Question 1

Loretta plans to start a small business, operated through 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.
A) $52,910 total tax cost
B) $88,250 total tax cost
C) $94,350 total tax cost
D) $118,800 total tax cost

Accepted Answer

Year 0 loss is carried forward, reducing year 1 taxable income to $50,000 with tax cost of $10,500. Year 2 tax cost is $52,500. Discounted cost is $52,910 [($10,500 × 0.909) + ($52,500 × 0.826)].

Question 2

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?
A) Travis can carry his share of LLC loss back two years as a net operating loss, and request an immediate tax refund of $1,200.
B) Travis can carry his share of LLC loss forward, and will get tax savings only when he generates future income.
C) Travis can only use his share of the LLC loss in the current year, and will receive no tax savings.
D) The LLC will reallocate Travis share of the loss to Gwen, who can claim $1,750 of additional tax savings.

Accepted Answer

Since Travis has no other taxable income in the current year, he cannot use his share of the LLC loss to offset any other income. Therefore, he will need to carry the loss forward to future years when he generates taxable income. Travis's tax savings will depend on his taxable income in the year(s) he uses the loss. The loss can be carried forward indefinitely until it is used up, but can be used to offset only 80% of taxable income in the applicable year. Therefore, Travis may need to generate more taxable income in the future to fully utilize the loss and maximize his tax savings.

Question 3

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%?
A) 21%
B) 58%
C) 36.8%
D) 37%

Accepted Answer

The corporate level tax on $200,000 is $42,000, leaving $158,000 to distribute. The individual tax on $158,000 at 20% is $31,600. Total tax paid is $73,600 or 36.8% of the $200,000.

Question 4

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. If Gwen's marginal tax rate is 35%, her tax savings from the first-year LLC loss is:
A) $3,500
B) $1,750
C) $5,000
D) $3,250

Accepted Answer

$10,000 × 50% × 35%.

Question 5

Which of the following is not exclusively a benefit of a passthrough entity?
A) Avoiding double taxation.
B) Ability to diffuse ownership.
C) Deductibility of start-up losses.
D) All of the above are exclusive benefits of a passthrough entity.

Accepted Answer

The answer of Which of the following is not exclusively...

Question 6

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?
A) Corporate tax, $21,000; individual tax, $37,000
B) Corporate tax, $21,000; individual tax, $0
C) Corporate tax, $0; individual tax, $37,000
D) Corporate tax, $21,000; individual tax, $15,800

Accepted Answer

S corporations are pass-through entities, which means that the business itself does not pay any income tax. Instead, the profit is distributed to the shareholders, and they pay individual income taxes on their share of the profit. In this scenario, if no income is distributed, then the business does not owe any corporate income tax. However, the owner will still owe individual income tax on their share of the profit, which would be $37,000 (37% of $100,000).

Question 7

Which of the following is not a good reason to form a family partnership?
A) Income can be shifted to lower-tax-rate individuals
B) A buy-sell agreement can ensure that all ownership interests are retained in the family
C) No gift tax is due on the transfer
D) Non-voting interests can be given to younger family members to ensure the older generation maintains operational control

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 8

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?
A) Corporate tax, $21,000; individual tax, $37,000
B) Corporate tax, $21,000; individual tax, $0
C) Corporate tax, $0; individual tax, $37,000
D) Corporate tax, $21,000; individual tax, $15,800

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 9

Which of the following statements regarding S corporations is true?
A) If an S corporation's election terminates, the corporation is forced to liquidate.
B) All states treat the S corporation as a taxable corporation for corporate franchise tax purposes.
C) Generally, the transfer of property by a controlling shareholder to a newly-formed S corporation in exchange for stock is a nontaxable event.
D) The owners of a new business should be indifferent between operating as an S corporation and a partnership.

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. Option A is incorrect because an S corporation that terminates its election will revert to a C corporation status. Option B is incorrect because state tax laws vary, and some states may treat S corporations differently for tax purposes. Option D is incorrect because the choice between an S corporation and a partnership depends on several factors, such as the number of owners, liability concerns, and tax considerations.

Question 10

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?
A) $0
B) ($74,000)
C) $126,000
D) ($126,000)

Accepted Answer

Kyrsten's has cash outflow from tax liability of $74,000, and no cash inflow.

