share of earnings to an S corp shareholder (K-1) income
77
Q

How to calculate self-employment tax (above the wage base of 142,800)

A
  • calculate self-employment income
  • subtract 7.65%
  • subtract the wage base from that
    -multiply the excess by 2.9%
  • multiply the wage base by 15.3%
    add those two numbers together to arrive at the total SE tax number
78
Q

Self-employed Health Insurance Deduction

A

Someone who is self employed may deduct 100% of the amount paid for health insurance and qualified long-term care insurance for the sole proprietor and their spouse, dependents and any child of the taxpayer who is under 27 at the close of the tax year.

79
Q

Who can use the SE health Insurance Deduction?

A
  • Sole proprietor
  • a partner
  • greater than 2% shareholder in an S corp, with wages from the S corp reported on form W-2
80
Q

SE Health Insurance Deduction Rules

A
  • Must be established under the taxpayer’s business
81
Q

Home Office Deduction

A

Self-Employed person may deduct qualifying home office expenses to reach AGI and that deduction is taken on Schedule C

82
Q

Two Methods for Calculating Home Office Deduction

A
  • Simplified Option

- Regular Method

83
Q

Simplified Option

A

Deduction for Home office use of a portion of a residence allowed only if that portion is exclusively used on a regular basis for business purposes

  • cannot use more than 300 sq ft of home
  • standard $5 per square foot used to determine home business deduction
  • home related
84
Q

Regular Method

A
  • gross income
  • deduct, in the following order:
    1. expense directly related to the business before considering any home office expenses
    2. determine percentage of the home used as an office
  • deduct allocable mortgage interest and property taxes, utilities and other expenses
    3. deduct depreciation

Course 4: Income Tax Planning (8 decks)

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