Chap12 - Chapter 12 The Choice of Business Entity Chapter...

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.