Tax 2-5 Identify requirements for a valid S corporation election. Flashcards
(32 cards)
S Corporations
Question 10 of 30
S corporation shareholders have the ability to deduct losses to the extent of
their original contribution of capital to the business.
their adjusted basis in the stock adjusted for corporate loans personally guaranteed.
their adjusted basis in the stock adjusted for money they have directly loaned to the corporation.
(LO 2-5, pg 51)
their adjusted basis in the stock adjusted for money they have directly loaned to the corporation.
A shareholder’s basis and ability to deduct losses from an S corporation are determined by the shareholder’s adjusted basis in the stock, increased by loans he or she has made to the corporation (basis in debt).
S Corporations
Question 11 of 30
Which one of the following is not a feature of a limited liability company (LLC)?
limited liability to all members
automatic transfer of management rights without the majority approval of the remaining members
conduit taxation
(LO 2-4, pg 57)
automatic transfer of management rights without the majority approval of the remaining members
In an LLC, there is a prohibition against the transfer of management rights without majority approval of the remaining members.
S Corporations
Question 13 of 30
Which of the following forms of business is not a conduit for tax purposes?
sole proprietorship
general partnership
C corporation
S corporation
(LO 2-4)
C corporation
Sole proprietorships, general partnerships, and S corporations are all conduit entities for tax purposes. Only a C corporation is a separate taxable entity.
S Corporations
Question 23 of 30
Which one of the following is correct regarding a shareholder’s basis in an S corporation?
The basis is increased if the shareholder actually loans funds directly to the S corporation.
The basis is increased if the shareholder guarantees a loan for the S corporation.
Basis is increased by net income and distributions that flow through to the shareholder.
(LO 2-4, 45)
The basis is increased if the shareholder actually loans funds directly to the S corporation.
The stockholder’s basis is increased if the stockholder loans funds directly to the S corporation. A stockholder typically has basis in stock, and may have basis in debt as well.
The shareholders of an S corporation are allowed to count as basis only that debt created by a direct loan from the shareholder to the corporation.
S Corporations
Question 29 of 30
Which one of the following is a requirement for an election to be taxed as an S corporation for a particular year?
The election must be filed on or before the fifteenth day of the fourth month of the tax year.
All shareholders must consent in writing to the election.
The corporation may have no more than 35 shareholders.
(LO 2-5, pg 50)
All shareholders must consent in writing to the election.
To be taxed as an S corporation for a given year, all shareholders must consent in writing to such election and the election must be filed by the fifteenth day of the third month (generally March 15th) of the taxable year. Also, the corporation may have no more than 100 shareholders.
S Corporations
Question 30 of 30
Which one of the following is correct regarding an S corporation?
The S corporation may have two classes of stock.
All shareholders must elect to revoke the S corporation election.
The shareholders in an S corporation enjoy limited liability.
(LO 2-5, pg 50)
The shareholders in an S corporation enjoy limited liability.
As with a C corporation, shareholders do have limited liability.
S Corporations
Identify income tax characteristics and advantages of a sole proprietorship.
2-5
A sole proprietorship is a conduit. The Schedule C is part of the individual income tax return, and the income or loss is a part of the AGI. The net income of the sole proprietorship is subject to the self-employment tax. There are no tax consequences on the formation or liquidation of a sole proprietorship. A proprietor has the ability to set up his own retirement plan; any losses generally may offset other income, and there is an above-the-line deduction for health and a portion of long-term care insurance.
S Corporations
Identify nontax disadvantages generally associated with a sole proprietorship.
2-5
unlimited personal liability for business debts or lawsuits
capital structure is typically dependent on the resources of the proprietor
lack of continuity of business life
S Corporations
Identify tax and nontax characteristics of a partnership.
2-5
conduit entity—income or loss is reported on the partners’ personal income tax returns;
generally no tax on formation or liquidation of the partnership;
joint and several liability—unlimited personal liability for business debts or lawsuits;
capital structure is typically dependent on the resources of the partners;
lack of continuity of business life
S Corporations
In some situations, a partnership has the disadvantage of causing income recognition to the partners upon formation. Identify three situations in which income recognition may occur.
2-5
if appreciated securities are contributed to a partnership that is considered an exchange fund partnership
if a partner contributes services and receives an interest in capital
if the partnership relieves a partner of debt
S Corporations
In some situations, a partnership has the disadvantage of causing the recognition of income upon liquidation. When will income be recognized in the liquidation of a partnership?
2-5
When Section 751 assets (“hot assets”) are distributed disproportionately to the partners. The so-called hot assets are unrealized receivables, appreciated inventory, and recapture on cost recovery property. The common denominator between all three of these items is that they can be recognized as ordinary income. The hot assets do not cause automatic income recognition upon liquidation of the partnership. Income recognition occurs only if a partner receives either more or less than her proportionate share of such assets. The rationale for such a rule is that each partner should receive a proportionate share of the ordinary income items. If there were no such rule, a high-bracket partner and a low-bracket partner could distribute assets upon liquidation in such a manner as to ensure that the high-bracket taxpayer received none of the ordinary income property, while the low-bracket taxpayer received all of the ordinary income. When liquidating a partnership, care must be exercised to ensure that unwanted tax consequences do not occur through a disproportionate distribution of hot assets.
