Exam 15: Entities Overview

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.

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

Which of the following is most effective in mitigating the double tax?

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.

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

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.

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

Which of the following legal entities are classified as C corporations for tax purposes?

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 after-tax 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.

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

Limited partnerships are legally formed by filing a certificate of limited partnership with the state in which the partnership will be organized.

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?

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

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?

For tax purposes, only unincorporated entities can be considered to be disregarded entities.

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?

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?

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.

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?

Corporations are legally better suited for taking a business public compared with LLCs and general partnerships.