Question 1

Individual shareholders who create a brother-sister controlled group do not derive any federal tax advantage from doing so.

Accepted Answer

The answer of Individual shareholders who create a brother-sister controlled...

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 had sufficient taxable income in prior years to pay tax in the 28% tax bracket. Which of the following statements regarding Travis' tax savings from the current LLC loss is true?

Accepted Answer

The answer of Gwen and Travis organized a new business...

Question 3

Kyrsten Haas expects her S corporation to generate a profit of $200,000. Kyrsten's marginal tax rate on ordinary income is 35%. What is Kyrsten's after-tax cash flow from the S corporation if no cash is distributed?

Accepted Answer

Since Kyrsten's S corporation is a pass-through entity, the profit of $200,000 will flow through to her personal income tax return. She will therefore owe income tax on this profit at her marginal tax rate of 35%, which amounts to $70,000 ($200,000 x 35%). However, no cash is being distributed to Kyrsten, so her after-tax cash flow from the S corporation will be negative, equal to the tax liability of $70,000. Therefore, the correct answer is (B) $(70,000).

Question 4

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

The answer of Homer currently operates a successful S corporation....

Question 5

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

Accepted Answer

Establishing a family partnership or a family-owned S corporation has a number of consequences, including the potential dilution of control for the original owners, the need for legally binding transfers to younger family members to fully establish the structure of the business, and the requirement that these transfers be irrevocable. Thus, option D is correct as all of the given statements are correct.

Question 6

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 35%. Using 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.

Accepted Answer

To calculate the present value of expected tax savings and costs, we need to first calculate the tax savings and costs for each year and then discount them to their present values using the 10% discount rate.

Year 0:

Since Loretta expects the corporation to generate a loss of $100,000 in year 0, there will be no tax savings/costs. Therefore, the present value of tax savings/costs for year 0 is $0.

Year 1:

Profit for year 1 = $150,000
Taxable income for year 1 = $150,000 - $100,000 (carryover loss from year 0) = $50,000
Corporate tax liability for year 1 = $50,000 * 21% = $10,500
Personal tax liability for year 1 = $150,000 * 35% = $52,500
Total tax liability for year 1 = $10,500 + $52,500 = $63,000
Tax savings for year 1 = $63,000 - $52,500 = $10,500
Present value of tax savings for year 1 = $10,500 / (1 + 0.10) = $9,545

Year 2:

Profit for year 2 = $250,000
Taxable income for year 2 = $250,000 - $50,000 (carryover loss from year 1) = $200,000
Corporate tax liability for year 2 = $200,000 * 21% = $42,000
Personal tax liability for year 2 = $250,000 * 35% = $87,500
Total tax liability for year 2 = $42,000 + $87,500 = $129,500
Tax savings for year 2 = $129,500 - $87,500 = $42,000
Present value of tax savings for year 2 = $42,000 / (1 + 0.10)^2 = $33,058

Total present value of tax savings = $9,545 + $33,058 = $42,603

Total present value of tax costs = $0 (year 0) + $10,500 (year 1) + $42,000 (year 2) = $52,500

Total present value of expected tax savings and costs = $42,603 - $52,500 = -$9,897

Since the total present value of expected tax savings and costs is negative, this means that choosing S corporation election would result in a tax cost. Therefore, the best choice is B, which shows a total tax cost of $93,748.

Question 7

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 8

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

The answer of Sandy, Sue, and Shane plan to open...

Question 9

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 25%, and Ben's marginal tax rate is 28%.

Accepted Answer

Each partner's share of the ordinary income is $10,000 ($40,000/4).

Mr. and Mrs. Johnson's tax cost would be $7,000 each ($10,000 x 0.35).

Alice's tax cost would be $2,500 ($10,000 x 0.25).

Ben's tax cost would be $2,800 ($10,000 x 0.28).

Therefore, the total tax cost associated with the income is $12,300 ($7,000 + $7,000 + $2,500 + $2,800).