S Corporations
Identify a nontax advantage and disadvantage of limited partnerships.
2-5
Advantage—limited personal liability for the limited partners
Disadvantage—no service limited partners, limited partners cannot have day-to-day control or they lose limited partnership status
S Corporations
Partnerships may allow special items of deduction between partners. Explain why special allocations are an advantage of a partnership.
2-5
This may allow particular tax items to flow through to the partners who are most able to use them.
S Corporations
Briefly explain how a partner’s basis in a partnership is determined, and explain the importance of basis in a partnership.
2-5
The partner’s basis is equal to the partner’s contributions of cash to the partnership, the contribution of property (measured in adjusted basis), increased by the partners’ proportionate share of recourse and nonrecourse debt, increased by flow-through of income, and decreased by flow-through of loss and distributions. Payment of loan principal on the debt results in a decrease of the partners’ basis. A partner may deduct her distributive share of partnership losses only up to the amount of her basis in the partnership at the end of the tax year.
S Corporations
Identify and explain tax and nontax characteristics and advantages generally associated with a C corporation.
2-5
separate taxable entity; ability to create a separate taxable entity to retain earnings at a potentially lower tax rate limited liability; liability generally is limited to capital contributed transferability of interest; easy to transfer ownership of the corporation through the sale of stock raising additional business capital; generally easy to raise capital through the sale of stock, or borrowing continuity of life; the C corporation’s existence is not affected by transfer of ownership, death, bankruptcy, or disability of a shareholder management characteristics; centralized management, mere ownership of stock does not give the owner the right to participate in management employee fringe benefits; many benefits (group term life insurance up to $50,000, health and accident insurance, disability insurance, pension or profit sharing plans) may be deductible to the corporation, but are not taxable to the employee
S Corporations
Identify and explain tax and nontax disadvantages generally associated with a C corporation.
2-5
Tax—potential for double taxation—the net income of the corporation is subject to income tax; the dividends distributed are not deductible at the corporate level, but are taxable (generally at preferential tax rates) to the shareholders
Nontax—corporate formalities; large amounts of paperwork; generally more expensive to run; limited ability to operate out of state; less management flexibility; possible oppression of minority shareholders
S Corporations
Explain how the accumulated earnings tax rules can be a disadvantage to a C corporation.
2-5
They prevent the corporation from retaining excess accumulations, forcing those accumulations to be distributed as dividends.
S Corporations
Explain the disadvantage of classifying a C corporation as a personal service corporation.
2-5
The benefit of the corporate graduated tax rate is denied, and the first dollar of taxable income is taxed at the highest corporate marginal rate of 35%. The mere fact that a corporation is considered a qualified personal service corporation should not be the sole reason for deciding against a C corporation. The availability of fringe benefits, limited personal liability, and a variety of other considerations may still lead to the selection of a C corporation. However, the opportunity to retain income within the corporation at lower tax rates is not available. Note that the PSC classification is relevant to the C corporation only.
S Corporations
Section 1244 stock is considered to be an advantage of a corporation.
Briefly describe the requirements for stock to be classified as Section 1244 stock.
2-5
The issuing corporation (C or S) must be domestic. The stock must have been issued for money or other certain property. The stock must be held by the individual who was the original purchaser. The treatment applies only to the first $1 million of stock issued.
S Corporations
Section 1244 stock is considered to be an advantage of a corporation. Why is the ability to issue Section 1244 stock an advantage?
2-5
The loss from Section 1244 stock is treated as an ordinary loss for up to $100,000 annually on a joint return ($50,000 annually on any other return), rather than as a capital loss, which is limited to a $3,000 annual deduction. Excess losses in a given year are treated as capital losses.
S Corporations
Forming as an S corporation is of particular advantage to a new business. Identify the major advantages an S corporation offers a new business.
2-5
The ability to pass the losses of the company through to the shareholders. Limited liability for the shareholders is attractive for a start-up business
S Corporations
After the start-up period has passed, an S corporation often becomes a disadvantage, regardless of whether the new business is successful.
Identify the disadvantage of an S corporation to an unprofitable business after the start-up period.
2-5
Losses are deductible only to the extent of basis in a shareholder’s stock and debt. After several years of deducting losses, the shareholder’s basis is likely to be exhausted, and the losses would no longer be deductible.
S Corporations
The basis in an S corporation is an important concept. How is basis calculated and why is it important?
2-5
The shareholder in an S corporation has basis in stock and basis in debt. The basis in stock is equal to the shareholder’s contributions of cash to the partnership, the contribution of property (measured in adjusted basis), increased by shareholder’s flow-through of income, and decreased by flow-through of loss and distributions. The basis in debt is the amount of money that the shareholder has personally loaned to the S corporation, reduced by any principal repayment from the corporation to the shareholder. A shareholder may deduct his distributive share of S corporation losses only up to the amount of his basis.
S Corporations
An S corporation is unique in that there are certain requirements that must be met to qualify for S status. Identify the requirements for S status.
2-5
The corporation must be domestic. There may be only one class of stock, although differences in voting rights are allowed. There may be no more than 100 shareholders; members of a family (broadly defined) may elect to be treated as a single shareholder. All shareholders must be U.S. citizens or residents. All shareholders must be individuals or certain qualified trusts or estates. All shareholders must consent to the election (a husband and wife are treated as a single shareholder for this purpose).
