Exam 12: The Choice of Business Entity

Mr.and Mrs.Johnson and their two children,Alice and Ben,are the four equal partners in JAB Partnership.This year,JAB generated $40,000 of ordinary income.Compute the tax cost associated with this income if Mr.and Mrs.Johnson's marginal tax rate is 35%,Alice's marginal tax rate is 24%,and Ben's marginal tax rate is 32%.

Loretta plans to start a small business,operated through a corporation.In year 0,she expects the corporation to generate a loss of $100,000.Subsequently,she expects the corporation to be profitable,and projects profit of $150,000 in year 1,and $250,000 in year 2.Using Appendix A and a 10% discount rate,calculate the present value of expected tax savings and costs on the business earnings for the first 3 years of operations if the business does not make an S corporation election.

Kansas Corporation is a 68% shareholder in Colorado,Inc.Last year,Colorado paid Kansas $100,000 as compensation for unspecified services provided by Kansas employees to Colorado,and deducted the payment on its federal income tax return.The revenue agent who audited both corporations' returns concluded that the payment is a constructive dividend.Both corporations have a 21% marginal tax rate.What is the effect of this audit conclusion on each corporation's income tax liability?

The revenue agent who audited the Form 1120 filed by LCW Inc.recharacterized $125,000 of the salary paid to Ms.Lewis (LCW's president and controlling shareholder)as a constructive dividend.LCW's marginal tax rate is 21%,and Ms.Lewis' marginal tax rate is 32%.Which of the following is not a consequence of the recharacterization?

Betsy Williams is the sole shareholder of Kurt Corporation.She also owns the office building that serves as corporate headquarters for Kurt.Last year,Kurt paid $200,000 annual rent to Betsy for use of the building.Kurt's marginal tax rate was 21 percent and Betsy's marginal tax rate was 37 percent.The revenue agent who audited Kurt's return concluded that the fair rental value of the office building was $140,000. a.What effect does this conclusion have on Betsy's personal income tax liability? b.What effect does this conclusion have on Kurt's corporate income tax liability?

Gerry is the sole shareholder and president of Garmon Corporation.He also owns the office building that serves as the corporation's headquarters.Last year,Garmon paid Gerry $250,000 for the use of the building.Garmon's MTR was 21% and Gerry's was 37%.The revenue agent who audited Garmon's return has concluded that the fair rental value of the office building was $200,000.What is the net impact of this audit conclusion on Gerry and Garmon's combined income tax liability?

Partnerships offer owners the maximum flexibility to tailor their business arrangement to fit their needs.

Which of the following is not a good reason to form a family partnership?

Kyrsten Haas expects her S corporation to generate a profit of $200,000.What is the effective tax rate on the $200,000 if no cash is distributed? Kyrsten's marginal tax rate on ordinary income is 37%.

Mr.Longwood and Mrs.Kennett are the equal shareholders in LK Corporation.Both shareholders have a 37 percent marginal tax rate on ordinary income.LK's financial records show the following: a.Compute the combined tax cost for LK,Mr.Longwood,and Mrs.Kennett attributable to LK's operations. b.How would your computation change if the interest on the shareholder debt was $175,000 and LK paid no dividends?

Which of the following would not be a successful means of avoiding double tax on the earnings of a closely-held corporation?

A family partnership can shift taxable income to younger family members without any corresponding shift of cash flow to those family members.

After-tax cash flow is minimized when a business operates as a passthrough entity rather than a taxable corporation.

The use of a corporation as a tax shelter is most effective when the corporate tax rate is significantly higher than the individual tax rate.

Mrs.Ford,who has a 37% marginal tax rate,is the sole shareholder and CEO of Fast Inc.She also holds a $1 million interest-bearing note issued by Fast.The corporation's current-year financial records show the following: Compute Fast's taxable income.

Family partnerships attempt to divide the income of a business among family members in order to decrease the overall tax burden of the family unit.

Which of the following statements regarding the use of a corporation as a tax shelter is false?

Both individual general partners and S corporation shareholders must pay self-employment tax on their share of the entity's ordinary business income.

The IRS agent who audited the Form 1120 filed by Alano Inc.concluded that $300,000 of the salary that Alano paid to its CEO and sole shareholder was a constructive dividend.As a result:

Recent tax legislation reducing the individual tax on dividends has made C corporations more attractive than they were prior to the legislation.