Chap015
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Chap015

Course Number: BUS 167, Fall 2012

College/University: UC Riverside

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Chapter 15 - Entities Overview Chapter 15 Entities Overview True / False Questions 1. Corporations are legally formed by filing articles of organization with the state in which the corporation will be created. True False 2. General partnerships are legally formed by filing a partnership agreement with the state in which the partnership will be formed. True False 3. Limited partnerships are legally formed by...

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15 Chapter - Entities Overview Chapter 15 Entities Overview True / False Questions 1. Corporations are legally formed by filing articles of organization with the state in which the corporation will be created. True False 2. General partnerships are legally formed by filing a partnership agreement with the state in which the partnership will be formed. True False 3. Limited partnerships are legally formed by filing a certificate of limited partnership with the state in which the partnership will be organized. True False 4. Sole proprietorships are not treated as legal entities separate from their individual owners. True False 5. S corporation shareholders are legally responsible for paying the S corporation's debts because it is treated as a flow-through entity for tax purposes. True False 6. LLC members have more flexibility than shareholders to alter their legal arrangements with respect to one another, the entity, and with outsiders. True False 15-1 Chapter 15 - Entities Overview 7. Corporations are legally better suited for taking a business public compared with LLCs and general partnerships. True False 8. Both tax and nontax objectives should be considered when choosing an appropriate business entity. True False 9. Tax rules require that entities be classified the same way for tax purposes as they are classified for legal purposes. True False 10. C corporations and S corporations are separate taxpaying entities that pay tax on their own income. True False 11. All unincorporated entities are generally treated as flow-through entities for tax purposes. True False 12. In certain circumstances, C corporations can elect to be treated as flow-through entities. True False 13. An unincorporated entity with more than one owner is, by default, taxed as a partnership. True False 14. A single-member LLC is taxed as a partnership. True False 15-2 Chapter 15 - Entities Overview 15. For tax purposes, a disregarded entity is an unincorporated entity with only one individual owner. True False 16. Unincorporated entities with only one individual owner are taxed as sole proprietorships. True False 17. S corporations have more restrictive ownership requirements than other entities. True False 18. Entities taxed as partnerships use special allocations to reward owners based on their responsibilities, contributions, and individual needs. True False 19. Sole proprietorships are subject to self-employment taxes on net income from their sole proprietorships. True False 20. Shareholders of C corporations receiving property distributions must recognize dividend income equal to the fair market value of the distributed property if the distributing corporation has sufficient earnings and profits. True False 21. Losses from C corporations are never available to offset a shareholder's personal income. True False 15-3 Chapter 15 - Entities Overview Multiple Choice Questions 22. Which of the following legal entities file documents with the state to be formally recognized by the state? A. Limited Liability Company B. General Partnership C. Sole Proprietorship D. A and B E. A and C F. B and C G. All of above must file documents with the state. 23. If an individual forms a sole proprietorship, which nontax factor will be of greatest benefit to the sole proprietor? A. Liability protection B. Legal flexibility in defining rights and responsibilities of owners C. Facilitates initial public offerings D. Minimal time and cost to organize 24. Which legal entity is correctly paired with the party that bears the ultimate responsibility for paying the legal entity's liabilities? A. LLC - LLC members B. Corporation - Corporation C. General Partnership - Partnership D. Limited Partnership - General partner E. Both B and D. 25. Which legal entity provides the least flexible legal arrangement for owners? A. Corporation B. LLC C. Partnership D. Sole Proprietorship 15-4 Chapter 15 - Entities Overview 26. Which legal entity is generally best suited for going public? A. Corporation B. LLC C. Limited Liability Partnership D. General Partnership E. A and C F. A and D 27. What document must LLCs file with the state to organize their business? A. Articles of incorporation B. Certificate of LLC C. Articles of organization D. Partnership agreement E. None of the above. LLCs do not have to file with the state to organize their business. 28. Which of the following entity characteristics are generally key drivers for small business owners in deciding which entity to choose? A. Double taxation B. Required accounting period C. Liability protection D. A and B E. A and C 29. On which form is income from a single member LLCs with one corporate owner reported? A. Form 1120 used by C corporations to report their income B. Form 1120S used by S corporations to report their income C. Form 1065 used by partnerships to report their income D. Form 1040, Schedule C used by sole proprietorships to report their income E. None of the above. 15-5 Chapter 15 - Entities Overview 30. On which tax form do single member LLCs with one individual owner report their income and losses? A. Form 1120 B. Form 1120S C. Form 1065 D. Form 1040, Schedule C 31. On which tax form do LLCs with more than one owner report their income and losses? A. Form 1120 B. Form 1120S C. Form 1065 D. Form 1040, Schedule C 32. Which tax classifications can potentially apply to LLCs? A. S corporation B. Partnership C. Sole proprietorship D. A and B E. A and C F. B and C G. All of the above 33. Generally, which of the following flow-through entities can elect to be treated as a C corporation? A. Limited partnership B. Limited Liability Company C. General partnership D. All of the above. 15-6 Chapter 15 - Entities Overview 34. Which of the following legal entities are classified as C corporations for tax purposes? A. Limited Liability Company B. S corporations C. Limited partnerships D. Sole proprietorship E. None of the above 35. If PST Corporation is a shareholder of MNO Corporation, how many levels of tax is MNO's pre-tax income potentially exposed to? A. No taxation B. Single taxation C. Double taxation D. Triple taxation 36. Crocker and Company, Inc. had taxable income of $550,000 for 2011. At the end of 2011, it distributes all its after-tax earnings to Jimmy, the company's sole shareholder. Jimmy's marginal ordinary tax rate is 34 percent and his marginal dividend tax rate is 15 percent. What is the overall tax rate on Crocker and Company's pre-tax income? A. 9.9% B. 15.0% C. 35.0% D. 43.9% E. 66.7% 37. If C corporations retain their after-tax earnings, when will corporate shareholders be taxed on the retained earnings? A. Shareholders will be taxed when they sell their shares at a gain B. Shareholders will be taxed in the year they elect to be taxed on undistributed retained earnings C. Shareholders will be taxed on undistributed retained earnings in the year the corporation files its tax return D. None of the above 15-7 Chapter 15 - Entities Overview 38. Which of the following is most effective in mitigating the double tax? A. Shift income from high tax rate shareholders to low tax rate corporations B. Shift income from low tax rate shareholders to high tax rate corporations C. Shift income from high tax rate corporations to low tax rate shareholders D. Shift income from low tax rate corporations to high tax rate shareholders 39. While a C corporation's losses cannot be used by their shareholders to offset personal income, a C corporation may carry back and carry forward losses to help offset the taxable income a corporation had or will have. How are these net operating losses carried back and carried forward? A. Carried back two years, carried forward indefinitely B. Carried back indefinitely, carried forward two years C. Carried back two years, carried forward five years D. Carried back two years, carried forward twenty years E. None of the above. 