Chapter 2 - 4. Explain how the related party construct and...

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Unformatted text preview: 4. Explain how the related party construct and the arm's-length transaction concept interact. Related parties are defined as certain relatives (children, parents, grandparents) and other relationships in which one party controls the action of the other party (e.g., greater than 50% ownership of a corporation). In such cases, there is an incentive to cooperate to structure transactions that have favorable tax effects for the transaction group (i.e., related parties may enter into transactions that they would not otherwise enter into with an unrelated party). Because of this potential for structuring transactions that could lead to abuse, related parties are deemed not to transact at arm's- length. 6. What is the difference between a taxable entity and a conduit entity? A taxable entity is an entity that must pay tax on its income. The two primary taxable entities are individuals and corporations. The owners of a corporation do not pay the income tax on the corporation's taxable income. However, the owner's are taxed when the corporation distributes income, in the form of dividends, to the owners. A conduit entity is a tax reporting entity that reports its results to the government, but does not pay tax on its income. Rather, the conduit entity's income flows through to its owners, who report their share of the conduit entity income on their returns. Thus, the owners of the conduit entity pay the tax on the conduit’s income, not the conduit entity. 8. What are the two basic methods of accounting that may be used by taxpayers? How do the two basic methods differ? The two basic accounting methods that are acceptable for tax purposes are the cash method and the accrual method. The basic difference between the two methods is the criteria used to determine the timing of the recognition of income and expenses. The cash method recognizes income when cash or its equivalent is received. Expenses are deducted when they are paid. That is, it is basically a cash flow system (although capital expenditures cannot be deducted in total in the period in which they are paid). The accrual method recognizes income when it is earned (the receipt of cash or its equivalent is not a factor). Expenses are deducted when all events have occurred that fix the liability for the payment and the amount of the payment can be reasonably estimated. The payment of the expense is not a factor for accrual basis taxpayers. 11. What is capital gain income? How is it different from ordinary income? Capital gain income (loss) results from the sale or other disposition of a capital asset. For individuals, capital assets consist of stocks, bonds, other investment assets, and personal use property....
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This note was uploaded on 04/18/2008 for the course ACCT 3013 taught by Professor Murphy during the Spring '08 term at Oklahoma State.

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Chapter 2 - 4. Explain how the related party construct and...

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