Question 1

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 2

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 3

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

This is a possibility if the IRS determines that the amount paid to the CEO/shareholder exceeds the fair market value of their services. In this case, the excess amount would be deemed a constructive dividend and not deductible as salary.

Question 4

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

When a closely-held business is formed as a regular corporation, earnings that are distributed to a shareholder-employee as dividends are taxed at both the corporate level and the individual level, resulting in double taxation.

Question 5

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 6

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 may recharacterize salary payments as constructive dividends if they determine that the amount is unreasonable.

Question 7

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 8

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 typically defined as a corporation that is controlled by a small number of shareholders (five or fewer) and makes most of its income from passive sources, such as dividends, interest, and rents, rather than from active business operations.

Question 9

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 10

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

Accepted Answer

Thin capitalization means that a corporation has a high level of debt and a low level of equity. When a corporation is thinly capitalized, the IRS may reclassify some of the debt as equity because it appears that the corporation is not able to support the debt with sufficient capital. This can result in changes to the tax treatment of the corporation's income and expenses.

Question 11

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

Accepted Answer

If a corporation has a high debt-to-equity ratio, it may be considered "thinly capitalized" and the IRS may reclassify deductible interest payments as nondeductible dividends. This is known as the "debt-equity recharacterization rule."

Question 12

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 13

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

When the individual tax rate is higher than the corporate tax rate, using a corporation as a tax shelter can result in significant tax savings. This is because the corporation can retain profits at a lower tax rate, which can then be paid out to the individual as dividends that are taxed at a lower rate than ordinary income. However, if the individual tax rate is not significantly higher than the corporate tax rate, the tax savings may not be as substantial.

Question 14

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

Accepted Answer

Shareholders are not necessarily prohibited from serving as corporate officers and executives, but conflicts of interest may arise and should be disclosed and managed appropriately.

Question 15

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 recent tax legislation has reduced the individual tax on dividends, making C corporations more attractive than they were prior to the legislation because they are subject to double taxation, meaning both the corporation and the individual shareholder have to pay taxes on their earnings. However, with the reduced individual tax on dividends, the overall tax burden on shareholders has decreased, making C corporations more appealing.

Question 16

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 17

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

Accepted Answer

Partnerships are flexible business structures that allow owners to customize their partnership agreement according to their specific requirements.

Question 18

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 business is created, ownership may be inherited or shared with other family members, which can lead to a dilution of control for the original business owners.

Question 19

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

Accepted Answer

The personal holding company tax was enacted in 1937 as part of the Revenue Act with the aim of discouraging individuals from avoiding higher personal income tax rates by incorporating their investment portfolios.

Question 20

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.

Quiz 12: The Choice of Business Entity