40. Logan, a 50 percent shareholder in Military Gear, Inc., is comparing the tax consequences of losses from C corporations compared with losses from S corporations. Assume Military Gear, Inc has a $100,000 loss for the year, Logan's tax basis in Military Gear, Inc. was $150,000 at the beginning of the year, and he received $75,000 ordinary income from other sources during the year. Assuming Logan's marginal income tax rate is 15%, how much more tax will Logan pay currently if Military Gear, Inc. is a C corporation compared to the tax he would pay if it were an S corporation? A. $0 B. $3,750 C. $7,500 D. $11,250 41. Which of the following is not an effective strategy for mitigating double taxation in a C corporation? A. C corporations can shift income to shareholders via deductible payments B. C corporations can make an S election C. C corporations can pay dividends to their shareholders D. None of the above. All of these statements are effective strategies to mitigate or avoid double taxation. 15-8 Chapter 15 - Entities Overview 42. Robert is seeking additional capital to expand ABC, Inc. In order to qualify ABC as an S corporation, which type of investor group should Robert obtain capital from? A. 30 different partnerships B. 10 different C corporations C. 90 nonresident individuals D. 120 unrelated resident individuals E. None of the above. 43. What tax year-end must unincorporated entities with only one owner adopt? A. The entity is free to adopt any tax year-end B. The entity must adopt the same year-end as its owner C. The entity must adopt a calendar year-end D. The entity may adopt any year-end except for a calendar year-end 44. Roberto and Reagan are both 25 percent owner/managers for Bright Light, Inc. Roberto runs the retail store in Sacramento, CA, and Reagan runs the retail store in San Francisco, CA. Bright Light, Inc. generated a $125,000 profit companywide made up of a $75,000 profit from the Sacramento store, a ($25,000) loss from the San Francisco store, and a combined $75,000 profit from the remaining stores. If Bright Light, Inc. is an S corporation, how much income will be allocated to Roberto? A. $31,250 B. $62,500 C. $75,000 D. $125,000 15-9 Chapter 15 - Entities Overview 45. Roberto and Reagan are both 25 percent owner/managers for Bright Light Enterprises. Roberto runs the retail store in Sacramento, CA, and Reagan runs the retail store in San Francisco, CA. Bright Light generated a $125,000 profit companywide made up of a $75,000 profit from the Sacramento store, a ($25,000) loss from the San Francisco store, and a combined $75,000 profit from the remaining stores. If Bright Light is taxed as a partnership and decides that Roberto and Reagan will be allocated 70 percent of their own store's profit with the remaining profits allocated pro rata among all the owners, how much income will be allocated to Reagan? A. ($25,000) B. ($17,500) C. $5,000 D. $20,000 46. When an employee/shareholder receives an income allocation from an S corporation, what taxes apply to the income allocation? A. FICA tax only. B. Self-employment tax only. C. FICA and self-employment tax. D. None of the above. This income will never be taxed. E. None of the above. This income will be taxed, but another type of tax will apply. 47. What is the tax impact to a C corporation or an S corporation when it makes a property distribution to a shareholder? A. Recognizes either gain or loss B. Doesn't recognize gain or loss C. Recognizes gain only D. Recognizes loss only 15-10 Chapter 15 - Entities Overview 48. Assume you plan to start a new enterprise; you know the probability of having losses for the first three years of operations is almost 90 percent, and you know you will report a substantial amount of income from other sources during those same three years. From a tax perspective, which of the following entity choices would be least favorable? A. C corporation B. LLC C. General partnership D. Limited partnership E. S corporation 49. From a tax perspective, which entity choice is preferred when a liquidating distribution occurs and the entity has depreciated assets? A. Partnership B. S corporation C. LLC D. A and B E. B and C 50. From a tax perspective, which entity choice is preferred when a liquidating distribution occurs and the entity has appreciated assets? A. Partnership B. S corporation C. LLC D. A and C E. B and C 51. If you were seeking an entity with the most favorable tax treatment regarding (1) the number of owners allowed, (2) the flexibility to select your accounting period, and (3) the availability of preferential capital gains rates when selling your ownership interest, which entity should you decide to use? A. C corporation B. S corporation C. Partnership D. Sole proprietorship 15-11 Chapter 15 - Entities Overview 52. Which of the following is not an effective strategy for mitigating the double tax associated with C corporations? A. Paying a salary to a shareholder-employee B. Leasing property from a shareholder C. Borrowing money from a shareholder D. Paying fringe benefits to a shareholder-employee E. All of the above are effective strategies for mitigating double taxation 53. What is the maximum number of unrelated shareholders a C corporation can have, the maximum number of unrelated shareholders an S corporation can have, and the maximum number of partners a partnership may have? A. 100; no limit; no limit B. no limit; 100; 2 C. no limit; 100; no limit D. 100; 100; no limit Essay Questions 54. David would like to organize HOS as either an LLC or as a corporation generating a 12 percent annual before-tax return on a $300,000 investment. Individual and corporate tax rates are both 30 percent and individual capital gains and dividend tax rates are 15 percent. HOS will pay out its after-tax earnings every year to either its members or its shareholders. a. Ignoring self-employment taxes, how much would David keep after taxes if HOS is organized as either an LLC or a corporation? b. Ignoring self-employment taxes, what are the overall tax rates if HOS is organized as either an LLC or a corporation? 15-12 Chapter 15 - Entities Overview 55. Jaron would like to organize TMZ as either an LLC or as a corporation generating a 6 percent annual before-tax return on a $200,000 investment. Individual and corporate tax rates are both 40 percent and individual capital gains and dividends tax rates are 10 percent. TMZ will distribute its earnings annually to either its members or shareholders. a. Ignoring self-employment taxes, how much would Jaron keep after taxes if TMZ is organized as either a corporation or an LLC? b. Ignoring self-employment taxes, what are the overall tax rates if TMZ is organized as either an LLC or a corporation? 56. Emmy would like to organize PRK as either an LLC or as a corporation generating a 15 percent annual before-tax return on a $100,000 investment. Individual ordinary rates are 25 percent, corporate rates are 15 percent, and individual capital gains and dividends tax rates are 5 percent. PRK will distribute its earnings annually to either its members or shareholders. a. Ignoring self-employment taxes, how much would Emmy keep after taxes if PRK is organized as either a corporation or an LLC? b. Ignoring self-employment taxes, what are the overall tax rates if PRK is organized as either an LLC or a corporation? 15-13 Chapter 15 - Entities Overview 57. Jerry would like to organize FBC as either an LLC or as a corporation generating an 8 percent annual before-tax return on a $400,000 investment. Individual and corporate tax rates are both 35 percent and individual capital gains and dividends tax rates are 15 percent. FBC will pay out its after-tax earnings every year to either its members or its shareholders. How much would Jerry keep after taxes if FBC is organized as either a corporation or an LLC? 58. Taylor would like to organize DRK as either an LLC or as a corporation generating a 13 percent annual before-tax return on a $250,000 investment. Individual and corporate tax rates are both 30 percent and individual capital gains and dividends tax rates are 5 percent. DRK will distribute its earnings annually to either its members or shareholders. a. Ignoring self-employment taxes, how much would Taylor keep after taxes if DRK is organized as either a corporation or an LLC? b. Ignoring self-employment taxes, what are the overall tax rates if DRK is organized as either an LLC or a corporation? 15-14 Chapter 15 - Entities Overview 59. Becca would like to organize BMI as either an LLC or as a corporation generating a 4 percent annual before-tax return on a $450,000 investment. Individual ordinary rates are 28 percent, corporate rates are 15 percent, and individual capital gains and dividends tax rates are 15 percent. BMI will distribute its earnings annually to either its members or shareholders. a. How much would Becca keep after taxes if BMI is organized as either a corporation or an LLC? b. What are the overall tax rates if BMI is organized as either an LLC or a corporation? 60. SNL corporation, a C corporation, reports $400,000 of taxable income in the current year. SNL's tax rate is 35 percent. Answer the following questions, assuming Keegan, SNL's sole shareholder, has a marginal tax rate of 28 percent on ordinary income and 15 percent on dividend income. a. Compute the first level of tax on SNL's taxable income for the year. b. Compute the second level of tax on SNL's income assuming that SNL currently distributes all of its after-tax earnings to Keegan. What is the overall corporate (double) tax rate on SNL's taxable income for the year? 15-15 Chapter 15 - Entities Overview 61. In the current year, DNS (a C corporation) had taxable income of $600,000 and distributed all of its after-tax earnings to Daniel, its sole shareholder. DNS's tax rate is 38 percent. Assuming Daniels's marginal tax rate on ordinary income is 28 percent and his dividend rate is 15 percent, what is the amount of the double-tax that DNS Corporation and Daniel must pay on DNS's $600,000 of taxable income? 62. In its first year of existence, BYC Corporation (a C corporation) reported a loss for tax purposes of ($40,000). How much tax will BYC pay in year 2 if it reports taxable income from operations of $35,000 in year 2 before any loss carryovers? 63. In its first year of existence Aspen Corp. (a C corporation) reported a loss for tax purposes of $50,000. In year 2, it reports a $30,000 loss. For year 3, it reports taxable income from operations of $120,000. How much tax will Aspen Corp. pay for year 3? Consult the corporate tax rate table provided to calculate your answer. 15-16 Chapter 15 - Entities Overview 64. For the current year, Creative Designs Inc., a C corporation, reports taxable income of $300,000 before paying salary to Ben the sole shareholder of Creative Designs Inc. (CD). Ben's marginal tax rate on ordinary income is 28 percent and 15 percent on dividend income. Assume CD's tax rate is 39 percent. a. How much total income tax will Creative Designs and Ben pay on the $300,000 taxable income for the year if CD doesn't pay any salary to Ben and instead distributes all of its aftertax income to Ben as a dividend? b. How much total income tax will Creative Designs and Ben pay on the $300,000 of income if CD pays Ben a salary of $100,000 and distributes its remaining after-tax earnings to Ben as a dividend? c. Why is the answer to part b lower than the answer to part a? 65. For the current year, Birch Corporation, a C corporation, reports taxable income of $400,000 before paying salary to its sole shareholder Elaine. Elaine's marginal tax rate on ordinary income is 33 percent and 15 percent on dividend income. If Birch pays Elaine a salary of $200,000 but the IRS determines that Elaine's salary in excess of $100,000 is unreasonable compensation, what is the overall income tax rate on Birch's $400,000 presalary income? Assume Birch's tax rate is 35 percent and it always distributes all after-tax earnings to Elaine. 15-17 Chapter 15 - Entities Overview 66. Cali Corp. (a C corporation) projects that it will have taxable income of $250,000 for the year before paying any fringe benefits. Stacey, Cali's sole shareholder, has a marginal tax rate of 33 percent on ordinary income and 15 percent on dividend income. Assume Cali's tax rate is 34 percent. a. What is the amount of the double income tax on Cali's $250,000 of pre-benefit income if Cali Corp. does not pay out any fringe benefits and distributes all of its after-tax earnings to Stacey? b. What is the amount of the double income tax on Cali's $250,000 of pre-benefit income if Cali Corp. pays Stacey's adoption expenses of $50,000 and the payment is considered to be a qualified fringe benefit? Cali Corp. distributes all of its after-tax earnings to Stacey. c. What is the amount of the double income tax on Cali's $250,000 of pre-benefit income if Cali Corp. pays Stacey's adoption expenses of $50,000 and the payment is considered to be a nonqualified fringe benefit? Cali Corp. distributes all of its after-tax earnings to Stacey. 15-18 Chapter 15 - Entities Overview 67. Jamal Corporation, a C corporation, projects that it will have taxable income of $500,000 before incurring any lease expenses. Jamal's tax rate is 34 percent. Ali, Jamal's sole shareholder, has a marginal tax rate of 33 percent on ordinary income and 15 percent on dividend income. Jamal always distributes all of its after-tax earnings to Ali. a. What is the amount of the double-tax on Jamal Corp.'s $500,000 pre-lease expense income if Jamal Corp. distributes all of its after-tax earnings to its sole shareholder Ali? b. What is the amount of the double-tax on Jamal Corp.'s $500,000 pre-lease expense income if Jamal leases equipment from Ali at a cost of $120,000 for the year? c. What is the amount of double-tax on Jamal Corp.'s $500,000 pre-lease expense income if Jamal Corp. leases equipment from Ali at a cost of $120,000 for the year but the IRS determines that the fair market value of the lease payments is $80,000? 68. Tuttle Corporation (a C corporation) projects that it will have taxable income for the year of $300,000 before incurring any interest expense. Assume Tuttle's tax rate is 35 percent. a. What is the amount of the double-tax on the $300,000 of pre-interest expense earnings if Ruth, Tuttle's sole shareholder, lends Tuttle Corporation $100,000 at the beginning of the year, Tuttle pays Ruth $10,000 of interest on the loan (interest is considered to be reasonable), and Tuttle distributes all of its after-tax earnings to Ruth? Assume her ordinary marginal rate is 33 percent and dividend tax rate is 15 percent. b. Assume the same facts as in part a except that the IRS determines that the fair market value of the interest should be $8,000. What is the amount of the double-tax on Tuttle Corporation's pre-interest expense earnings? 