Exam 12: The Choice of Business Entity

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:

The net operating losses of a C corporation can be carried forward to reduce its taxable income in future tax years.

When the personal holding company tax was originally enacted, its purpose was to discourage individuals from incorporating their investment portfolios.

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

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

Which of the following is not a permissible reason for a regular corporation to accumulate earnings at the entity level and avoid the imposition of the accumulated earnings tax?

Mr. Allen, whose marginal tax rate is 37%, owns an office building that generates $100,000 annual taxable income. He plans to create a family partnership by giving each of his three children a 15% interest in the building. Mr. Allen will retain a 55% interest. Mr. Allen will manage the building and receive a guaranteed payment of $20,000. If Mr. Allen's children are in the 12% tax bracket, compute the annual tax savings from this income-shifting arrangement.

Which of the following statements regarding the accumulated earnings tax is true?

Marcia is a shareholder in an S corporation and also works for the corporation. This year, her share of ordinary income was $250,000 and her compensation was $100,000. Which of the following accurately describes her tax consequences from these earnings?

A business generates profit of $100,000. The owner has a 37% marginal tax rate. What amount of corporate and individual income tax will be paid on this profit if the business is a regular corporation and no income is distributed?

A personal holding company is a corporation owned by a large number of individual shareholders that has taxable income arising primarily from nonbusiness sources.

Ms. Chou, who is in the 37 percent marginal tax bracket, is the sole shareholder of Liu Corporation. This year, Liu earned $200,000 of taxable income and distributed $50,000 to Ms. Chou. Calculate the combined tax cost for Liu and Ms. Chou.

During a recent IRS audit, the revenue agent decided that the Emig family used their closely held corporation, Gamekeeper, to avoid shareholder tax by accumulating earnings beyond the reasonable needs of the business. Gamekeeper's taxable income was $800,000, it paid no dividends, and it had no business need to retain any income. Compute Gamekeeper's accumulated earnings tax assuming that it had accumulated $2 million of after-tax income in prior years.

The accumulated earnings tax is imposed on a partnership formed for or availed of for the purpose of avoiding the income tax with respect to its owners by permitting earnings and profits to accumulate instead of being divided or distributed.

Bart owns 100% of an S corporation that had a net operating loss in the current year. If there is sufficient basis in the stock, he will carry this loss back to reduce taxes in a prior S corporation tax year.

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?

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.

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: Gross income from sales \8 75,000 Operating expenses (420,000) Interest paid on debt to shareholders (75,000) Dividend distributions: Mr. Longwood (50,000) Mrs. Kennett (50,000) Compute the combined tax cost for LK, Mr. Longwood, and Mrs. Kennett attributable to LK's operations.How would your computation change if the interest on the shareholder debt was $175,000 and LK paid no dividends?

Which of the following entities does not provide all the owners with limited liability for debts incurred by the entity?

If a new business organized as a C Corporation incurs start-up losses, the tax benefits of those losses will be recognized in the current tax year.