Test bank taxation of individuals and business entities 2015 6e by brian c spilker chap015

Chapter 15 Entities Overview True / False Questions Corporations are legally formed by filing articles of organization with the state in which the corporation will be created True False General partnerships are legally formed by filing a partnership agreement with the state in which the partnership will be formed True False Limited partnerships are legally formed by filing a certificate of limited partnership with the state in which the partnership will be organized True False Sole proprietorships are not treated as legal entities separate from their individual owners True False S corporation shareholders are legally responsible for paying the S corporation's debts because S corporations are treated as flow-through entities for tax purposes True False LLC members have more flexibility than corporate shareholders to alter their legal arrangements with respect to one another, the entity, and with outsiders True False Corporations are legally better suited for taking a business public compared with LLCs and general partnerships True False Both tax and nontax objectives should be considered when choosing an appropriate business entity True False 15-1 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Tax rules require that entities be classified the same way for tax purposes as they are classified for legal purposes True False 10 C corporations and S corporations are separate taxpaying entities that pay tax on their own income True False 11 All unincorporated entities are generally treated as flow-through entities for tax purposes True False 12 In certain circumstances, C corporations can elect to be treated as flow-through entities True False 13 An unincorporated entity with more than one owner is, by default, taxed as a partnership True False 14 A single-member LLC is taxed as a partnership True False 15 For tax purposes, only unincorporated entities can be considered to be disregarded entities True False 16 Unincorporated entities with only one individual owner are taxed as sole proprietorships True False 17 S corporations have more restrictive ownership requirements than other entities True False 18 Entities taxed as partnerships can use special allocations to reward owners based on their responsibilities, contributions, and individual needs True False 19 Sole proprietors are subject to self-employment taxes on net income from their sole proprietorships True False 15-2 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 20 Shareholders of C corporations receiving property distributions must recognize dividend income equal to the fair market value of the distributed property if the distributing corporation has sufficient earnings and profits True False 21 Losses from C corporations are never available to offset a shareholder's personal income True False Multiple Choice Questions 22 Which of the following legal entities file documents with the state to be formally recognized by the state? A Limited Liability Company B General Partnership C Sole Proprietorship D None of these 23 If an individual forms a sole proprietorship, which nontax factor will be of greatest benefit to the sole proprietor? A Liability protection B Legal flexibility in defining rights and responsibilities of owners C Facilitates initial public offerings D Minimal time and cost to organize 15-3 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 24 Which legal entity is correctly paired with the party that bears the ultimate responsibility for paying the legal entity's liabilities? A LLC - LLC members B Corporation Corporation C General Partnership Partnership D Limited Partnership - General partner E Both Corporation - Corporation and Limited Partnership - General partner 25 Which legal entity provides the least flexible legal arrangement for owners? A Corporati on B LLC C Partnershi p D Sole Proprietorship 26 Which legal entity is generally best suited for going public? A Corporati on B LLC C Limited Liability Partnership D General Partnership E All of these entities are equally suited for going public 27 What document must LLCs file with the state to organize their business? A Articles of incorporation B Certificate of LLC C Articles of organization D Partnership agreement E None of these LLCs not have to file with the state to organize their business 15-4 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 28 Which of the following entity characteristics are generally key drivers for small business owners in deciding which entity to choose? A Double taxation B Required accounting period C Liability protection D Double taxation and required accounting period E Double taxation and liability protection 29 On which form is income from a single member LLC with one corporate (C corporation) owner reported? A Form 1120 used by C corporations to report their income B Form 1120S used by S corporations to report their income C Form 1065 used by partnerships to report their income D Form 1040, Schedule C used by sole proprietorships to report their income E None of these 30 On which tax form does a single member LLCs with one individual owner report its income and losses? A Form 1120 B Form 1120S C Form 1065 D Form 1040, Schedule C 15-5 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 31 On which tax form LLCs with more than one owner report their income and losses? A Form 1120 B Form 1120S C Form 1065 D Form 1040, Schedule C 32 Which tax classifications can potentially apply to LLCs? A S corporation B Partnershi p C Sole proprietorship D S corporation and Partnership E S corporation and Sole proprietorship F Partnership and Sole proprietorship G All of these 33 Generally, which of the following flow-through entities can elect to be treated as a C corporation? A