Exam 12: The Choice of Business Entity

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 39.6%. 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 Mimeo's income tax liability.

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.

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

Which of the following statements regarding the accumulated earnings tax is true?

A family partnership can shift taxable income to younger family members only if these family members own a partnership interest.

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.

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?

A family partnership can be used to shift a portion of the income from an accounting practice to a taxpayer's young children.

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.

Bryan Houlberg expects his C corporation to generate a profit of $200,000. What is Bryan's after-tax cash flow from the corporation if net income after corporate tax is distributed to him as a dividend and his marginal tax rate on ordinary income is 39.6%?

Bart owns 100% of an S corporation that had a net operating loss in the current year. If there is sufficient basis in the stock, he will carry this loss back to reduce taxes in a prior S corporation tax year.

When the personal holding company tax was originally enacted, its purpose was to discourage individuals from incorporating their investment portfolios.

Which of the following statements regarding the use of a corporation as a tax shelter is false?

Zenon Corporation generates taxable income of $100,000 per year. Yellow Corporation generates taxable income of $50,000 per year. a. Calculate regular income tax liability for Zenon and Yellow. b. How would your answers to part (a) change if Mary Jones is the sole shareholder of both Zenon and Yellow? c. How would the ownership of the two corporations impact their tax liability if Zenon and Yellow each generated taxable income of $500,000? Provide calculations to support your conclusion.

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 25%, and Ben's marginal tax rate is 28%.

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.

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.

Chad is the president and sole shareholder of Greenfield, Inc., a regular corporation. The corporation reported taxable income of $575,000 after deducting his $900,000 salary. If the IRS disallowed $550,000 as unreasonable compensation, Chad's taxable income will:

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

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?