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chapter_2_solution - 2-1 Chapter 2 Solutions Corporations...

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2-1 Chapter 2 Solutions Corporations: Introduction and Operating Rules (2011) updated: August 13, 2010 34. a. Otter, a partnership, is not a taxpaying entity. Its profit (loss) and separate items flow through to the partners. The partnership’s Form 1065 reports net profit of $150,000 ($400,000 income – $250,000 expenses). The partnership also reports the $20,000 tax- exempt interest as a separately stated item on Form 1065. Ellie and Linda each receive a Schedule K-1 reflecting net profit of $75,000 and separately stated tax-exempt interest of $10,000, which each reports on her own return. The withdrawals do not affect taxable income but decrease their basis in the partnership. Example 2 b. Otter, an S corporation, is not a taxpaying entity. Its profit (loss) and separate items flow through to the shareholders. The S corporation’s Form 1120S reports net profit of $150,000 ($400,000 income – $250,000 expenses). The S corporation also shows the $20,000 tax-exempt interest as a separately stated item on Form 1120S. Ellie and Linda each receive a Schedule K-1 reporting net profit of $75,000 and separately stated tax- exempt interest of $10,000, which each reports on her own return. The withdrawals do not affect taxable income but decrease their basis in the S corporation. p. 2-3 c. Otter, a C corporation, is a taxpaying entity. Otter’s Form 1120 reports taxable income of $150,000 ($400,000 income – $250,000 expenses). The $20,000 of tax-exempt interest is excluded from Otter’s gross income. Ellie and Linda report dividend income of $50,000 each. The dividend income is subject to a maximum tax rate of 15%. pp. 2-3, 2-4, and Example 3 35. a. Azure Company, as a C corporation, has taxable income of $550,000 ($500,000 net operating income + $50,000 LTCG), and corporate income tax of $187,000 [$550,000 × 34% (see Exhibit 2.1)]. C corporations do not receive a preferential tax rate with respect to LTCGs. Since Sasha received no dividends or salary from Azure during the year, she is not currently taxed on any the corporation’s income. b. Since dividend distributions are not deductible, the income tax consequences to Azure Company, a C corporation, are the same as in a. above (i.e., corporate income tax of $187,000). Sasha incurs income tax of $15,000 ($100,000 × 15%) with respect to the dividends she received during the year. c. The salary paid to Sasha is deducible by Azure Company, resulting in taxable income of $450,000 ($400,000 net operating income + $50,000 LTCG), and corporate income tax of $153,000 [$450,000 × 34% (see Exhibit 2.1)]. Sasha incurs income tax of $35,000 ($100,000 × 35%) with respect to the salary she received during the year. d. There is no Federal income tax applicable to businesses formed as sole proprietorships. Instead, the income and expenses of a proprietorship retain their character and are reported on the individual income tax return of the proprietor. Sasha therefore incurs income tax of $182,500 [$175,000 ($500,000 net operating income x 35% marginal tax rate) + $7,500 (LTCG × 15% preferential tax rate)] with respect to Azure Company.
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