Limited partnership B Limited Liability Company C General partnership D All of these 15-6 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 34 Which of the following legal entities are classified as C corporations for tax purposes? A Limited Liability Company B S corporations C Limited partnerships D Sole proprietorship E None of these 35 If PST Corporation is a shareholder of MNO Corporation, how many levels of tax is MNO's pre-tax income potentially exposed to? A No taxation B Single taxation C Double taxation D Triple taxation 36 Crocker and Company, Inc had taxable income of $550,000 At the end of the year, it distributes all its after-tax earnings to Jimmy, the company's sole shareholder Jimmy's marginal ordinary tax rate is 34 percent and his marginal tax rate on dividends is 15 percent What is the overall tax rate on Crocker and Company's pretax income? A 9.9 % B 15.0 % C 35.0 % D 43.9 % E 66.7 % 15-7 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 37 If C corporations retain their after-tax earnings, when will their shareholders be taxed on the retained earnings? A Shareholders will be taxed when they sell their shares at a gain B Shareholders will be taxed in the year they elect to be taxed on undistributed retained earnings C Shareholders will be taxed on undistributed retained earnings in the year the corporation files its tax return D None of these 38 Which of the following is most effective in mitigating the double tax? A Shift income from high tax rate shareholders to low tax rate corporations B Shift income from low tax rate shareholders to high tax rate corporations C Shift income from high tax rate corporations to low tax rate shareholders D Shift income from low tax rate corporations to high tax rate shareholders 39 While a C corporation's losses cannot be used by their shareholders to offset personal income, a C corporation may carry back and carry forward losses to help offset the taxable income a corporation had or will have How are these net operating losses carried back and carried forward? A Carried back two years, carried forward indefinitely B Carried back indefinitely, carried forward two years C Carried back two years, carried forward five years D Carried back two years, carried forward twenty years E None of these 15-8 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 40 Logan, a 50 percent shareholder in Military Gear Inc., is comparing the tax consequences of losses from C corporations with losses from S corporations Assume Military Gear Inc has a $100,000 loss for the year, Logan's tax basis in his Military Gear Inc stock was $150,000 at the beginning of the year, and he received $75,000 ordinary income from other sources during the year Assuming Logan's marginal income tax rate is 15%, how much more tax will Logan pay currently if Military Gear Inc is a C corporation compared to the tax he would pay if it were an S corporation? A $ B $3,75 C $7,50 D $11,25 41 Which of the following is not an effective strategy for mitigating double taxation in a C corporation? A C corporations can shift income to shareholders via deductible payments B C corporations can make an S election C C corporations can pay dividends to their shareholders D None of these All of these statements are effective strategies to mitigate or avoid double taxation 42 Robert is seeking additional capital to expand ABC Inc In order to qualify ABC as an S corporation, which type of investor group should Robert obtain capital from? A 30 different partnerships B 10 different C corporations C 90 nonresident individuals D 120 unrelated resident individuals E None of these 15-9 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 43 What tax year-end must unincorporated entities with only one owner adopt? A The entity is free to adopt any tax year-end B The entity must adopt the same year-end as its owner C The entity must adopt a calendar year-end D The entity may adopt any year-end except for a calendar year-end 44 Roberto and Reagan are both 25 percent owner/managers for Bright Light Inc Roberto runs the retail store in Sacramento, CA, and Reagan runs the retail store in San Francisco, CA Bright Light Inc generated a $125,000 profit companywide made up of a $75,000 profit from the Sacramento store, a ($25,000) loss from the San Francisco store, and a combined $75,000 profit from the remaining stores If Bright Light Inc is an S corporation, how much income will be allocated to Roberto? A $31,25 B $62,50 C $75,00 D $125,00 45 Roberto and Reagan are both 25 percent owner/managers for Bright Light Enterprises Roberto runs the retail store in Sacramento, CA, and Reagan runs the retail store in San Francisco, CA Bright Light generated a $125,000 profit companywide made up of a $75,000 profit from the Sacramento store, a ($25,000) loss from the San Francisco store, and a combined $75,000 profit from the remaining stores If Bright Light is taxed as a partnership and decides that Roberto and Reagan will be allocated 70 percent of his own store's profit with the remaining profits allocated pro rata among all the owners, how much income will be allocated to Reagan? A ($25,00 0) B ($17,50 0) C $5,00 D $20,00 15-10 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 60 SNL corporation, a C corporation, reports $400,000 of taxable income in the current year SNL's tax rate is 35 percent Answer the following questions, assuming Keegan, SNL's sole shareholder, has a marginal tax rate of 39.6 percent on ordinary income and 20 percent on dividend income a Compute the first level of tax on SNL's taxable income for the year b Compute the second level of tax on SNL's income assuming that SNL currently distributes all of its after-tax earnings to Keegan What is the overall (combined owner and entity level) tax rate on SNL's taxable income for