Question 1

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 2

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

Accepted Answer

Partnerships allow for customization of the agreement between partners, including the allocation of profits, decision-making authority, and liability distribution. This flexibility can make partnerships an attractive option for many business owners.

Question 3

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

Accepted Answer

Shareholders are not prohibited by law from serving as corporate officers and executives, but there may be conflicts of interest that need to be managed appropriately.

Question 4

When the personal holding company tax was originally enacted,its purpose was to discourage individuals from incorporating their investment portfolios.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 1935 as part of the Revenue Act, and its purpose was to discourage individuals from incorporating their investment portfolios as a way to avoid personal income tax. The tax rate for personal holding companies is higher than the regular corporate tax rate, and it is applied to income that is not derived from the corporation's active trade or business.

Question 5

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 6

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 7

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

Accepted Answer

When a corporation is thinly capitalized, it means that it has very little equity compared to debt. In such a situation, the IRS may reclassify some of the debt as equity because it appears that the corporation is relying more on debt than equity. This can have tax implications for the corporation and its shareholders.

Question 8

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 9

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 10

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 as constructive dividends if it determines that the amount of the payment is unreasonable given the facts and circumstances. This is because some business owners may attempt to classify dividend payments as salary in order to reduce their tax liability, and the IRS seeks to prevent such actions.

Question 11

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, additional family members may become involved in decision making and ownership, which can lead to a dilution of control for the original business owners.

Question 12

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 high, forming a corporation and funneling income through it can allow for significant tax savings due to the lower corporate tax rate.

Question 13

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 when the shareholder receives the dividends.

Question 14

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

Accepted Answer

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

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 reduction in individual tax on dividends has made C corporations more attractive as they are now able to distribute more of their profits to shareholders in the form of dividends which are taxed at a lower rate. This has increased the after-tax return for shareholders and made C corporations more appealing.

Question 16

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 if they determine that the amount paid was excessive and not based on reasonable compensation for services rendered. This means that the payment would not be considered a deductible salary expense for the corporation.

Question 17

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.

Accepted Answer

Spreading the taxable income among separate corporations may not necessarily reduce the total tax burden imposed on the income, as each corporation would be subject to its own tax liability. In fact, setting up separate corporations can lead to additional administrative and legal costs.

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

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 essentially one individual or closely-held group of individuals, and its taxable income arises primarily from passive sources such as investments, royalties, or rents.

Question 20

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

Accepted Answer

When a corporation has a high debt-to-equity ratio, the IRS may determine that the corporation is paying excessive interest to its lenders and reclassify some of those interest payments as nondeductible dividends. This is done to prevent corporations from using debt to inappropriately reduce their taxable income.

Quiz 12: The Choice of Business Entity

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.

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

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

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

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

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.

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

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.

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.

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.

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

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.

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.

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

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

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.

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.

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.

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

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