Question 1

Mr. Allen, whose marginal tax rate is 35%, owns an office building that generates $100,000 annual taxable income. He plans to create a family partnership by giving each of his three children a 15% interest in the building. Mr. Allen will retain a 55% interest. Mr. Allen will manage the building, and receive a guaranteed payment of $20,000. If Mr. Allen's children are in the 15% tax bracket, compute the annual tax savings from this income-shifting arrangement.

Accepted Answer

By giving each of his children a 15% interest in the building, Mr. Allen is shifting $45,000 ($100,000 x 45%) of the building's income to his children's lower tax bracket. This results in a tax savings of $7,200 [(45,000 x 20%) - (45,000 x 15%)]. The $20,000 guaranteed payment to Mr. Allen is not affected by this income-shifting arrangement, and he will continue to pay taxes on it at his marginal rate of 35%. Therefore, the total tax savings from this arrangement is $7,200.

Question 2

Chad is the president and sole shareholder of Greenfield, Inc., a regular corporation. The corporation reported taxable income of $575,000 after deducting his $900,000 salary. If the IRS disallowed $550,000 as unreasonable compensation, Chad's taxable income will:

Accepted Answer

The answer of Chad is the president and sole shareholder...

Question 3

Kansas Corporation is a 68% shareholder in Colorado, Inc. Last year, Colorado paid Kansas $100,000 as compensation for unspecified services provided by Kansas employees to Colorado, and deducted the payment on its federal income tax return. The revenue agent who audited both corporations' returns concluded that the payment is a constructive dividend. Both corporations have a 34% marginal tax rate. What is the effect of this audit conclusion on each corporation's income tax liability?

Accepted Answer

The answer of Kansas Corporation is a 68% shareholder in...

Question 4

Which of the following would not be a successful means of avoiding double tax on the earnings of a closely-held corporation?

Accepted Answer

Paying a fixed percentage of the par value of the stock that a shareholder owns does not provide a legitimate reason for the payment and is likely to be viewed as a disguised dividend by the IRS, resulting in double taxation of both the corporation's earnings and the shareholder's income. The other choices provide legitimate business purposes for the transactions and would be more likely to avoid double taxation.

Question 5

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

The IRS concluded that $50,000 of the rent was excessive. Mimeo can only deduct $150,000 instead of $200,000, resulting in an additional $50,000 taxable income. At a 34% tax rate, this increases Mimeo's tax liability by $17,000 (0.34 * $50,000).

Question 6

The three Crosby children intend to form a business. The business will borrow $900,000 from a local bank. Which of the following statements is true?

Accepted Answer

If the business is a partnership, the owners can allocate income and losses in any reasonable manner. As partners, the Crosby children will be personally liable for any debts or obligations of the partnership, including the bank loan. However, they will also be able to share in the profits and losses of the business and have flexibility in how they allocate the income and losses among themselves. If the business were an S corporation, the owners would still include the bank debt in the tax basis of their ownership interests, but they would not be personally liable for the debts or obligations of the corporation. However, they would also have less flexibility in allocating income and losses among themselves.

Question 7

Mr. Eddy loaned his solely-owned corporation $3,000,000. The corporation paid a market rate of interest annually. Upon audit, the IRS reclassified some of the debt as equity. Which of the following statements is true?

Accepted Answer

When the IRS reclassifies some of the debt as equity, it means that the loan is no longer considered a debt, but rather an investment in the company. Therefore, the interest paid on that reclassified amount cannot be deducted as interest expense by the corporation, and instead, it must be treated as a dividend to Mr. Eddy. This will result in an increase in Mr. Eddy's taxable income. The taxable income of the corporation may also be affected, depending on the specifics of the reclassification.

Question 8

Platte River Corporation is a calendar year S corporation. At the beginning of the year, Mr. Reeves owned 100% of Platte River's outstanding stock. On June 30 of the current year, he gave 25% of the stock to his son Mark and 10% of the stock to his daughter Megan. Platte River's ordinary income for the year was $220,000. What portion of this income must each shareholder report?

Accepted Answer

Since Platte River is an S corporation, its income or losses are passed through to its shareholders in proportion to their ownership interest. Therefore, for the first half of the year, Mr. Reeves will report all of the income or loss as he owns 100% of the business. 
For the second half of the year, he will report 75% of the income or loss and his children, Mark and Megan, will report the remaining percentage of income or loss as per their ownership. 
Mr. Reeves owns 75% of the business after giving away 25% of the stock to his son and 10% of the stock to his daughter. Therefore, he will report $165,000 ($220,000 x 75%) and Mark will report $55,000 ($220,000 x 25%) while Megan will report $22,000 ($220,000 x 10%). Hence, option C is the correct answer.

Question 9

Which of the following items might an IRS agent seek to recharacterize as a constructive dividend?