15-19 Chapter 15 - Entities Overview 69. Nancy decided that she would purchase a building and then lease the building to ZML. She leased the building to ZML for $2,500 per month. However, the IRS determined that the fair market value of the lease payment should only be $1,500 per month. How would the lease payment be treated with respect to both Nancy and ZML? 70. Rodger owns 100% of the shares in Trevor, Inc., a C corporation. Assume the following for the current year: Given these assumptions, how much cash does Rodger have from the dividend after all taxes have been paid? 15-20 Chapter 15 - Entities Overview 71. Corporation A owns 10% of Corporation C. The marginal tax rate on non-dividend income for both A and C is 34% in 2011. Corporation C earns a total of $200 million before taxes in 2011, pays corporate tax on this income and distributes the remainder proportionately to its shareholders as a dividend. In addition, Corporation A owns 20% of partnership P that earns $500 million in 2011. Given this fact pattern, answer the following questions: a. How much cash from the Corporation C dividend remains after Corporation A pays the tax on the dividend? b. If partnership P distributes all of its year 2011 earnings in proportion to the partner's ownership percentages, how much cash from Partnership P does Corporation A have after paying taxes on its share of income from the partnership? c. If you were to replace corporation A with individual A (her marginal tax rate on ordinary income is 28% and on qualified dividends is 15%) in the original fact pattern above, how much cash does individual A have from the Corporation C dividend after all taxes assuming the dividends are qualified dividends? Consistent with the original facts, assume that Corporation C distributes all of its after-tax income to its shareholders. 15-21 Chapter 15 - Entities Overview Chapter 15 Entities Overview Answer Key True / False Questions 1. Corporations are legally formed by filing articles of organization with the state in which the corporation will be created. FALSE Corporations file articles of incorporation. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Medium 2. General partnerships are legally formed by filing a partnership agreement with the state in which the partnership will be formed. FALSE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Medium 3. Limited partnerships are legally formed by filing a certificate of limited partnership with the state in which the partnership will be organized. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Easy 15-22 Chapter 15 - Entities Overview 4. Sole proprietorships are not treated as legal entities separate from their individual owners. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Easy 5. S corporation shareholders are legally responsible for paying the S corporation's debts because it is treated as a flow-through entity for tax purposes. FALSE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Medium 6. LLC members have more flexibility than shareholders to alter their legal arrangements with respect to one another, the entity, and with outsiders. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Easy 7. Corporations are legally better suited for taking a business public compared with LLCs and general partnerships. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Easy 15-23 Chapter 15 - Entities Overview 8. Both tax and nontax objectives should be considered when choosing an appropriate business entity. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Medium 9. Tax rules require that entities be classified the same way for tax purposes as they are classified for legal purposes. FALSE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Easy 10. C corporations and S corporations are separate taxpaying entities that pay tax on their own income. FALSE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 11. All unincorporated entities are generally treated as flow-through entities for tax purposes. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 15-24 Chapter 15 - Entities Overview 12. In certain circumstances, C corporations can elect to be treated as flow-through entities. TRUE An S-Corporation election achieves this purpose. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 13. An unincorporated entity with more than one owner is, by default, taxed as a partnership. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Easy 14. A single-member LLC is taxed as a partnership. FALSE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 15. For tax purposes, a disregarded entity is an unincorporated entity with only one individual owner. FALSE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 15-25 Chapter 15 - Entities Overview 16. Unincorporated entities with only one individual owner are taxed as sole proprietorships. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 17. S corporations have more restrictive ownership requirements than other entities. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 18. Entities taxed as partnerships use special allocations to reward owners based on their responsibilities, contributions, and individual needs. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 19. Sole proprietorships are subject to self-employment taxes on net income from their sole proprietorships. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-26 Chapter 15 - Entities Overview 20. Shareholders of C corporations receiving property distributions must recognize dividend income equal to the fair market value of the distributed property if the distributing corporation has sufficient earnings and profits. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 21. Losses from C corporations are never available to offset a shareholder's personal income. TRUE AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 15-27 Chapter 15 - Entities Overview Multiple Choice Questions 22. Which of the following legal entities file documents with the state to be formally recognized by the state? A. Limited Liability Company B. General Partnership C. Sole Proprietorship D. A and B E. A and C F. B and C G. All of above must file documents with the state. LLCs file articles of organization with the state to receive formal recognition from the state, but general partnerships typically don't file their partnership agreements. Because sole proprietorships are not treated as legal entities separate from their owners, sole proprietors don't need to do anything to receive legal recognition from the state. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Medium 23. If an individual forms a sole proprietorship, which nontax factor will be of greatest benefit to the sole proprietor? A. Liability protection B. Legal flexibility in defining rights and responsibilities of owners C. Facilitates initial public offerings D. Minimal time and cost to organize While a sole proprietorship can be organized with minimal time and cost, sole proprietorships don't provide a shield for the individual owner. Legal flexibility to define the rights and responsibilities of owners and the ability to go public are irrelevant because they are not characteristics that pertain to sole proprietorships. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Medium 15-28 Chapter 15 - Entities Overview 24. Which legal entity is correctly paired with the party that bears the ultimate responsibility for paying the legal entity's liabilities? A. LLC - LLC members B. Corporation - Corporation C. General Partnership - Partnership D. Limited Partnership - General partner E. Both B and D. Corporations and LLCs, rather than their owners, are responsible for their debts. General partners are responsible for debts of general and limited partnerships. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Medium 25. Which legal entity provides the least flexible legal arrangement for owners? A. Corporation B. LLC C. Partnership D. Sole Proprietorship State partnership and LLC statutes provide members and partners with a great deal of flexibility. In contrast, corporate governance rules limit the flexibility of shareholders. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Easy 15-29 Chapter 15 - Entities Overview 26. Which legal entity is generally best suited for going public? A. Corporation B. LLC C. Limited Liability Partnership D. General Partnership E. A and C F. A and D Corporations have the governance structure to successfully achieve an initial public offering. The other entities would have to restructure to make this possible. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Easy 27. What document must LLCs file with the state to organize their business? A. Articles of incorporation B. Certificate of LLC C. Articles of organization D. Partnership agreement E. None of the above. LLCs do not have to file with the state to organize their business. LLCs must file articles of organization with the state the LLC desires to organize its business in. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities. Level of Difficulty: Medium 15-30 Chapter 15 - Entities Overview 28. Which of the following entity characteristics are generally key drivers for small business owners in deciding which entity to choose? A. Double taxation B. Required accounting period C. Liability protection D. A and B E. A and C While each circumstance is different, small business owners typically seek liability protection while avoiding double taxation. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types legal of entities. Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 29. On which form is income from a single member LLCs with one corporate owner reported? A. Form 1120 used by C corporations to report their income B. Form 1120S used by S corporations to report their income C. Form 1065 used by partnerships to report their income D. Form 1040, Schedule C used by sole proprietorships to report their income E. None of the above. A single member LLC with one corporate owner is considered to be a disregarded entity. In essence, the entity is treated like a division of its parent company. Thus, its income will be reported on the Form 1120 of its parent corporation. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Hard 15-31 Chapter 15 - Entities Overview 30. On which tax form do single member LLCs with one individual owner report their income and losses? A. Form 1120 B. Form 1120S C. Form 1065 D. Form 1040, Schedule C Single member LLCs with one individual owner follow the same filing guidelines as sole proprietorships. Thus, their income is reported on, Form 1040, Schedule C. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 31. On which tax form do LLCs with more than one owner report their income and losses? A. Form 1120 B. Form 1120S C. Form 1065 D. Form 1040, Schedule C LLCs with more than one owner are taxed as partnerships and report their income on Form 1065. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 15-32 Chapter 15 - Entities Overview 32. Which tax classifications can potentially apply to LLCs? A. S corporation B. Partnership C. Sole proprietorship D. A and B E. A and C F. B and C G. All of the above LLCs can elect to be taxed as corporations and then make an S election if they satisfy the requirements for number and type of shareholder. The default tax status for LLCs with more than one member is partnership, and the default tax status for single-member LLCs with an individual owner is sole proprietorship. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 33. Generally, which of the following flow-through entities can elect to be treated as a C corporation? A. Limited partnership B. Limited Liability Company C. General partnership D. All of the above. Owners of unincorporated entities may elect to have them treated as C corporations. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 15-33 Chapter 15 - Entities Overview 34. Which of the following legal entities are classified as C corporations for tax purposes? A. Limited Liability Company B. S corporations C. Limited partnerships D. Sole proprietorship E. None of the above Limited liability companies and limited partnerships are generally taxed as partnerships. S corporations are taxed under a separate set of rules applicable to S corporations. Sole proprietorships are not taxed separately from their owners. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 35. If PST Corporation is a shareholder of MNO Corporation, how many levels of tax is MNO's pre-tax income potentially exposed to? A. No taxation B. Single taxation C. Double taxation D. Triple taxation MNO will have to pay taxes on the amount of pre-tax income it earns. Then, if MNO pays a dividend to PST, the income will be taxed second time. If PST pays a dividend to its shareholders, the income will be taxed a third time. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-02 Describe the different types of entities for tax purposes. Level of Difficulty: Medium 15-34 Chapter 15 - Entities Overview 36. Crocker and Company, Inc. had taxable income of $550,000 for 2011. At the end of 2011, it distributes all its after-tax earnings to Jimmy, the company's sole shareholder. Jimmy's marginal ordinary tax rate is 34 percent and his marginal dividend tax rate is 15 percent. What is the overall tax rate on Crocker and Company's pre-tax income? A. 9.9% B. 15.0% C. 35.0% D. 43.9% E. 66.7% Crocker and Company pays taxes of $187,000 ($550,000 .34). Therefore $363,000 ($550,000 - $187,000) will be distributed to the shareholder as a dividend. The shareholder pays taxes of $54,450 ($363,000 .15). The total taxes paid on Crocker and Company's pretax income are $241,450 ($187,000 + $54,450), and the overall tax rate will be 43.9 percent ($241,450/$550,000). AACSB: Analytic AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Hard 37. If C corporations retain their after-tax earnings, when will corporate shareholders be taxed on the retained earnings? A. Shareholders will be taxed when they sell their shares at a gain B. Shareholders will be taxed in the year they elect to be taxed on undistributed retained earnings C. Shareholders will be taxed on undistributed retained earnings in the year the corporation files its tax return D. None of the above Corporate shareholders generally pay taxes on corporate earnings either when they sell their shares or they receive dividends. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-35 Chapter 15 - Entities Overview 38. Which of the following is most effective in mitigating the double tax? A. Shift income from high tax rate shareholders to low tax rate corporations B. Shift income from low tax rate shareholders to high tax rate corporations C. Shift income from high tax rate corporations to low tax rate shareholders D. Shift income from low tax rate corporations to high tax rate shareholders When income is shifted from a high tax rate corporation to a low rate shareholder, the double tax is avoided and the income is taxed at a lower rate. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 39. While a C corporation's losses cannot be used by their shareholders to offset personal income, a C corporation may carry back and carry forward losses to help offset the taxable income a corporation had or will have. How are these net operating losses carried back and carried forward? A. Carried back two years, carried forward indefinitely B. Carried back indefinitely, carried forward two years C. Carried back two years, carried forward five years D. Carried back two years, carried forward twenty years E. None of the above. A C corporation may carry back an NOL two years and carry forward an NOL 20 years. