Exam 12: The Choice of Business Entity

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?

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.

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. Loretta's personal marginal tax rate on ordinary income is 35%. Using 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.

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 an S corporation and no income is distributed?

Partnerships offer more flexibility in allocating income among owners than S corporations.

Glover, Inc. had $350,000 of taxable income, all of which was personal holding company income. The corporation paid a dividend of $350,000 in November. The corporation will owe a personal holding company tax for the year.

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?

When the personal holding company tax was originally enacted, its purpose was to discourage individuals from incorporating their investment portfolios.

Individual shareholders who create a brother-sister controlled group do not derive any federal tax advantage from doing so.

Sandy, Sue, and Shane plan to open Friends, an upscale restaurant. They project that the business will incur a $90,000 operating loss in Year 1, and $75,000 of profit in Year 2. 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.

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?

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 39.6%.

Contributions of property to S corporations are tax-free only if the contributing parties have control (80% ownership) immediately after the contribution.

Ms. Alfred anticipates that her business will generate $500,000 taxable income. She can reduce the total tax burden imposed on this income if she spreads it among five separate corporations.

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.

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

For the current tax year, Cuddle Corporation's $500,000 of taxable income is all considered to be personal holding company income. The corporation did not pay dividends. Which of the following statements is true?

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

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: