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Chapter 15
Entities Overview
True / False Questions
1. Corporations are legally formed by filing articles of organization with the state in which the
corporation will be created.
True False
2. General partnerships are legally formed by filing a partnership agreement with the state in which
the partnership will be formed.
True False
3. Limited partnerships are legally formed by filing a certificate of limited partnership with the state in
which the partnership will be organized.
True False
4. Sole proprietorships are not treated as legal entities separate from their individual owners.
True False
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5. 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
6. 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
7. Corporations are legally better suited for taking a business public compared with LLCs and general
partnerships.
True False
8. Both tax and nontax objectives should be considered when choosing an appropriate business
entity.
True False
9. 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
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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
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19. Sole proprietors are subject to self-employment taxes on net income from their sole
proprietorships.
True False
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
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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
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. Corporation
B. LLC
C. Partnership
D. Sole Proprietorship
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26. Which legal entity is generally best suited for going public?
A. Corporation
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 do not have to file with the state to organize their business.
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
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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
31. On which tax form do 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
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32. Which tax classifications can potentially apply to LLCs?
A. S corporation
B. Partnership
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.
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
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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 pre-tax income?
A. 9.9%
B. 15.0%
C. 35.0%
D. 43.9%
E. 66.7%
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
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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.
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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. $0
B. $3,750
C. $7,500
D. $11,250
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.
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42. 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?
A. 30 different partnerships
B. 10 different C corporations
C. 90 nonresident individuals
D. 120 unrelated resident individuals
E. None of these.
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. $31,250
B. $62,500
C. $75,000
D. $125,000
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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. ($25,000)
B. ($17,500)
C. $5,000
D. $20,000
46. When an employee/shareholder receives an income allocation from an S corporation, what taxes
apply to the income allocation?
A. FICA tax only.
B. Self-employment tax only.
C. FICA and self-employment tax.
D. None of these. This income will never be taxed.
E. None of these. This income will be taxed, but another type of tax will apply.
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47. What is the tax impact to a C corporation or an S corporation when it makes a property
distribution to a shareholder?
A. Recognizes either gain or loss
B. Does not recognize gain or loss
C. Recognizes gain but not loss
D. Recognizes loss only
48. 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?
A. C corporation
B. LLC
C. General partnership
D. S corporation
49. From a tax perspective, which entity choice is preferred when a liquidating distribution occurs and
the entity has assets that have declined in value?
A. Partnership
B. S corporation
C. LLC
D. Partnership and S corporation
E. S corporation and LLC
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50. From a tax perspective, which entity choice is preferred when a liquidating distribution occurs and
the entity has appreciated assets?
A. Partnership
B. S corporation
C. LLC
D. Partnership and LLC
E. S corporation and LLC
51. 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?
A. C corporation
B. S corporation
C. Partnership
D. Sole proprietorship
52. Which of the following is not an effective strategy for mitigating the double tax associated with C
corporations?
A. Paying a salary to a shareholder-employee
B. Leasing property from a shareholder
C. Borrowing money from a shareholder
D. Paying fringe benefits to a shareholder-employee
E. All of these are effective strategies for mitigating double taxation
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53. 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?
A. 100; no limit; no limit
B. no limit; 100; 2
C. no limit; 100; no limit
D. 100; 100; no limit
Essay Questions
54. David would like to organize HOS as either an LLC or as a corporation generating a 12 percent
annual before-tax return on a $300,000 investment. Individual and corporate tax rates are both 30
percent and individual capital gains and dividend tax rates are 15 percent. HOS will pay out its
after-tax earnings every year to either its members or its shareholders.
a. Ignoring self-employment taxes, how much would David keep after taxes if HOS is organized as
either an LLC or a corporation?
b. Ignoring self-employment taxes, what are the overall tax rates (combined owner and entity
level) if HOS is organized as either an LLC or a corporation?
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55. 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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56. Emmy would like to organize PRK as either an LLC or as a C corporation generating a 15 percent
annual before-tax rate of return on a $100,000 investment. Individual ordinary rates are 25 percent,
corporate rates are 15 percent, and individual capital gains and dividends tax rates are 5 percent.
