Questions and Answers
Which of the following legal entities file documents with the state to be formally recognized by the state?
If an individual forms a sole proprietorship, which nontax factor will be of greatest benefit to the sole proprietor?
Which legal entity is correctly paired with the party that bears the ultimate responsibility for paying the legal entity's liabilities?
Which legal entity provides the least flexible legal arrangement for owners?
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Which legal entity is generally best suited for going public?
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What document must LLCs file with the state to organize their business?
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Which of the following entity characteristics are generally key drivers for small business owners in deciding which entity to choose?
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On which form is income from a single member LLC with one corporate (C corporation) owner reported?
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On which tax form does a single member LLC with one individual owner report its income and losses?
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On which tax form do LLCs with more than one owner generally report their income and losses?
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Which tax classifications can potentially apply to LLCs?
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Generally, which of the following flow-through entities can elect to be treated as a C corporation?
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Which of the following legal entities are generally classified as C corporations for tax purposes?
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If PST Corporation is a shareholder of MNO Corporation, how many levels of tax is MNO's pre-tax income potentially exposed to?
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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?
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If C corporations retain their after-tax earnings, when will their shareholders be taxed on the retained earnings?
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Which of the following is most effective in mitigating the double tax?
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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?
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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 regular 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?
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Which of the following is not an effective strategy for mitigating double taxation in a C corporation?
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Robert is seeking additional capital to expand ABC Inc. In order to qualify ABC as an S corporation, which type of investor group could Robert obtain capital from?
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What tax year-end must unincorporated entities with only one owner adopt?
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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?
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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?
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When an employee/shareholder receives an income allocation from an S corporation, what taxes apply to the income allocation?
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What is the tax impact to a C corporation or an S corporation when it makes a property distribution to a shareholder?
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Assume you plan to start a new enterprise; you know the probability of having losses for the first three years of operations is almost 90 percent, and you know you will report a substantial amount of income from other sources during those same three years. From a tax perspective, which of the following entity choices would be least favorable?
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From a tax perspective, which entity choice is preferred when a liquidating distribution occurs and the entity has assets that have declined in value?
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From a tax perspective, which entity choice is preferred when a liquidating distribution occurs and the entity has appreciated assets?
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If you were seeking an entity with the most favorable tax treatment regarding (1) the number of owners allowed, (2) the flexibility to select your accounting period, and (3) the availability of preferential capital gains rates when selling your ownership interest, which entity should you decide to use?
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Which of the following is not an effective strategy for mitigating the double tax associated with C corporations?
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What is the maximum number of unrelated shareholders a C corporation can have, the maximum number of unrelated shareholders an S corporation can have, and the maximum number of partners a partnership may have?
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Study Notes
Legal Entities and Tax Responsibilities
- Limited Liability Companies (LLCs) must file documents with the state to be recognized legally.
- Sole proprietorships offer minimal time and cost to organize but lack liability protection.
- In an LLC, members are ultimately responsible for liabilities, while corporations are generally liable for their debts.
Tax Forms and Classifications
- Single-member LLCs owned by a corporation report income on Form 1120.
- Single-member LLCs owned by individuals report income on Form 1040, Schedule C.
- LLCs with multiple owners typically report income and losses on Form 1065.
- LLCs can be classified as S corporations, partnerships, or sole proprietorships for tax purposes, offering flexibility regarding taxation.
Corporate Structures and Tax Implications
- C corporations often face double taxation on profits distributed to shareholders; this means tax at both the corporate and personal level on dividends.
- Retained earnings in C corporations are not taxed until shareholders sell shares, unless dividends are issued.
- Losses in C corporations can be carried back two years and carried forward up to twenty years for tax purposes.
S Corporations vs. C Corporations
- S corporations allow income to flow through to shareholders' personal tax returns, unlike C corporations which are subject to double taxation.
- The allocation of income in an S corporation is based on ownership percentages unless otherwise specified.
- S corporations must adhere to restrictions on the number and type of shareholders, typically limited to 100 individuals who are resident and U.S. citizens.
Strategies for Mitigating Double Taxation
- Shifting income from high-tax shareholders to low-tax corporations can help reduce overall tax burden.
- Salaries and benefits can be paid to shareholder-employees as a method to mitigate double taxation in C corporations.
- Making an S election can allow corporations to evade double taxation; however, not all strategies are effective.
Entity Selection Considerations
- When considering potential losses, a C corporation is generally less favorable due to its taxation structure.
- An entity with appreciated assets may see more favorable tax outcomes in liquidating distributions if structured correctly.
- Entities should be chosen based on criteria like number of owners, accounting period flexibility, and capital gains tax treatment for best tax advantages.
Miscellaneous Tax Facts
- Shareholder tax implications are determined by whether distributions are classified as dividends or salary, each subject to different taxes.
- Tax treatment differences exist between partnerships and sole proprietorships, affecting how income and losses are reported and taxed based on ownership structure and entity choice.
- Understanding tax forms and compliance is crucial for strategic tax planning and optimizing business structure for financial benefits.
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Description
Test your knowledge on legal entities and sole proprietorships with these flashcards from TAX 2 Chapter 4. Each card presents a question that explores important concepts in business law and taxation, providing a valuable review tool for students. Challenge yourself to understand the intricacies of these legal structures and their implications.
