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Student Outline Chapter 2

Student Outline Chapter 2 - CHAPTER 2 CORPORATIONS...

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CHAPTER 2 CORPORATIONS: INTRODUCTION AND OPERATING RULES 2.1 TAX TREATMENT OF VARIOUS BUSINESS FORMS 1. Business forms include: sole proprietorships, partnerships (covered in Chapters 10 and 11), trusts and estates (covered in Chapters 17), Subchapter S corporations (covered in Chapter 12), and regular Subchapter C corporations. 2. C corporations are separate taxable entities, compute their own taxable income, and pay their own taxes. Sole Proprietorship 3. Sole proprietorship is not a taxable entity. Net income or loss from the proprietorship is computed on Schedule C, which is attached to the proprietor’s Form 1040. Thus, the proprietor pays tax on the profits of the proprietorship. Partnerships 4. Partnerships, which are not taxable entities, must file Form 1065 (an information return). Each partner receives a Schedule K-1 that reports the partner’s share of net income or loss along with each separately reported pass-through item. Schedule K-1 items are reported on each partner’s return. Corporations 5. There are two types of corporations: regular corporations governed by Subchapter C and nontaxable corporations governed by Subchapter S. The S corporations have the following characteristics. Similar to partnerships with respect to tax treatment because both are not taxable entities, but are reporting entities. Income and expense items pass through to shareholders, who report the items on their own returns. Generally enjoy the same legal benefits (e.g., limited liability) as C corporations. 6. Many items, such as capital gains and losses, retain their character when passed through to the owners of proprietorships, partnerships, and S corporations. 7. Regular C corporations are subject to double taxation effects. a. Closely held corporations may attempt to avoid the double taxation by making deductible payments to their shareholders (e.g., salaries, interest, or rents) that are large enough to reduce corporate taxable income to zero. b. Reduction of the dividend tax rate to a maximum of 15% (0% for low-income taxpayers) alleviates some of the double taxation effect. (1) Shareholders prefer dividends rather than salary or interest because of the lower tax rate dividends receive.
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Chapter 2 - Solution to Research Problems 2-2 (2) Corporations prefer payments that are deductible in computing their taxable income. However, dividends do reduce the possible accumulated earning tax, unreasonable compensation, and thin capitalization problems with the IRS. 8. The choice of entity should be based on a combination of tax and nontax factors. a. Tax Factors. The top corporate rate is 35% (39% on a limited range of taxable income), as is the top rate for individuals. However, for a specified level of income the corporate or individual tax rate can be higher because their tax rate schedules are different. (1)
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Student Outline Chapter 2 - CHAPTER 2 CORPORATIONS...

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