Question 1

When the personal holding company tax was originally enacted, its purpose was to discourage individuals from incorporating their investment portfolios.

Accepted Answer

A) True 
 B)False

Question 2

The use of a corporation as a tax shelter is most effective when the corporate tax rate is significantly higher than the individual tax rate.

Accepted Answer

A) True 
 B)False

Question 3

Because of conflicts of interest, shareholders are usually prohibited by law from serving as corporate officers and executives.

Accepted Answer

A) True 
 B)False

Question 4

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

Accepted Answer

A) True 
 B)False

Question 5

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

Accepted Answer

A) True 
 B)False

Question 6

A business generates profit of $100,000. The owner has a 35% 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?

Accepted Answer

A)  Corporate tax, $22,250; individual tax, $35,000 
B)  Corporate tax, $22,250; individual tax, $0 
C)  Corporate tax, $0; individual tax, $35,000 
D)  Corporate tax, $22,250; individual tax, $27,213

Question 7

Family partnerships are generally created when the owner of a business makes a gift of an equity interest in the business to a relative.

Accepted Answer

A) True 
 B)False

Question 8

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 Mimeo's income tax liability.

Accepted Answer

A)  $17,000 increase 
B)  $17,000 decrease 
C)  $17,500 increase 
D)  $17,500 decrease

Question 9

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 makes an S corporation election.

Accepted Answer

A)  $105,000 total tax cost 
B)  $93,748 total tax cost 
C)  $96,933 
D)  $0

Question 10

A partner in a limited liability partnership (LLP) is protected from malpractice-related claims arising from the professional misconduct/negligence of another partner.

Accepted Answer

A) True 
 B)False

Question 11

Which of the following statements regarding the personal holding company tax is false?

Accepted Answer

A)  The personal holding company tax is imposed in addition to the regular corporate income tax. 
B)  The personal holding company tax was originally enacted to discourage individuals from incorporating their investment portfolios. 
C)  The personal holding company tax is calculated by a qualifying corporation and paid on its annual corporate income tax return. 
D)  The personal holding company tax is assessed on a qualifying corporation's undistributed personal holding company income.

Question 12

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.

Accepted Answer

A) True 
 B)False

Question 13

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

Accepted Answer

A) True 
 B)False

Question 14

Bryan Houlberg expects his C corporation to generate a profit of $200,000. What is the effective tax rate on the $200,000 if net income after corporate tax is distributed to him as a dividend and his marginal tax rate on ordinary income is 35%?

Accepted Answer

A)  35% 
B)  57.43% 
C)  41.03% 
D)  39%

Question 15

Mr. Longwood and Mrs. Kennett are the equal shareholders in LK Corporation. Both shareholders have a 35 percent marginal tax rate on ordinary income. LK's financial records show the following:  a. Compute the combined tax cost for LK, Mr. Longwood, and Mrs. Kennett attributable to LK's operations.
b. How would your computation change if the interest on the shareholder debt was $175,000 and LK paid no dividends?

Accepted Answer

The answer of Mr. Longwood and Mrs. Kennett are the...

Question 16

One disadvantage of the creation of a family-owned entity is that there is dilution of control with respect to the original business owners.

Accepted Answer

A) True 
 B)False

Question 17

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

Accepted Answer

A)  In years in which the individual tax rates were significantly higher than the corporate rates, individuals could reduce the tax on business income by operating as a regular corporation rather than as a passthrough entity. 
B)  The combination of deferral of individual tax and conversion of ordinary income into capital gain enhanced the attractiveness of corporations as tax shelters. 
C)  Under the current tax rate structure, the opportunity for individuals to exploit differences between the individual and corporate rate structures is significant. 
D)  Under the current tax rate structure, corporations are effective tax shelters only if business income is very small and the owners are willing to forgo dividends for a long period of time.

Exam 12: The Choice of Business Entity

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

The use of a corporation as a tax shelter is most effective when the corporate tax rate is significantly higher than the individual tax rate.

Because of conflicts of interest, shareholders are usually prohibited by law from serving as corporate officers and executives.

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

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

A business generates profit of $100,000. The owner has a 35% 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?

Family partnerships are generally created when the owner of a business makes a gift of an equity interest in the business to a relative.

A partner in a limited liability partnership (LLP) is protected from malpractice-related claims arising from the professional misconduct/negligence of another partner.

Which of the following statements regarding the personal holding company tax is false?

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.

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

Bryan Houlberg expects his C corporation to generate a profit of $200,000. What is the effective tax rate on the $200,000 if net income after corporate tax is distributed to him as a dividend and his marginal tax rate on ordinary income is 35%?

One disadvantage of the creation of a family-owned entity is that there is dilution of control with respect to the original business owners.

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