the year? Answer to parts a and b: AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types Level of Difficulty: Easy Topic: Entity tax characteristics 15-52 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 61 In the current year, DNS (a C corporation) had taxable income of $600,000 and distributed all of its after-tax earnings to Daniel, its sole shareholder DNS's tax rate is 38 percent Assuming Daniels's marginal tax rate on ordinary income is 28 percent and his dividend rate is 15 percent, what is the overall tax rate (combined corporate level and shareholder level) on DNS's $600,000 of taxable income? AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types Level of Difficulty: Easy Topic: Entity tax characteristics 62 In its first year of existence, BYC Corporation (a C corporation) reported a loss for tax purposes of ($40,000) How much tax will BYC pay in year if it reports taxable income from operations of $35,000 in year before any loss carryovers? None BYC's loss in year of ($40,000) will be available to offset income generated by BYC in year Since BYC earned $35,000 of taxable income in year before any loss carryovers, it can use ($35,000) of the loss carryover from year to offset its entire taxable income BYC will have a ($5,000) loss carryover available for year and beyond AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types Level of Difficulty: Easy Topic: Entity tax characteristics 15-53 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 63 In its first year of existence Aspen Corp (a C corporation) reported a loss for tax purposes of $50,000 In year 2, it reports a $30,000 loss For year 3, it reports taxable income from operations of $120,000 How much tax will Aspen Corp pay for year 3? Consult the corporate tax rate table provided to calculate your answer AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types Level of Difficulty: Medium Topic: Entity tax characteristics 15-54 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 64 For the current year, Creative Designs Inc., a C corporation, reports taxable income of $300,000 before paying salary to Ben the sole shareholder of Creative Designs Inc (CD) Ben's marginal tax rate on ordinary income is 28 percent and 15 percent on dividend income Assume CD's tax rate is 39 percent a How much total income tax will Creative Designs and Ben pay on the $300,000 taxable income for the year if CD doesn't pay any salary to Ben and instead distributes all of its after-tax income to Ben as a dividend? b How much total income tax will Creative Designs and Ben pay on the $300,000 of income if CD pays Ben a salary of $100,000 and distributes its remaining aftertax earnings to Ben as a dividend? c Compare your answer in part a with your answer to part b Explain why these numbers are different Answer parts a and b: Part a: $144,450 total taxes Part b: $124,300 total taxes Answer to part c: The combined taxes are lower under part b because $100,000 of the corporation's earnings is only subject to one level of tax (the individual tax on the salary) Conversely, total taxes paid are greater in part a than in part b because a greater share of corporate pre-tax earnings is subject to the double tax AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types Level of Difficulty: Hard Topic: Entity tax characteristics 15-55 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 65 For the current year, Birch Corporation, a C corporation, reports taxable income of $400,000 before paying salary to its sole shareholder Elaine Elaine's marginal tax rate on ordinary income is 33 percent and 15 percent on dividend income If Birch pays Elaine a salary of $200,000 but the IRS determines that Elaine's salary in excess of $100,000 is unreasonable compensation, what is the overall income tax rate on Birch's $400,000 pre-salary income? Assume Birch's tax rate is 35 percent and it always distributes all after-tax earnings to Elaine Feedback: In calculating the double-tax on Birch Corp's pre-salary taxable income, the $100,000 amount the IRS will allow Birch to deduct is taken into account rather than the $200,000 amount it would prefer to deduct AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types Level of Difficulty: Medium Topic: Entity tax characteristics 15-56 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 15-57 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 66 Cali Corp (a C corporation) projects that it will have taxable income of $250,000 for the year before paying any fringe benefits Stacey, Cali's sole shareholder, has a marginal tax rate of 33 percent on ordinary income and 15 percent on dividend income Assume Cali's tax rate is 34 percent a What is the amount of the combined corporate and shareholder level income tax on Cali's $250,000 of pre-benefit income if Cali Corp does not pay out any fringe benefits and distributes all of its after-tax earnings to Stacey? b What is the amount of the combined corporate and shareholder level income tax on Cali's $250,000 of pre-benefit income if Cali Corp pays Stacey's adoption expenses of $50,000 and the payment is considered to be a qualified fringe benefit? Cali Corp distributes all of its after-tax earnings to Stacey c What is the amount of the combined corporate and shareholder level income tax on Cali's $250,000 of pre-benefit income if Cali Corp pays Stacey's adoption expenses of $50,000 and the payment is considered to be a nonqualified fringe benefit? Cali Corp distributes all of its after-tax earnings to Stacey Answer to parts a and b: Stacey is not taxed on the $50,000 payout of adoption expenses because this is considered a qualified fringe benefit Answer to part c: 15-58 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types Level of Difficulty: Hard Topic: Entity tax characteristics 15-59 