Exam 12: The Choice of Business Entity

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

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.

Mrs. Jansen is the sole shareholder of Mimeo Corporation. She also owns the office building that serves as corporate headquarters. Last year, Mimeo paid $200,000 annual rent to Mrs. Jansen for use of the building. Mimeo's marginal tax rate was 34% and Mrs. Jansen's marginal tax rate on ordinary income was 35%. The revenue agent who audited Mimeo's return concluded that the fair rental value of the office building was $150,000. Compute the net impact of this audit conclusion on Mrs. Jansen's income tax liability.

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?

Homer currently operates a successful S corporation. He would like to bring his two teenage children into the business. If he gives each child 10% of the stock, which of the following statements is true?

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.

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 34% and Gerry's was 35%. 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?

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.

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.

Which of the following statements regarding the tax treatment of start-up losses is false?

Kyrsten Haas expects her S corporation to generate a profit of $200,000. Kyrsten's marginal tax rate on ordinary income is 35%. What is Kyrsten's after-tax cash flow from the S corporation if no cash is distributed?

Typical family-owned businesses are operated as passthrough entities.

A brother-sister controlled group consists of two or more corporations controlled by the same set of individual shareholders.

Which of the following is a consequence of establishing a family partnership or a family-owned S corporation?

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.

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

Mr. and Mrs. Maxwell are equal partners in Family partnership. The Maxwell's marginal tax rate is 35%. Next year, the partnership is expected to generate $200,000 of ordinary income. The Maxwells are considering transferring 20% interests in the partnership to each of their children. Their daughter, Melissa, has a 15% marginal tax rate. Their son, Mark, has a 25% marginal tax rate. Calculate the expected annual tax savings to the family from the proposed transfer of partnership interests.

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.

Limited liability companies (LLCs) provide owners the tax advantages of a passthrough entity and the limited liability protection of corporations.

Which of the following benefits does not occur when owner-shareholders accumulate earnings of their closely-held corporations at the entity level and later sell their stock at an increased value?