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 15-36 Chapter 15 - Entities Overview 40. Logan, a 50 percent shareholder in Military Gear, Inc., is comparing the tax consequences of losses from C corporations compared with losses from S corporations. Assume Military Gear, Inc has a $100,000 loss for the year, Logan's tax basis in Military Gear, Inc. was $150,000 at the beginning of the year, and he received $75,000 ordinary income from other sources during the year. Assuming Logan's marginal income tax rate is 15%, how much more tax will Logan pay currently if Military Gear, Inc. is a C corporation compared to the tax he would pay if it were an S corporation? A. $0 B. $3,750 C. $7,500 D. $11,250 Logan would pay $11,250 in taxes if Military Gear, Inc. is a C corporation ($75,000 15 percent). If it were an S corporation, he would have to pay $3,750 in taxes (($75,000 ($50,000)) 15 percent). Thus, he has to pay $7,500 more in taxes ($11,250 - $3,750) currently if Military Gear, Inc. is a C corporation. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 41. Which of the following is not an effective strategy for mitigating double taxation in a C corporation? A. C corporations can shift income to shareholders via deductible payments B. C corporations can make an S election C. C corporations can pay dividends to their shareholders D. None of the above. All of these statements are effective strategies to mitigate or avoid double taxation. Paying dividends actually triggers the double tax rather than avoid it. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-37 Chapter 15 - Entities Overview 42. Robert is seeking additional capital to expand ABC, Inc. In order to qualify ABC as an S corporation, which type of investor group should Robert obtain capital from? A. 30 different partnerships B. 10 different C corporations C. 90 nonresident individuals D. 120 unrelated resident individuals E. None of the above. S corporations have strict rules regarding the number and type of owners they may have. An S corporation cannot have more than 100 unrelated shareholders. Furthermore, shareholders may not be corporations, partnerships, nonresident aliens, or certain types of trusts. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 43. What tax year-end must unincorporated entities with only one owner adopt? A. The entity is free to adopt any tax year-end B. The entity must adopt the same year-end as its owner C. The entity must adopt a calendar year-end D. The entity may adopt any year-end except for a calendar year-end Owners of unincorporated entities can be either individuals or corporations. In either case, the tax year-end of the entity must match the tax year-end of the owner. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-38 Chapter 15 - Entities Overview 44. Roberto and Reagan are both 25 percent owner/managers for Bright Light, Inc. Roberto runs the retail store in Sacramento, CA, and Reagan runs the retail store in San Francisco, CA. Bright Light, Inc. generated a $125,000 profit companywide made up of a $75,000 profit from the Sacramento store, a ($25,000) loss from the San Francisco store, and a combined $75,000 profit from the remaining stores. If Bright Light, Inc. is an S corporation, how much income will be allocated to Roberto? A. $31,250 B. $62,500 C. $75,000 D. $125,000 S corporations may not specially allocate income to shareholders; thus, the $125,000 companywide profit must be allocated to Roberto based on his ownership percentage in Bright Light, Inc. Roberto would receive 25 percent of the total profits, or $31,250 ($125,000 .25). AACSB: Analytic AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-39 Chapter 15 - Entities Overview 45. Roberto and Reagan are both 25 percent owner/managers for Bright Light Enterprises. Roberto runs the retail store in Sacramento, CA, and Reagan runs the retail store in San Francisco, CA. Bright Light generated a $125,000 profit companywide made up of a $75,000 profit from the Sacramento store, a ($25,000) loss from the San Francisco store, and a combined $75,000 profit from the remaining stores. If Bright Light is taxed as a partnership and decides that Roberto and Reagan will be allocated 70 percent of their own store's profit with the remaining profits allocated pro rata among all the owners, how much income will be allocated to Reagan? A. ($25,000) B. ($17,500) C. $5,000 D. $20,000 Because Bright Lights, Inc. is a partnership, the special allocation described is permissible. Reagan would receive 70 percent of the loss from his store, or ($17,500) (($25,000 70 percent)). Additionally, Reagan will receive 25 percent of the remaining profits not specially allocated, or $22,500 [.25 (125,000 + 17,500 - ($75,000 .7))] Thus, Reagan will be allocated a total of $5,000 of income. AACSB: Analytic AICPA: BB Critical thinking Bloom's: Analyze Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Hard 15-40 Chapter 15 - Entities Overview 46. When an employee/shareholder receives an income allocation from an S corporation, what taxes apply to the income allocation? A. FICA tax only. B. Self-employment tax only. C. FICA and self-employment tax. D. None of the above. This income will never be taxed. E. None of the above. This income will be taxed, but another type of tax will apply. An S corporation employee/shareholder must pay the 7.65 percent FICA tax on any salary received from an S corporation; however, any S corporation ordinary business income allocated to them is not subject to either FICA or self-employment tax. Rather, it will only be subject to the marginal ordinary income tax rate of the shareholder. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 47. What is the tax impact to a C corporation or an S corporation when it makes a property distribution to a shareholder? A. Recognizes either gain or loss B. Doesn't recognize gain or loss C. Recognizes gain only D. Recognizes loss only Gains must be recognized on distributed appreciated property for both taxable corporations and S corporations. However, losses are not allowed if the distributed property has depreciated in value. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-41 Chapter 15 - Entities Overview 48. Assume you plan to start a new enterprise; you know the probability of having losses for the first three years of operations is almost 90 percent, and you know you will report a substantial amount of income from other sources during those same three years. From a tax perspective, which of the following entity choices would be least favorable? A. C corporation B. LLC C. General partnership D. Limited partnership E. S corporation A C corporation is the least favorable entity choice because the losses from the first three years of operations will not flow-through to you and be available to offset income from other sources. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 49. From a tax perspective, which entity choice is preferred when a liquidating distribution occurs and the entity has depreciated assets? A. Partnership B. S corporation C. LLC D. A and B E. B and C When depreciated assets are distributed in liquidation, S corporations may immediately deduct losses from the assets whereas these losses are typically deferred if the distributing entity is taxed as a partnership. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-42 Chapter 15 - Entities Overview 50. From a tax perspective, which entity choice is preferred when a liquidating distribution occurs and the entity has appreciated assets? A. Partnership B. S corporation C. LLC D. A and C E. B and C Partnerships and their owners generally don't recognize any gain during a liquidating distribution. Conversely, S corporations and their shareholders must recognize gain when appreciated assets are distributed in a liquidating distribution. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 51. If you were seeking an entity with the most favorable tax treatment regarding (1) the number of owners allowed, (2) the flexibility to select your accounting period, and (3) the availability of preferential capital gains rates when selling your ownership interest, which entity should you decide to use? A. C corporation B. S corporation C. Partnership D. Sole proprietorship These three tax considerations are most favorable for a company that chooses to be taxed as a taxable corporation. There is no limit to the number of owners allowed, no restrictions on what accounting period to use, and all of the gains from selling shares in a taxable corporation are capital gains. