Question 1

Bryan Houlberg expects his C corporation to generate a profit of $200,000. What is Bryan's after-tax cash flow from the corporation if net income after corporate tax is distributed to him as a dividend and his marginal tax rate on ordinary income is 37%?

Accepted Answer

The answer of Bryan Houlberg expects his C corporation to...

Question 2

Bryan Houlberg expects his C corporation to generate a profit of $200,000. What is the effective tax rate on the $200,000 if net income after corporate tax is distributed to him as a dividend and his marginal tax rate on ordinary income is 37%?

Accepted Answer

- The corporate tax rate for a C corporation with a taxable income of $200,000 is 21%, which equals to $42,000 ($200,000 x 21%).
- After paying the corporate tax, the corporation has $158,000 ($200,000 - $42,000) left for distribution.
- As a dividend recipient, Bryan has to pay 20% dividend tax rate on the $158,000, which equals to $31,600 ($158,000 x 20%).
- Bryan also has to pay his marginal tax rate of 37% on the $158,000 dividend, which equals to $58,460 ($158,000 x 37%).
- Therefore, the total tax paid on the $200,000 profit is $131,060 ($42,000 + $31,600 + $58,460), which is an effective tax rate of 65.53% ($131,060 / $200,000).
- However, the effective tax rate only on the amount distributed as a dividend to Bryan is 36.8% ($90,060 / $158,000), which is the closest option to the correct answer.

Question 3

Kyrsten Haas expects her S corporation to generate a profit of $200,000. What is the effective tax rate on the $200,000 if no cash is distributed? Kyrsten's marginal tax rate on ordinary income is 37%.

Accepted Answer

S corporations pass their profits directly to their shareholders, who then report the income on their personal tax returns. Therefore, the effective tax rate on the $200,000 would be Kyrsten's marginal tax rate of 37%.

Question 4

Which of the following is not a good reason to form a family partnership?

Accepted Answer

Gift taxes may still apply to transfers within a family partnership, depending on the amount and circumstances of the transfer. The other options (A, B, D) are considered benefits or reasons to form a family partnership.

Question 5

A business generates profit of $100,000. The owner has a 37% marginal tax rate. What amount of corporate and individual income tax will be paid on this profit if the business is an S corporation and no income is distributed?

Accepted Answer

S corporations are pass-through entities, meaning the income is passed through to the owners and taxed at their individual tax rates. There is no corporate tax, so the individual tax on $100,000 at a 37% rate would be $37,000.

Question 6

Which of the following is not exclusively a benefit of a passthrough entity?

Accepted Answer

While avoiding double taxation and deductibility of start-up losses are exclusive benefits of passthrough entities, the ability to diffuse ownership is not. Both passthrough entities and traditional corporations can have multiple owners/shareholders.

Question 7

Which of the following is a consequence of establishing a family partnership or a family-owned S corporation?

Accepted Answer

All of these choices are consequences of establishing a family partnership or a family-owned S corporation. The original owners may have their control of the business diluted, the transfers to the younger family members must be complete and legally binding, and the transfers must be irrevocable for the structure of the family business to be honored.

Question 8

Which of the following statements regarding alternative business forms is true?

Accepted Answer

Some states do treat S corporations as taxable corporations for purposes of corporate franchise taxes. Option A is false because if an S corporation's election is terminated, it will become a C corporation rather than forced to liquidate. Option C is also false because the transfer of property to a partnership in exchange for a partnership interest is generally not a taxable event. Option D is subjective and depends on the specific circumstances of the business, so it cannot be generalized as true or false.

Question 9

Which of the following statements regarding the tax burden imposed on business entities is true?

Accepted Answer

This statement is true because dividend income is generally taxed at a lower rate than other forms of income, such as salary or interest income. Option A is incorrect because the tax burden of an S-corporation may not always be lower, as it depends on the specific circumstances of the corporation and its owners. Option B is incorrect because regular corporations (C-corporations) are subject to double taxation, which can decrease after-tax cash flow.

Question 10

Homer currently operates a successful S corporation. He would like to bring his two teenage children into the business. If he gives each child 10% of the stock, which of the following statements is true?

Accepted Answer

Homer must receive a reasonable salary for any time he spends working on behalf of the business to avoid issues with the IRS regarding reasonable compensation. The assignment of income doctrine does not apply in this situation as the children are legitimate shareholders.

Question 11

Sandy, Sue, and Shane plan to open Friends, an upscale restaurant. They project that the business will incur a $90,000 operating loss in Year 1, and $75,000 of profit in Year 2. Which of the following statements is true?

Accepted Answer

If the business is a C corporation, it will owe income tax in Year 2, regardless of the Year 1 operating loss. C corporations are taxed as separate entities and are subject to income tax on their net income each year. The loss in Year 1 can be carried forward to offset future profits, but it cannot be used to eliminate tax liability in Year 2.

Question 12

Gwen and Travis organized a new business as an LLC in which they own equal interests. The new business generated a $10,000 operating loss its first year. Travis has no other taxable income for the current year, but expects to have sufficient taxable income in future years to pay tax in the 24% tax bracket. Which of the following statements regarding Travis' tax savings from the current LLC loss is true?