Accepted Answer

A and C both involve legitimate expenses that are necessary for the business and are being paid at market rates. B, on the other hand, involves a payment to a person who is not providing any services to the corporation, which could be seen as a way of distributing profits to a shareholder without officially declaring a dividend. Therefore, B is the item that an IRS agent might seek to recharacterize as a constructive dividend.

Question 10

Mrs. Fuente, who has a 35% marginal tax rate on ordinary income, is the sole shareholder and CEO of Furey Inc. She also holds a $1 million interest-bearing note issued by Furey. The corporation's current-year financial records show the following:  Compute Mrs. Fuente's tax on her income from Furey.

Accepted Answer

Mrs. Fuente's taxable income from Furey can be calculated as follows:

(Sales revenue - Cost of goods sold - Operating expenses - Interest paid to Mrs. Fuente) = Furey's taxable income

($8,500,000 - $5,300,000 - $1,600,000 - $0) = $2,600,000

Since Mrs. Fuente is the sole shareholder of Furey Inc, the corporation's taxable income is also her taxable income. Therefore, Mrs. Fuente's total taxable income for the year is:

(Ordinary income + Interest income from Furey) = Total taxable income

($915,000 + $60,000) = $975,000

Mrs. Fuente's tax on her income from Furey would be:

($975,000 * 35%) - ($1,000,000 * 5%) = $322,500 - $50,000 = $272,500

Therefore, choice C is the correct answer.

Question 11

Gerry is the sole shareholder and president of Garmon Corporation. He also owns the office building that serves as the corporation's headquarters. Last year, Garmon paid Gerry $250,000 for the use of the building. Garmon's MTR was 34% and Gerry's was 35%. The revenue agent who audited Garmon's return has concluded that the fair rental value of the office building was $200,000. What is the net impact of this audit conclusion on Gerry and Garmon's combined income tax liability?

Accepted Answer

The answer of Gerry is the sole shareholder and president...

Question 12

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 Mrs. Jansen's income tax liability.

Accepted Answer

The answer of Mrs. Jansen is the sole shareholder of...

Question 13

Cathy is the President and sole shareholder of Boxer, Inc., a regular corporation. The corporation reported taxable income of $435,000 after deducting Cathy's $800,000 salary. If the IRS disallowed $550,000 of the salary as unreasonable compensation, the corporation's regular income tax will change by a:

Accepted Answer

The answer of Cathy is the President and sole shareholder...

Question 14

Mr. and Mrs. Maxwell are equal partners in Family partnership. The Maxwell's marginal tax rate is 35%. Next year, the partnership is expected to generate $200,000 of ordinary income. The Maxwells are considering transferring 20% interests in the partnership to each of their children. Their daughter, Melissa, has a 15% marginal tax rate. Their son, Mark, has a 25% marginal tax rate. Calculate the expected annual tax savings to the family from the proposed transfer of partnership interests.

Accepted Answer

The answer of Mr. and Mrs. Maxwell are equal partners...

Question 15

Which of the following statements concerning the differences in operating a business as a partnership or as an S corporation is true?

Accepted Answer

The statement that the owners of a general partnership have unlimited personal liability for the debts of the business is true. The statement in option A is false as both partnerships and S corporations offer flexibility in allocating income or loss among owners. The statement in option B is false as S corporations offer limited liability protection to their owners.

Question 16

The IRS agent who audited the Form 1120 filed by Alano Inc. concluded that $300,000 of the salary that Alano paid to its CEO and sole shareholder was a constructive dividend. As a result:

Accepted Answer

The answer of The IRS agent who audited the Form...

Question 17

Mrs. Ford, who has a 35% marginal tax rate, is the sole shareholder and CEO of Fast Inc. She also holds a $1 million interest-bearing note issued by Fast. The corporation's current-year financial records show the following:  Compute Fast's taxable income.

Accepted Answer

The answer of Mrs. Ford, who has a 35% marginal...

Question 18

Which of the following is NOT one of the characteristics of a constructive dividend?

Accepted Answer

The answer of Which of the following is NOT one...

Question 19

Which of the following entities does not provide all the owners with limited liability for debts incurred by the entity?

Accepted Answer

Limited partnerships have both general partners, who have unlimited personal liability for the partnership's debts, and limited partners, who have limited liability but cannot participate in the management of the partnership.

Question 20

The revenue agent who audited the Form 1120 filed by LCW Inc. recharacterized $125,000 of the salary paid to Ms. Lewis' (LCW's president and controlling shareholder) as a constructive dividend. LCW's marginal tax rate is 35%, and Ms. Lewis' marginal tax rate is 33%. Which of the following is not a consequence of the recharacterization?

Accepted Answer

The answer of The revenue agent who audited the Form...

Quiz 12: The Choice of Business Entity