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Comprehension Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-43 Chapter 15 - Entities Overview 52. Which of the following is not an effective strategy for mitigating the double tax associated with C corporations? A. Paying a salary to a shareholder-employee B. Leasing property from a shareholder C. Borrowing money from a shareholder D. Paying fringe benefits to a shareholder-employee E. All of the above are effective strategies for mitigating double taxation All of the strategies will reduce the amount of double taxation because they all shift income from C corporations to their shareholders with payments that are deductible at the corporate level. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 53. What is the maximum number of unrelated shareholders a C corporation can have, the maximum number of unrelated shareholders an S corporation can have, and the maximum number of partners a partnership may have? A. 100; no limit; no limit B. no limit; 100; 2 C. no limit; 100; no limit D. 100; 100; no limit An S corporation is the only type of entity that has a limit on the maximum number of owners it may have. S corporations may have up to 100 unrelated shareholders. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Knowledge Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-44 Chapter 15 - Entities Overview Essay Questions 54. David would like to organize HOS as either an LLC or as a corporation generating a 12 percent annual before-tax return on a $300,000 investment. Individual and corporate tax rates are both 30 percent and individual capital gains and dividend tax rates are 15 percent. HOS will pay out its after-tax earnings every year to either its members or its shareholders. a. Ignoring self-employment taxes, how much would David keep after taxes if HOS is organized as either an LLC or a corporation? b. Ignoring self-employment taxes, what are the overall tax rates if HOS is organized as either an LLC or a corporation? Answer to parts a and b: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 15-45 Chapter 15 - Entities Overview 55. Jaron would like to organize TMZ as either an LLC or as a corporation generating a 6 percent annual before-tax return on a $200,000 investment. Individual and corporate tax rates are both 40 percent and individual capital gains and dividends tax rates are 10 percent. TMZ will distribute its earnings annually to either its members or shareholders. a. Ignoring self-employment taxes, how much would Jaron keep after taxes if TMZ is organized as either a corporation or an LLC? b. Ignoring self-employment taxes, what are the overall tax rates if TMZ is organized as either an LLC or a corporation? Answer to parts a and b: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 15-46 Chapter 15 - Entities Overview 56. Emmy would like to organize PRK as either an LLC or as a corporation generating a 15 percent annual before-tax return on a $100,000 investment. Individual ordinary rates are 25 percent, corporate rates are 15 percent, and individual capital gains and dividends tax rates are 5 percent. PRK will distribute its earnings annually to either its members or shareholders. a. Ignoring self-employment taxes, how much would Emmy keep after taxes if PRK is organized as either a corporation or an LLC? b. Ignoring self-employment taxes, what are the overall tax rates if PRK is organized as either an LLC or a corporation? Answer to parts a and b: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 15-47 Chapter 15 - Entities Overview 57. Jerry would like to organize FBC as either an LLC or as a corporation generating an 8 percent annual before-tax return on a $400,000 investment. Individual and corporate tax rates are both 35 percent and individual capital gains and dividends tax rates are 15 percent. FBC will pay out its after-tax earnings every year to either its members or its shareholders. How much would Jerry keep after taxes if FBC is organized as either a corporation or an LLC? AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-48 Chapter 15 - Entities Overview 58. Taylor would like to organize DRK as either an LLC or as a corporation generating a 13 percent annual before-tax return on a $250,000 investment. Individual and corporate tax rates are both 30 percent and individual capital gains and dividends tax rates are 5 percent. DRK will distribute its earnings annually to either its members or shareholders. a. Ignoring self-employment taxes, how much would Taylor keep after taxes if DRK is organized as either a corporation or an LLC? b. Ignoring self-employment taxes, what are the overall tax rates if DRK is organized as either an LLC or a corporation? Answer to parts a and b: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 15-49 Chapter 15 - Entities Overview 59. Becca would like to organize BMI as either an LLC or as a corporation generating a 4 percent annual before-tax return on a $450,000 investment. Individual ordinary rates are 28 percent, corporate rates are 15 percent, and individual capital gains and dividends tax rates are 15 percent. BMI will distribute its earnings annually to either its members or shareholders. a. How much would Becca keep after taxes if BMI is organized as either a corporation or an LLC? b. What are the overall tax rates if BMI is organized as either an LLC or a corporation? Answer to parts a and b: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 15-50 Chapter 15 - Entities Overview 60. SNL corporation, a C corporation, reports $400,000 of taxable income in the current year. SNL's tax rate is 35 percent. Answer the following questions, assuming Keegan, SNL's sole shareholder, has a marginal tax rate of 28 percent on ordinary income and 15 percent on dividend income. a. Compute the first level of tax on SNL's taxable income for the year. b. Compute the second level of tax on SNL's income assuming that SNL currently distributes all of its after-tax earnings to Keegan. What is the overall corporate (double) tax rate on SNL's taxable income for the year? Answer to parts a and b: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 15-51 Chapter 15 - Entities Overview 61. In the current year, DNS (a C corporation) had taxable income of $600,000 and distributed all of its after-tax earnings to Daniel, its sole shareholder. DNS's tax rate is 38 percent. Assuming Daniels's marginal tax rate on ordinary income is 28 percent and his dividend rate is 15 percent, what is the amount of the double-tax that DNS Corporation and Daniel must pay on DNS's $600,000 of taxable income? AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 62. In its first year of existence, BYC Corporation (a C corporation) reported a loss for tax purposes of ($40,000). How much tax will BYC pay in year 2 if it reports taxable income from operations of $35,000 in year 2 before any loss carryovers? None. BYC's loss in year 1 of ($40,000) will be available to offset income generated by BYC in year 2. Since BYC earned $35,000 of taxable income in year 2 before any loss carryovers, it can use ($35,000) of the loss carryover from year 1 to offset its entire taxable income. BYC will have a ($5,000) loss carryover available for year 3 and beyond. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 15-52 Chapter 15 - Entities Overview 63. In its first year of existence Aspen Corp. (a C corporation) reported a loss for tax purposes of $50,000. In year 2, it reports a $30,000 loss. For year 3, it reports taxable income from operations of $120,000. How much tax will Aspen Corp. pay for year 3? Consult the corporate tax rate table provided to calculate your answer. