Exam 12: The Choice of Business Entity

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?

If a business is operated as a passthrough entity, the startup losses of the business may be deducted against the current taxable income of the owner.

Which of the following is not exclusively a benefit of a passthrough entity?

The accumulated earnings tax is assessed at the highest individual marginal tax rate on ordinary income.

The IRS may conclude that a CEO/shareholder of a closely held corporation has been paid a nondeductible constructive dividend rather than a deductible salary.

Gwen and Travis organized a new business as an LLC in which they own equal interests. The new business generated a $10,000 operating loss its first year. If Gwen's marginal tax rate is 35%, her tax savings from the first-year LLC loss is:

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:

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: Sales revenue $ 1,879,000 Mrs Ford's salary (160,000 ) Other operating expenses (414,000 ) Interest paid on Mrs Ford's note (60,000 ) Dividend distributed to Mrs Ford's (100,000 ) Compute Fast's taxable income.

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

A family partnership can be used to shift a portion of the income from a capital-intensive manufacturing business to a taxpayer's young children.

Typical family-owned businesses are operated as passthrough entities.

Which of the following is NOT one of the characteristics of a constructive dividend?

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

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

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%.

Sunny Daze, Inc., a publicly held company, has $9,000,000 of retained earnings and no financial justification for retaining the earnings. Therefore, it must calculate and pay an accumulated earnings tax on its annual corporate tax return.

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?

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.

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.