Exam 15: Entities Overview

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?

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Question 1

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Answer to parts a, b, and c: $\begin{array}{|l|r|r|r|l|}\hline & \text { a. No Lease Payment } & \begin{array}{c}\text { b. \$120,000 Lease } \\\text { Deduction }\end{array} & \begin{array}{c}\text { c. } \$ 80,000 \text { Lease } \\\text { Deduction }\end{array} & \text { Description } \\\hline \begin{array}{l}\text { (1) Taxable income } \\\text { before lease } \\\text { payment }\end{array} & \$ 500,000 & \$ 500,000 & \$ 500,000 & \\\hline \text { (2) Lease payment } & 0 & (120,000) & (80,000) & \\\hline \text { (3) Taxable income } & \$ 5 00,000 & \$ 380,000 & \$ 40,000 & (1)-(2) \\\hline \text { (4) Entity tax } & 170,000 & \$ 129,200 & \$ 142,800 & (3) \times 34 \% \\\hline \begin{array}{l}\text { (5) After-tax entity } \\\text { earnings }\end{array} & \$ 330,000 & \$ 250,800 & 277,200 & (3)-(4) \\\hline \begin{array}{c}\text { (6) Ali's tax on } \\\text { dividends }\end{array} & \$ 49,500 & \$ 37,620 & \$ 41,580 & (5) \times 15 \% \\\hline \text { (7) Ali's tax on lease }&0&\$39,600&\$26,400&(2)x33\% \\\text { payment }&&&&\\\hline (8) \text { Combined tax } & \$ 219,500 & \$ 206,420 & 210,780 & (4)+(6)+(7) \\\hline \text { Overall tax rate } & 43.9 \% & 41.28 \% & 42.16 \% & (8)/(1) \\\hline\end{array}$

Entities taxed as partnerships can use special allocations to reward owners based on their responsibilities, contributions, and individual needs.

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Question 2

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Jaron would like to organize TMZ as either an LLC or as a C corporation generating a 6 percent annual before-tax rate of return on a $200,000 investment. Individual and corporate tax rates are both 40 percent and individual capital gains and dividends tax rates are 10 percent. TMZ will distribute its earnings annually to either its members or shareholders. a. Ignoring self-employment taxes (and the additional Medicare Tax), how much would Jaron keep after taxes if TMZ is organized as either an LLC or a C corporation? b. Ignoring self-employment taxes (and the additional Medicare Tax), what are the overall tax rates (combined overall and entity level) if TMZ is organized as either an LLC or as a C corporation?

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Question 3

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Answer to parts a and b: $\begin{array} { | l | r | l | r | l | } \hline \text { a. } & { \text { LLC } } & \text { Description } & { \text { Corp. } } & \text { Description } \\\hline \text { (1) Pretax earnings } & \$ 12,000 & 6 \% \times \$ 200,000 & \$ 12,000 & 6 \% \times \$ 200,000 \\\hline \text { (2) Entity level tax } & - 0- . & & \$ 4,800 & 40 \% \times ( 1 ) \\\hline \begin{array} { c } \text { (3) After-tax entity } \\\text { earnings }\end{array} & \$ 12,000 & ( 1 ) - ( 2 ) & \$ 7,200 & ( 1 ) - ( 2 ) \\\hline \text { (4) Owner tax } & \$ 4,800 & ( 3 ) \times 40 \% & \$ 720 & ( 3 ) \times 10 \% \\\hline \text { (5) After-tax earning } & \$ 7,200 & ( 3 ) - ( 4 ) & \$ 6,480 & ( 3 ) - ( 4 ) \\\hline & & & & \\\hline \text { b. } & \text { LLC } & & \mathbf { C o r p } . & \\\hline \text { Overall tax rate } & 40 \% & ( 4 ) / ( 1 ) & 46 \% & { [ ( 2 ) + ( 4 ) ] / ( 1 ) } \\\hline & & & & \\\hline\end{array}$

On which form is income from a single member LLC with one corporate (C corporation) owner reported?