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-53 Chapter 15 - Entities Overview 64. For the current year, Creative Designs Inc., a C corporation, reports taxable income of $300,000 before paying salary to Ben the sole shareholder of Creative Designs Inc. (CD). Ben's marginal tax rate on ordinary income is 28 percent and 15 percent on dividend income. Assume CD's tax rate is 39 percent. a. How much total income tax will Creative Designs and Ben pay on the $300,000 taxable income for the year if CD doesn't pay any salary to Ben and instead distributes all of its aftertax income to Ben as a dividend? b. How much total income tax will Creative Designs and Ben pay on the $300,000 of income if CD pays Ben a salary of $100,000 and distributes its remaining after-tax earnings to Ben as a dividend? c. Why is the answer to part b lower than the answer to part a? Answer parts a and b: Answer part c: The combined taxes are lower under part b because $100,000 of the corporation's earnings is only subject to one level of tax (the individual tax on the salary). Conversely, total taxes paid are greater in part a. than in part b., because a greater share of corporate pre-tax earnings is subject to the double tax. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Hard 15-54 Chapter 15 - Entities Overview 65. For the current year, Birch Corporation, a C corporation, reports taxable income of $400,000 before paying salary to its sole shareholder Elaine. Elaine's marginal tax rate on ordinary income is 33 percent and 15 percent on dividend income. If Birch pays Elaine a salary of $200,000 but the IRS determines that Elaine's salary in excess of $100,000 is unreasonable compensation, what is the overall income tax rate on Birch's $400,000 presalary income? Assume Birch's tax rate is 35 percent and it always distributes all after-tax earnings to Elaine. In calculating the double-tax on Birch Corp's pre-salary taxable income, the $100,000 amount the IRS will allow Birch to deduct is taken into account rather than the $200,000 amount it would prefer to deduct. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-55 Chapter 15 - Entities Overview 66. Cali Corp. (a C corporation) projects that it will have taxable income of $250,000 for the year before paying any fringe benefits. Stacey, Cali's sole shareholder, has a marginal tax rate of 33 percent on ordinary income and 15 percent on dividend income. Assume Cali's tax rate is 34 percent. a. What is the amount of the double income tax on Cali's $250,000 of pre-benefit income if Cali Corp. does not pay out any fringe benefits and distributes all of its after-tax earnings to Stacey? b. What is the amount of the double income tax on Cali's $250,000 of pre-benefit income if Cali Corp. pays Stacey's adoption expenses of $50,000 and the payment is considered to be a qualified fringe benefit? Cali Corp. distributes all of its after-tax earnings to Stacey. c. What is the amount of the double income tax on Cali's $250,000 of pre-benefit income if Cali Corp. pays Stacey's adoption expenses of $50,000 and the payment is considered to be a nonqualified fringe benefit? Cali Corp. distributes all of its after-tax earnings to Stacey. 15-56 Chapter 15 - Entities Overview Answer to parts a and b: Stacey is not taxed on the $50,000 payout of adoption expenses because this is considered a qualified fringe benefit. Answer to part c: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Hard 15-57 Chapter 15 - Entities Overview 67. Jamal Corporation, a C corporation, projects that it will have taxable income of $500,000 before incurring any lease expenses. Jamal's tax rate is 34 percent. Ali, Jamal's sole shareholder, has a marginal tax rate of 33 percent on ordinary income and 15 percent on dividend income. Jamal always distributes all of its after-tax earnings to Ali. a. What is the amount of the double-tax on Jamal Corp.'s $500,000 pre-lease expense income if Jamal Corp. distributes all of its after-tax earnings to its sole shareholder Ali? b. What is the amount of the double-tax on Jamal Corp.'s $500,000 pre-lease expense income if Jamal leases equipment from Ali at a cost of $120,000 for the year? c. What is the amount of double-tax on Jamal Corp.'s $500,000 pre-lease expense income if Jamal Corp. leases equipment from Ali at a cost of $120,000 for the year but the IRS determines that the fair market value of the lease payments is $80,000? Answer to parts a, b, and c: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-58 Chapter 15 - Entities Overview 68. Tuttle Corporation (a C corporation) projects that it will have taxable income for the year of $300,000 before incurring any interest expense. Assume Tuttle's tax rate is 35 percent. a. What is the amount of the double-tax on the $300,000 of pre-interest expense earnings if Ruth, Tuttle's sole shareholder, lends Tuttle Corporation $100,000 at the beginning of the year, Tuttle pays Ruth $10,000 of interest on the loan (interest is considered to be reasonable), and Tuttle distributes all of its after-tax earnings to Ruth? Assume her ordinary marginal rate is 33 percent and dividend tax rate is 15 percent. b. Assume the same facts as in part a except that the IRS determines that the fair market value of the interest should be $8,000. What is the amount of the double-tax on Tuttle Corporation's pre-interest expense earnings? Answer to parts a and b: AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-59 Chapter 15 - Entities Overview 69. Nancy decided that she would purchase a building and then lease the building to ZML. She leased the building to ZML for $2,500 per month. However, the IRS determined that the fair market value of the lease payment should only be $1,500 per month. How would the lease payment be treated with respect to both Nancy and ZML? Of the total $2,500 lease payment to Nancy, $1,500 would be treated as a deductible rent expense to ZML and as ordinary income to Nancy. The remaining $1,000 would be treated as a non-deductible dividend to ZML and a taxable dividend to Nancy. AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-60 Chapter 15 - Entities Overview 70. Rodger owns 100% of the shares in Trevor, Inc., a C corporation. Assume the following for the current year: Given these assumptions, how much cash does Rodger have from the dividend after all taxes have been paid? AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Easy 15-61 Chapter 15 - Entities Overview 71. Corporation A owns 10% of Corporation C. The marginal tax rate on non-dividend income for both A and C is 34% in 2011. Corporation C earns a total of $200 million before taxes in 2011, pays corporate tax on this income and distributes the remainder proportionately to its shareholders as a dividend. In addition, Corporation A owns 20% of partnership P that earns $500 million in 2011. Given this fact pattern, answer the following questions: a. How much cash from the Corporation C dividend remains after Corporation A pays the tax on the dividend? b. If partnership P distributes all of its year 2011 earnings in proportion to the partner's ownership percentages, how much cash from Partnership P does Corporation A have after paying taxes on its share of income from the partnership? c. If you were to replace corporation A with individual A (her marginal tax rate on ordinary income is 28% and on qualified dividends is 15%) in the original fact pattern above, how much cash does individual A have from the Corporation C dividend after all taxes assuming the dividends are qualified dividends? Consistent with the original facts, assume that Corporation C distributes all of its after-tax income to its shareholders. 15-62 Chapter 15 - Entities Overview Answer to part a: Answer to part b: Answer to part c: 15-63 Chapter 15 - Entities Overview AACSB: Reflective thinking AICPA: BB Critical thinking Bloom's: Application Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types. Level of Difficulty: Medium 15-64
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