Question 11

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%.
A) 21%
B) 58%
C) 36.8%
D) 37%

Accepted Answer

There is only one level of tax.

Question 12

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 wealthy individuals from incorporating their investment portfolios in order to avoid paying higher personal income tax rates. The tax aimed to ensure that investment income earned through a corporation was taxed at a higher rate, similar to the tax rates for individual taxpayers.

Question 13

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 sold individual shareholder?
A) Corporate tax, $31,500; individual tax, $3,000
B) Corporate tax, $48,000; individual tax, $6,400
C) Corporate tax, $31,500; individual tax, $6,400
D) Corporate tax, $0; Individual tax, $48,000

Accepted Answer

The dividend tax rate on this individual shareholder is 15%.

Question 14

Loretta plans to start a small business, operated through 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.
A) $52,910 total tax cost
B) $94,350 total tax cost
C) $99,772 total tax cost
D) $0

Accepted Answer

Year 0 loss produces tax savings of $37,000. Year 1 tax cost, at 37%, is $55,500; year 2 tax cost is $92,500. Discounted cost is $94,350 [$37,000 savings - ($55,500 × 0.909) - ($92,500 × 0.826)].

Question 15

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 on corporations that meet certain criteria, intended to deter individuals from using corporations as a means of sheltering personal income from taxes. It is in addition to any regular income tax that the corporation may owe.

Question 16

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%?
A) $120,800
B) $90,188
C) $126,400
D) $158,000

Accepted Answer

The corporate level tax on $200,000 is $42,000, leaving $158,000 to distribute. The individual tax on $158,000 at 20% is $31,600. After-tax cash flow to Bryan is $158,000 - $31,600.

Question 17

Which of the following statements regarding the tax burden imposed on business entities is true?
A) The tax burden imposed on corporate earnings is always lower if the corporation makes an S election.
B) Business owners desiring current cash flow can maximize annual after-tax cash flow by operating as a regular corporation.
C) Current tax cost associated with shareholder cash flow received as dividends may be lower than cash flow received as payments of salary, interest, or rental income.
D) All of the above statements are true.

Accepted Answer

Current tax cost associated with shareholder cash flow received as dividends may be lower than cash flow received as payments of salary, interest, or rental income. This is because dividends are taxed at a lower rate than ordinary income. However, this statement does not hold true in all situations, and there may be other factors to consider when determining the most tax-efficient way to structure a business entity. The other statements (A and B) are not true in all cases and therefore incorrect.

Question 18

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%.
A) $12,600
B) $8,800
C) $35,200
D) $0

Accepted Answer

$40,000 × 50% × 35% + $40,000 × 25% × 24% + $40,000 × 25% × 32%.

Question 19

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?
A) If the business is a C corporation, it will not owe regular tax liability during the first two years.
B) If the business is a general partnership, it will owe income tax in Year 2.
C) If the business is an S corporation, the Year 1 loss can be allocated entirely to Sandy.
D) If the business is a C corporation, it will owe income tax in Year 2.

Accepted Answer

If the business is a C corporation, it will owe income tax in Year 2 on the $75,000 profit. C corporations are taxed separately from their owners, and so the profit is taxed at the corporate level before being distributed to the owners. Options A and C are incorrect because they assume the business is a pass-through entity, which means the income and losses are passed through to the owners to be included on their personal tax returns. Option B is incorrect because partnerships are also pass-through entities, but the income tax liability would be on the individual partners rather than the partnership itself.

Question 20

Which of the following statements regarding the tax treatment of start-up losses is false?
A) Start-up losses of a business organized as a C corporation create NOL carryforwards, deductible in future years when the business generates a profit.
B) Start-up losses of a business organized as a partnership are deductible by the partners, potentially generating immediate tax savings.
C) Start-up losses of a business organized as an S corporation create NOL carryforwards, deductible in future years when the business generates a profit.
D) Start-up losses of a business organized as an S corporation are deductible by the shareholders, potentially generating immediate tax savings.

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.

Quiz 12: The Choice of Business Entity

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%?

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. If Gwen's marginal tax rate is 35%, her tax savings from the first-year LLC loss is:

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

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?

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

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?

Which of the following statements regarding S corporations is true?

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?

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%.

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

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 sold individual shareholder?

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

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%?

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

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?

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