Accepted Answer

Travis cannot carry the loss back since he has no prior taxable income in the past two years. Therefore, he must carry the loss forward to offset his future taxable income. Once he generates income in the future, the $10,000 loss will reduce his taxable income and provide tax savings. He will save tax at a 24% rate, resulting in a $2,400 tax savings.

Question 13

A business generates profit of $100,000. The owner has a 37% marginal tax rate. What amount of corporate and individual income tax will be paid on this profit if the business is a regular corporation and no income is distributed?

Accepted Answer

If the business is a regular corporation (also known as a C corporation), it pays corporate income tax on its profits. The owner pays individual income tax only on income that is distributed to them, such as dividends. Since no income is distributed in this scenario, the owner pays no individual income tax. The corporate tax rate would apply to the $100,000 profit, but the specific rate isn't provided in the options. Option B is correct because it reflects corporate tax being paid with no individual tax due to no income distribution.

Question 14

Which of the following statements regarding the tax treatment of start-up losses is false?

Accepted Answer

S corporations pass through their income, deductions, losses, and credits to their shareholders for federal tax purposes. Therefore, start-up losses of an S corporation are directly deductible by the shareholders on their personal tax returns, not carried forward as NOLs by the corporation itself.

Question 15

A business generates profits of $150,000. The owner currently has a 32% marginal tax rate. What is the total amount of taxes paid if the business is a regular corporation and $20,000 in dividends is distributed to its sole individual shareholder?

Accepted Answer

The corporation pays taxes on its profits at the corporate tax rate, and then the individual pays taxes on the dividends at their personal tax rate. Assuming a corporate tax rate of 21%, the corporation would pay $150,000 * 21% = $31,500 in taxes. The individual would then pay taxes on the $20,000 in dividends received. Assuming a qualified dividend tax rate of 15% for this individual's tax bracket, the tax on dividends would be $20,000 * 15% = $3,000.

Question 16

Which of the following statements regarding S corporations is true?

Accepted Answer

Generally, the transfer of property by a controlling shareholder to a newly-formed S corporation in exchange for stock is a nontaxable event. This is known as a tax-free incorporation. However, there are conditions that need to be met in order for the transaction to be nontaxable. The other statements are false. If an S corporation's election terminates, it can still continue to operate as a C corporation. States have different rules regarding S corporations and corporate franchise tax. The choice between operating as an S corporation or a partnership depends on the specific circumstances of the business and the preferences of the owners.

Question 17

Loretta plans to start a small business, which will operate as a corporation. In year 0, she expects the corporation to generate a loss of $100,000. Subsequently, she expects the corporation to be profitable, and projects profit of $150,000 in year 1, and $250,000 in year 2. Using Appendix A and a 10% discount rate, calculate the present value of expected tax savings and costs on the business earnings for the first 3 years of operations if the business does not make an S corporation election.

Accepted Answer

The present value of expected tax savings and costs on the business earnings for the first 3 years of operations if the business does not make an S corporation election is $52,910. This is calculated by taking the present value of the tax savings in year 1 and year 2, and subtracting the present value of the tax cost in year 0. The tax savings in year 1 is $15,000, and the tax savings in year 2 is $25,000. The tax cost in year 0 is $10,000. The present value of the tax savings in year 1 is $13,636, and the present value of the tax savings in year 2 is $22,727. The present value of the tax cost in year 0 is $9,547. Therefore, the present value of expected tax savings and costs on the business earnings for the first 3 years of operations if the business does not make an S corporation election is $52,910.

Question 18

Kyrsten Haas expects her S corporation to generate a profit of $200,000. Kyrsten's marginal tax rate on ordinary income is 37%. What is Kyrsten's after-tax cash flow from the S corporation if no cash is distributed?

Accepted Answer

The answer of Kyrsten Haas expects her S corporation to...

Question 19

Loretta plans to start a small business, which will operate as a corporation. In year 0, she expects the corporation to generate a loss of $100,000. Subsequently, she expects the corporation to be profitable, and projects profit of $150,000 in year 1, and $250,000 in year 2. Loretta's personal marginal tax rate on ordinary income is 37%. Using Appendix A and a 10% discount rate, calculate the present value of expected tax savings and costs on the business earnings for the first 3 years of operations if the business makes an S corporation election. Assume the excess business loss limitation does not apply.

Accepted Answer

The answer of Loretta plans to start a small business,...

Question 20

Mr. and Mrs. Johnson and their two children, Alice and Ben, are the four equal partners in JAB Partnership. This year, JAB generated $40,000 of ordinary income. Compute the tax cost associated with this income if Mr. and Mrs. Johnson's marginal tax rate is 35%, Alice's marginal tax rate is 24%, and Ben's marginal tax rate is 32%.

Accepted Answer

The $40,000 of ordinary income generated by JAB Partnership will be divided equally among the four partners, giving each partner $10,000 of income to report. The tax cost for each partner is then calculated based on their individual marginal tax rates: Mr. and Mrs. Johnson (35% of $10,000) = $3,500 each, Alice (24% of $10,000) = $2,400, and Ben (32% of $10,000) = $3,200. Adding these amounts together gives a total tax cost of $12,600.

Quiz 12: The Choice of Business Entity