Question 10

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:

Accepted Answer

As an LLC, the loss is passed through to the members' personal tax returns. Since Gwen and Travis own equal interests, Gwen's share of the LLC loss is $5,000 ($10,000 operating loss / 2 equal interests).

Gwen's tax savings is calculated as her marginal tax rate multiplied by her share of the LLC loss: 
$5,000 x 35% = $1,750

Therefore, Gwen's tax savings from the first-year LLC loss is $1,750, which corresponds to choice B.

Question 11

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 35%?

Accepted Answer

The corporation pays corporate tax on the profit, and then Bryan pays personal tax on the dividend. Assuming a corporate tax rate of 21%, the net income after corporate tax is $158,000 ($200,000 - $42,000). Bryan then pays a 35% tax on the dividend, leaving him with $117,937 ($158,000 - $55,300).

Question 12

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

Accepted Answer

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

Question 13

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

Accepted Answer

This statement correctly explains that shareholder cash flow received as dividends may have a lower tax cost than cash flow received as salary, interest, or rental income. The other statements are incorrect. Making an S election does not always result in a lower tax burden, and operating as a regular corporation does not necessarily maximize after-tax cash flow.

Question 14

A business generates profit of $100,000. The owner has a 35% 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

An S corporation does not pay corporate income tax. Instead, profits are passed through to the owners, who pay individual income tax. The owner will pay $35,000 (35% of $100,000) in individual tax.

Question 15

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 35%. Using 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 answer of Loretta plans to start a small business,...

Question 16

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 35%.

Accepted Answer

In an S corporation, profits are passed through to the shareholders and taxed at their individual tax rates. Since Kyrsten's marginal tax rate is 35%, the effective tax rate on the $200,000 profit is also 35%, regardless of whether cash is distributed or not.

Question 17

A business generates profit of $100,000. The owner has a 35% 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

A regular corporation pays corporate tax on its profits, and if no income is distributed, the owner does not pay individual tax.

Question 18

A brother-sister controlled group consists of two or more corporations controlled by the same set of individual shareholders.

Accepted Answer

This statement is true. A brother-sister controlled group is a type of controlled group for tax purposes where the common ownership of two or more corporations is by five or fewer individuals who are related as brother and sister.

Question 19

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 35%?

Accepted Answer

The calculation is as follows:

- The C corporation will pay corporate income tax on its $200,000 profit at a flat rate of 21%, which amount to $42,000 ($200,000 x 21%).
- The remaining amount of $158,000 ($200,000 - $42,000) will be distributed to Bryan as a dividend.
- Dividends are taxed at the individual level, and Bryan's marginal tax rate on ordinary income is 35%.
- The effective tax rate on the $200,000 is therefore: 
   - $42,000 (corporate tax) + $55,300 (individual tax on dividends, calculated as $158,000 x 35%) = $97,300 in total tax
   - Effective tax rate = total tax / taxable income = $97,300 / $200,000 = 48.65%
   - However, since Bryan will receive a credit for the corporate tax paid ($42,000), the effective tax rate is reduced to:
        - $97,300 - $42,000 = $55,300 (individual tax on dividends only)
        - Effective tax rate = $55,300 / $200,000 = 27.65%
   - Since the question asks for the effective tax rate including both corporate and individual tax, the final answer is approximately 41.03% (the weighted average of the two tax rates based on their relative amounts).

Question 20

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

Accepted Answer

Some states treat S corporations as taxable corporations for purposes of corporate franchise taxes. This means that S corporations may still need to pay state-level taxes even if they are not subject to federal income tax. The other statements are incorrect. If an S corporation's election terminates, it can continue to operate as a C corporation. The transfer of property to a new partnership in exchange for a partnership interest is generally not a taxable event. The choice between operating as an S corporation and a partnership depends on various factors such as the number of owners, liability protection, and tax implications.

Quiz 12: The Choice of Business Entity