Question 1

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

Accepted Answer

Partnerships allow owners to establish their own roles, responsibilities, and profit-sharing arrangements, making it a highly customizable business structure.

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 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 3

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The accumulated earnings tax is no longer in effect, as it was repealed in 2017. Therefore, Sunny Daze, Inc. would not have to calculate and pay this tax on its annual corporate tax return.

Question 4

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 5

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 6

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 now offer greater tax benefits to their shareholders.

Question 7

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 8

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 9

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 may determine that a CEO/shareholder of a closely held corporation has received a nondeductible constructive dividend rather than a deductible salary if the amount paid is deemed excessive or unreasonable for the services rendered. This can result in adverse tax consequences for both the corporation and the CEO/shareholder.

Question 10

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 conflicts of interest may arise and need to be managed appropriately.

Question 11

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

Accepted Answer

Thinly capitalized corporations have a high proportion of debt in their capital structure relative to equity, which can result in the IRS reclassifying some of the debt as equity to prevent tax avoidance.

Question 12

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

As the family-owned entity evolves and expands, more family members may become involved and have a say in the decision-making process, leading to a dilution of control for the original business owners.

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

When earnings are distributed to a shareholder-employee as dividends in a regular corporation,they are taxed twice- once at the corporate level as income tax and then again at the individual level as a dividend tax.

Question 14

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 15

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 by using a corporation as a tax shelter, the individual can channel their income through the corporation and take advantage of the lower corporate tax rate, while reducing their personal tax liability. This strategy is most effective when the individual tax rate is significantly higher than the corporate tax rate.

Question 16

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

This is correct, the IRS has the authority to recharacterize salary payments to owners of closely-held corporations as constructive dividends if they determine the amount is unreasonable given the facts and circumstances. This is because owners may be tempted to characterize excessive salaries as a business expense to reduce their taxable income.

Question 17

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 18

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 a way to prevent wealthy individuals from using corporations to shelter passive income and avoid paying personal income taxes. It was intended to discourage the use of corporations as investment vehicles rather than as legitimate operating businesses.

Question 19

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, the IRS may consider the corporation to be more like a partnership than a corporation for tax purposes. This means that the interest payments the corporation makes on its debt may be recharacterized as nondeductible dividends, which are not tax-deductible. This is done to prevent corporations from excessively leveraging themselves with debt and deducting the interest payments from their taxes.

Question 20

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 that is imposed in addition to the regular income tax. It is applied to companies that primarily hold passive investments, and is designed to discourage individuals from using these types of companies as a way to shelter investment income from taxation.

Quiz 12: The Choice of Business Entity