Chap12 - Chapter 12 The Choice of Business Entity Chapter 12 The Choice of Business Entity Questions and Problems for Discussion 1 Capital is not a

Chapter 12 - The Choice of Business Entity Chapter 12 The Choice of Business Entity Questions and Problems for Discussion 1. Capital is not a material income-producing factor in Mr. and Mrs. Velotti’s professional service business. Therefore, they cannot form a family partnership to shift earned income to their children. 2. The restaurant business probably required a substantial investment in tangible assets and, therefore, capital is a material income-producing factor in the business. Mr. and Mrs. Barnes can create a family partnership by giving each child a 25 percent equity interest in this capital. 3. Ms. Johnson’s gift of an equity interest in either business to her children will be subject to federal transfer tax, based on the fair market value of the equity at date of gift. To minimize the transfer tax, Ms. Johnson should create a family partnership with the second business. 4. S corporations are closely held by individual shareholders who directly manage the corporate business. The individuals typically want to maintain managerial control through their stock ownership. Therefore, the stock is subject to a buy-sell agreement that prevents a shareholder from diluting control by transferring stock to outsiders without permission of the other shareholders. The agreement also prevents a shareholder from deliberately or inadvertently terminating the S corporation election by transferring stock to a nonqualified shareholder, such as another corporation or a partnership. 5. Mr. Eros should form a partnership with his two grandchildren. The partnership agreement can provide for a special allocation of 100 percent of the rent income (and cash flow) to Mr. Eros and a one-third allocation of the income (and cash flow) from the antique business to each partner (Mr. Eros and each grandchild). The partners can amend this agreement at any time in the future. This flexibility is not possible with an S corporation in which shares of stock must have identical rights to all business income and cash flows. 6. a. As general partners, Dr. Quinn, Dr. Rose, and Dr. Tanner are each personally liable for the $500,000 judgment. b. If QRT Dental Services is a LLP, only Dr. Rose is personally liable for the $500,000 judgment. c. If QRT Dental Services is an LLC, only Dr. Rose is personally liable for the $500,000 judgment. 7. a. As general partners, Dr. Quinn, Dr. Rose, and Dr. Tanner are each personally liable for the $30,000 judgment. b. If QRT Dental Services is a LLP, Dr. Quinn, Dr. Rose, and Dr. Tanner are each personally liable for the $30,000 judgment. c. If QRT Dental Services is an LLC, no member is personally liable for the $30,000 judgment. 8. Mrs. Tran apparently does not need the cash flow generated by her business for personal consumption. By incorporating the business, she can take advantage of the lower corporate tax rates (15 percent and 25 percent) on the first $75,000 of income. She avoids any additional tax by reinvesting after-tax income in the corporation rather than distributing a dividend. In contrast, Mrs. Nutter apparently spends the cash from the business and would pay a double tax by operating the business in corporate form.