Question 1

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.

Accepted Answer

Earnings that are distributed to a shareholder-employee as dividends are taxed twice when the business is formed as a regular corporation - once at the corporate level and again at the individual level.

Question 2

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 personal holding company is a corporation owned by individual shareholders that has taxable income arising primarily from passive sources like investments, royalties, rents, and dividends. However, it is required to meet certain ownership and income criteria to qualify as a personal holding company for tax purposes.

Question 3

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

When a family-owned entity is created, ownership and control are often spread across multiple family members, resulting in a dilution of control for the original owners or founders.

Question 4

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.

Accepted Answer

The IRS has the authority to recharacterize salary payments to owners of closely-held corporations as constructive dividends if it finds that the amount of the payment is excessive or unreasonable based on the company's profits, the shareholder's responsibilities, and other relevant factors. This is done to prevent owners from avoiding taxes by disguising dividends as salary payments.

Question 5

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.

Accepted Answer

This is because the corporate tax rate is generally lower than the individual tax rate, so by using a corporation as a tax shelter, individuals can reduce their personal tax liability by shifting income to the corporation and paying taxes at the lower corporate rate rather than their higher personal rate.

Question 6

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

In a limited liability partnership (LLP), each partner is protected from personal liability for certain obligations of the LLP, including malpractice claims arising from the professional misconduct or negligence of another partner, allowing only the assets of the LLP to be used to settle such claims.

Question 7

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.

Accepted Answer

The statement is incorrect. An accumulated earnings tax is only imposed on corporations that retain earnings without a reasonable business purpose, such as to avoid taxation. If Sunny Daze, Inc. has no financial justification for retaining the earnings, it can distribute them as dividends without incurring any additional tax liabilities.

Question 8

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.

Accepted Answer

The IRS has the authority to reclassify payments to a CEO/shareholder of a closely held corporation as a nondeductible constructive dividend, rather than a deductible salary, if they determine that the amount paid is excessive in relation to the services performed. This may result in the corporation being subject to additional taxes and penalties.

Question 9

When a corporation is thinly capitalized,the IRS is more likely to reclassify a portion of the corporation's debt as equity.

Accepted Answer

This is because thinly capitalized corporations have a small amount of equity compared to their debt, which makes it more likely that the debt could be considered part of the equity. This is known as the debt-equity classification rule.

Question 10

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

Accepted Answer

The reduction in individual tax on dividends has made C corporations more attractive as they are able to provide their shareholders with higher after-tax dividends.

Question 11

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

Accepted Answer

The accumulated earnings tax is assessed at a flat rate of 20% on corporations' accumulated taxable income, not at the highest individual marginal tax rate.

Question 12

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

Accepted Answer

Shareholders are not usually prohibited by law from serving as corporate officers and executives, but it may create conflicts of interest and be discouraged by the company's governance policies.

Question 13

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

Accepted Answer

Partnerships allow for flexibility in allocating income and losses among partners, while S corporations have strict rules for allocating income and losses based on ownership percentage.

Question 14

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.

Accepted Answer

Since Glover, Inc. distributed all of its personal holding company income as dividends, it will not owe personal holding company tax for the year. Personal holding company tax generally applies to undistributed personal holding company income.

Question 15

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.

Accepted Answer

The accumulated earnings tax is imposed on corporations, not partnerships, for the purpose of avoiding income tax by allowing earnings and profits to accumulate instead of being distributed to shareholders.

Question 16

Following the Tax Cuts and Jobs Act of 2017,it is no longer possible to use a corporation as a tax shelter.

Accepted Answer

While the Tax Cuts and Jobs Act of 2017 made significant changes to the corporate tax system, including reducing the corporate tax rate, it is still possible to use a corporation as a tax shelter through various strategies such as income shifting, deducting excess executive compensation, and utilizing tax havens. However, the Act did introduce limitations on certain deductions and exemptions that corporations may have previously used to reduce their tax liability.

Question 17

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 corporation acts as a tax shelter when the corporate tax rate is lower than the individual tax rate, allowing individuals to minimize their tax liabilities by keeping income within the corporation.

Question 18

In today's tax environment,the opportunity for individuals to exploit the difference between the individual and the corporate rate structure is greater than ever.

Accepted Answer

The tax environment is subject to frequent changes and reforms aimed at closing loopholes and ensuring fairness between individual and corporate tax structures. Many countries have implemented measures to reduce the opportunities for exploiting differences between individual and corporate tax rates.

Question 19

Partnerships offer owners the maximum flexibility to tailor their business arrangement to fit their needs.

Accepted Answer

Partnerships allow for a customizable arrangement between owners, allowing them to divide responsibilities, profits, and liabilities in a way that works best for their business.

Question 20

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

Accepted Answer

This is true because a high debt-to-equity ratio indicates that the corporation is relying heavily on debt financing, and the IRS may view the interest payments as being more like dividends because they are similar to returns to shareholders rather than pure interest payments on debt. As a result, the IRS may decide to reclassify these interest payments as nondeductible dividends.

Quiz 12: The Choice of Business Entity