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Chapter 19 - CHAPTER 19-TAXATION OF BUSINESS FORMS AND...

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CHAPTER 19—TAXATION OF BUSINESS FORMS AND THEIR OWNERS TRUE/FALSE 1. Reasonable compensation paid to owners (other than sole proprietors) is deductible by the business. ANS: T Reasonable compensation paid to owners who are not proprietors are deductible business expenses. PTS: 1 REF: Examples 1, 3, and 6 and pp. 19-2, 19-12, 19-20, 19-21, and 19-22). 2. A partnership has a $7,000 basis for proprietorship land it has just received in exchange for a 20 per- cent capital interest. The land had a $7,000 market value and $8,200 basis to the proprietorship. ANS: F The proprietorship's $8,200 basis transfers to the partnership. This is true of all nontaxable transfers of business assets to all four organizational forms. The $7,000, the lower of market value or basis, is the business' basis only if the land had been a personal use asset. PTS: 1 REF: Example 14, p. 19-30, and § 723 3. A disadvantage of the partnership form is that general partners have unlimited liability for part- nership debts. ANS: T General partners have unlimited liability. PTS: 1 REF: p. 19-5 4. Capital gains of a partnership and an S corporation flow through to owners to be reported by them on their own tax returns. ANS: T The flow-through concept generally is a significant advantage of both the partnership and S corporate forms over the C corporate form. PTS: 1 REF: Example 3; Schedule K-l at Chapter 19-3; pp. 19-5, 19-6, 19-9, and 19-14; and §§ 701, 702(b), and 1366 5. Reasonable compensation paid to owners (other than proprietors) qualifies as self-employment in- come. ANS: F Reasonable compensation paid to owners of C and S corporations does not qualify as self-employment income, while amounts paid to general and limited partners do qualify as self-employment income. PTS: 1 REF: Examples 1, 3, and 17; pp. 19-2, 19-12, 19-14, and 19-19; and § 1402 6. R is an employee/owner of a C corporation. Q is an employee/owner of an S corporation. Both R and Q's salaries are deductible by the corporations they work for.
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ANS: T Salaries of shareholders who are employees of their C corporations are treated in the same manner as those of S corporations. As long as the salaries are reasonable in amount, they are deductible corporate expenses and subject to withholding. PTS: 1 REF: p. 19-14 and 19-20 7. An accrual basis partnership may deduct interest owed on a note as of the end of its taxable year, even though it is not paid until May of the next year. The note is held by a cash basis taxpayer who owns 60 percent of the business. ANS: F The partnership cannot deduct the interest until the following year, when it is includible by the cash basis partner. This same treatment is applicable for a C or an S corporation. PTS: 1 REF: p. 19-11 and § 267 8. A partner may recognize a loss on the sale of equipment to a partnership in which he has a 40 percent interest. ANS: T Losses may be recognized on transactions between a partner and his partnership as long as the partner does not own directly or indirectly more than 50 percent of the partnership.
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