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 67 Jamal Corporation, a C corporation, projects that it will have taxable income of $500,000 before incurring any lease expenses Jamal's tax rate is 34 percent Ali, Jamal's sole shareholder, has a marginal tax rate of 33 percent on ordinary income and 15 percent on dividend income Jamal always distributes all of its after-tax earnings to Ali a What is the amount of the combined corporate and shareholder level tax on Jamal Corp.'s $500,000 pre-lease expense income if Jamal Corp distributes all of its after-tax earnings to its sole shareholder Ali? b What is the amount of the combined corporate and shareholder level tax on Jamal Corp.'s $500,000 pre-lease expense income if Jamal leases equipment from Ali at a cost of $120,000 for the year? c What is the amount of the combined corporate and shareholder level tax on Jamal Corp.'s $500,000 pre-lease expense income if Jamal Corp leases equipment from Ali at a cost of $120,000 for the year but the IRS determines that the fair market value of the lease payments is $80,000? Answer to parts a, b, and c: AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types Level of Difficulty: Medium Topic: Entity tax characteristics 15-60 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 68 Tuttle Corporation (a C corporation) projects that it will have taxable income for the year of $300,000 before incurring any interest expense Assume Tuttle's tax rate is 35 percent a What is the amount of the combined corporate and shareholder level tax on the $300,000 of pre-interest expense earnings if Ruth, Tuttle's sole shareholder, lends Tuttle Corporation $100,000 at the beginning of the year, Tuttle pays Ruth $10,000 of interest on the loan (interest is considered to be reasonable), and Tuttle distributes all of its after-tax earnings to Ruth? Assume her ordinary marginal rate is 33 percent and dividend tax rate is 15 percent b Assume the same facts as in part a except that the IRS determines that the fair market value of the interest should be $8,000 What is the amount of the combined corporate and shareholder level tax on Tuttle Corporation's pre-interest expense earnings? Answer to parts a and b: AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types Level of Difficulty: Medium Topic: Entity tax characteristics 15-61 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 69 Nancy purchased a building and then leased the building to ZML Nancy is the sole shareholder of ZML She leased the building to ZML for $2,500 per month However, the IRS determined that the fair market value of the lease payment should only be $1,500 per month How would the lease payment be treated with respect to both Nancy and ZML? Of the total $2,500 lease payment to Nancy, $1,500 would be treated as a deductible rent expense to ZML and as ordinary income to Nancy The remaining $1,000 would be treated as a non-deductible dividend to ZML and a taxable dividend to Nancy AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types Level of Difficulty: Medium Topic: Entity tax characteristics 70 Rodger owns 100% of the shares in Trevor Inc., a C corporation Assume the following for the current year: Given these assumptions, how much cash does Rodger have from the dividend after all taxes have been paid? AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types 15-62 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education Level of Difficulty: Easy Topic: Entity tax characteristics 15-63 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 15-64 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education 71 Corporation A owns 10% of Corporation C The marginal tax rate on non-dividend income for both A and C is 34% Corporation C earns a total of $200 million before taxes in the current year, pays corporate tax on this income and distributes the remainder proportionately to its shareholders as a dividend In addition, Corporation A owns 20% of partnership P that earns $500 million in the current year Given this fact pattern, answer the following questions: a How much cash from the Corporation C dividend remains after Corporation A pays the tax on the dividend assuming Corporation A is eligible for the 70 percent dividends received deduction? b If partnership P distributes all of its current year earnings in proportion to the partner's ownership percentages, how much cash from Partnership P does Corporation A have after paying taxes on its share of income from the partnership? c If you were to replace corporation A with individual A (her marginal tax rate on ordinary income is 28% and on qualified dividends is 15%) in the original fact pattern above, how much cash does individual A have from the Corporation C dividend after all taxes assuming the dividends are qualified dividends? Consistent with the original facts, assume that Corporation C distributes all of its after-tax income to its shareholders Answer to part a: Answer to part b: Answer to part c: 15-65 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education AACSB: Reflective Thinking AICPA: BB Critical Thinking Blooms: Apply Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types Level of Difficulty: Medium Topic: Entity tax characteristics 15-66 Copyright © 2015 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education ... Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities Level of Difficulty: Easy Topic: Entity legal classification and nontax characteristics 15-24 Copyright... Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities Level of Difficulty: Medium Topic: Entity legal classification and nontax characteristics LLC... Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities Level of Difficulty: Easy Topic: Entity legal classification and nontax characteristics Corporations