Exam 12: The Choice of Business Entity

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 $130,000 after-tax income in prior years.

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

The personal holding company tax is a penalty tax imposed in addition to the regular income tax.

If a new business organized as a C corporation incurs start-up losses, the tax benefits of those losses will be recognized immediately.

If a corporation has a high debt-to-equity ratio, the IRS may reclassify deductible interest payments as nondeductible dividends.

Which of the following statements regarding S corporations is true?

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?

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 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 statements regarding alternative business forms is true?

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.

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?

The revenue agent who audited the Form 1120 filed by LCW Inc. recharacterized $125,000 of the salary paid to Ms. Lewis' (LCW's president and controlling shareholder) as a constructive dividend. LCW's marginal tax rate is 35%, and Ms. Lewis' marginal tax rate is 33%. Which of the following is not a consequence of the recharacterization?

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 39.6%. 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 individual tax rate is significantly higher than the corporate tax rate.

Which of the following items might an IRS agent seek to recharacterize as a constructive dividend?

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

Parent-subsidiary and brother-sister controlled corporate groups are eligible to file consolidated income tax returns.

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?

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.