(Multiple Choice)

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Question 4

An unincorporated entity with more than one owner is, by default, taxed as a partnership.

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Question 5

Which of the following is not an effective strategy for mitigating double taxation in a C corporation?

(Multiple Choice)

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Question 6

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 pre-tax income?

(Multiple Choice)

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Question 7

When an employee/shareholder receives an income allocation from an S corporation, what taxes apply to the income allocation?

(Multiple Choice)

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Question 8

What tax year-end must unincorporated entities with only one owner adopt?

(Multiple Choice)

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Question 9

Both tax and nontax objectives should be considered when choosing an appropriate business entity.

(True/False)

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Question 10

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)

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Question 11

Which legal entity provides the least flexible legal arrangement for owners?

(Multiple Choice)

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Question 12

All unincorporated entities are generally treated as flow-through entities for tax purposes.

(True/False)

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Question 13

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.

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Question 14

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?

(Multiple Choice)

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Question 15

Which of the following entity characteristics are generally key drivers for small business owners in deciding which entity to choose?

(Multiple Choice)

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Question 16

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.

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Question 17

Becca would like to organize BMI as either an LLC or as a C corporation generating a 4 percent annual before-tax rate of return on a $450,000 investment. Individual ordinary rates are 28 percent, corporate rates are 15 percent, and individual capital gains and dividends tax rates are 15 percent. BMI will distribute its earnings annually to either its members or shareholders. a. Ignoring self-employment taxes, how much would Becca keep after taxes if BMI is organized as either a LLC or as a C corporation? b. Ignoring self-employment taxes, what are the overall (combined owner and entity level) tax rates if BMI is organized as either an LLC or as a C corporation?

(Essay)

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Question 18

If PST Corporation is a shareholder of MNO Corporation, how many levels of tax is MNO's pre-tax income potentially exposed to?

(Multiple Choice)

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Question 19

On which tax form do LLCs with more than one owner report their income and losses?

(Multiple Choice)

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Question 20

Entities taxed as partnerships can use special allocations to reward owners based on their responsibilities, contributions, and individual needs.

On which form is income from a single member LLC with one corporate (C corporation) owner reported?

An unincorporated entity with more than one owner is, by default, taxed as a partnership.

Which of the following is not an effective strategy for mitigating double taxation in a C corporation?

When an employee/shareholder receives an income allocation from an S corporation, what taxes apply to the income allocation?

What tax year-end must unincorporated entities with only one owner adopt?

Both tax and nontax objectives should be considered when choosing an appropriate business entity.

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.

Which legal entity provides the least flexible legal arrangement for owners?

All unincorporated entities are generally treated as flow-through entities for tax purposes.

Which of the following entity characteristics are generally key drivers for small business owners in deciding which entity to choose?

If PST Corporation is a shareholder of MNO Corporation, how many levels of tax is MNO's pre-tax income potentially exposed to?

On which tax form do LLCs with more than one owner report their income and losses?

An Introduction to Tax

Tax Compliance, the Irs, and Tax Authorities

Tax Planning Strategies and Related Limitations

Individual Income Tax Overview, Exemptions, and Filing Status

Gross Income and Exclusions

Individual Deductions

Individual Income Tax Computation and Tax Credits

Business Income, Deductions, and Accounting Methods

Property Acquisition and Cost Recovery

Property Dispositions

Investments

Compensation

Retirement Savings and Deferred Compensation

Tax Consequences of Home Ownership

Corporate Operations

Accounting for Income Taxes

Corporate Taxation: Nonliquidating Distributions

Corporate Formation, Reorganization, and Liquidation

Forming and Operating Partnerships

Dispositions of Partnership Interests and Partnership Distributions

S Corporations

State and Local Taxes

The Us Taxation of Multinational Transactions

Transfer Taxes and Wealth Planning of the Cfa Institute

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