Exam 12: The Choice of Business Entity

If a business is formed as a regular corporation, the income may be subject to double taxation.

Which of the following statements regarding S corporations is true?

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.

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 IRS may recharacterize salary payments to the owners of a closely-held corporation as constructive dividends if it concludes that the amount of the payment is unreasonable in light of the facts and circumstances.

When a corporation is thinly capitalized, the IRS is more likely to reclassify a portion of the corporation's debt as equity.

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 34 percent and Betsy's marginal tax rate was 39.6 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?

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

Platte River Corporation is a calendar year S corporation. At the beginning of the year, Mr. Reeves owned 100% of Platte River's outstanding stock. On June 30 of the current year, he gave 25% of the stock to his son Mark and 10% of the stock to his daughter Megan. Platte River's ordinary income for the year was $220,000. What portion of this income must each shareholder report?

A business generates profit of $100,000. The owner has a 39.6% 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?

Kyrsten Haas expects her S corporation to generate a profit of $200,000. Kyrsten's marginal tax rate on ordinary income is 39.6%. 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.

Mrs. Fuente, who has a 39.6% marginal tax rate on ordinary income, is the sole shareholder and CEO of Furey Inc. She also holds a $1 million interest-bearing note issued by Furey. The corporation's current-year financial records show the following: Sales revenue \ 1,879,000 Mrs. Fuente's salary (160,000) Other operating expenses (414,000) Interest paid on Mrs. Fuente's note (60,000) Dividend distributed to Mrs. Fuente (100,000) Compute Mrs. Fuente's tax on her income from Furey.

Cathy is the President and sole shareholder of Boxer, Inc., a regular corporation. The corporation reported taxable income of $435,000 after deducting Cathy's $800,000 salary. If the IRS disallowed $550,000 of the salary as unreasonable compensation, the corporation's regular income tax will change by a:

Andrews Corporation owns all of the outstanding stock of Zeta Inc. The two corporations do not file a consolidated income tax return. This year, each corporation recorded $200,000 of taxable income. What is the regular tax liability of each corporation?

During a recent IRS audit, the revenue agent decided that Roger used his closely-held corporation, Dodger Inc., to avoid shareholder tax by accumulating earnings beyond the reasonable needs of the business. Dodger's taxable income for the year was $500,000, and it paid no dividends. Compute Dodger's accumulated earnings tax, assuming that it had accumulated $2 million after-tax income in prior years.

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

When a closely held business is formed as a regular corporation, earnings that are distributed to a shareholder-employee as dividends are taxed only once.

Mr. Eddy loaned his solely-owned corporation $3,000,000. The corporation paid a market rate of interest annually. Upon audit, the IRS reclassified some of the debt as equity. Which of the following statements is true?

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 34% marginal tax rate. What is the effect of this audit conclusion on each corporation's income tax liability?