PRK will distribute its earnings annually to either its members or shareholders.
a. Ignoring self-employment taxes, how much would Emmy keep after taxes if PRK is organized as
either an LLC or as a C corporation?
b. Ignoring self-employment taxes, what are the overall tax rates (combined entity and owner
level) if PRK is organized as either an LLC or a corporation?
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57. Jerry would like to organize FBC as either an LLC or as a C corporation generating an 8 percent
annual before-tax rate of return on a $400,000 investment. Individual and corporate tax rates are
both 35 percent and individual capital gains and dividends tax rates are 15 percent. FBC will pay
out its after-tax earnings every year to either its members or its shareholders.
a. How much would Jerry keep after taxes if FBC is organized as either an LLC or as a C
corporation (ignore self-employment taxes)?
b. Ignoring self-employment taxes, what are the overall tax rates (combined owner and entity
level) tax rates if FBC is organized as either an LLC or as a C corporation?
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58. Taylor would like to organize DRK as either an LLC or as a C corporation generating a 13 percent
annual before-tax rate of return on a $250,000 investment. Individual and corporate tax rates are
both 30 percent and individual capital gains and dividends tax rates are 5 percent. DRK will
distribute its earnings annually to either its members or shareholders.
a. Ignoring self-employment taxes, how much would Taylor keep after taxes if DRK is organized as
either an LLC or as a C corporation?
b. Ignoring self-employment taxes, what are the overall (combined owner and entity level) tax
rates if DRK is organized as either an LLC or as a C corporation?
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59. 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?
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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?
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 (he is not
subject to the net investment income tax), what is the overall tax rate (combined corporate level
and shareholder level) on DNS's $600,000 of taxable income?
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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 2 if it reports taxable income from operations of
$35,000 in year 2 before any loss carryovers?
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.
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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 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.
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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.
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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.
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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 (ignore the 3.8% net investment income tax)?
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 (ignore the 3.8% net investment income tax)?
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
(ignore the 3.8% net investment income tax)?
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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?
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?
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70. Rodger owns 100% of the shares in Trevor Inc., a C corporation. Assume the following for the
current year:
Trevor Inc.’s pre-tax income = $16,000
Trevor Corp’s marginal tax rate = 35%
Percentage of after-tax earnings retained
by Trevor Corp = 0% (i.e. all after-tax
earnings distributed)
Rodger’s dividend tax rate = 5%
Given these assumptions, how much cash does Rodger have from the dividend after all taxes have
been paid?
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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% (the net investment tax does not apply)] 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.
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Chapter 15 Entities Overview Answer Key
True / False Questions
1. Corporations are legally formed by filing articles of organization with the state in which the
corporation will be created.
FALSE
Corporations file articles of incorporation.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 2 Medium
Topic: Entity Legal Classification and Nontax Characteristics
2. General partnerships are legally formed by filing a partnership agreement with the state in
which the partnership will be formed.
FALSE
General partnerships may be formed by written agreement among the partners, called a
partnership agreement, or may be formed informally without a written agreement when two or
more owners join together in an activity to generate profits.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
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Accessibility: Keyboard Navigation
Blooms: Understand
Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 2 Medium
Topic: Entity Legal Classification and Nontax Characteristics
3. Limited partnerships are legally formed by filing a certificate of limited partnership with the
state in which the partnership will be organized.
TRUE
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 1 Easy
Topic: Entity Legal Classification and Nontax Characteristics
4. Sole proprietorships are not treated as legal entities separate from their individual owners.
TRUE
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 1 Easy
Topic: Entity Legal Classification and Nontax Characteristics
5. 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.
FALSE
AACSB: Reflective Thinking
15-33
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Blooms: Understand
Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 2 Medium
Topic: Entity Legal Classification and Nontax Characteristics
6. LLC members have more flexibility than corporate shareholders to alter their legal
arrangements with respect to one another, the entity, and with outsiders.
TRUE
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Blooms: Remember
Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 1 Easy
Topic: Entity Legal Classification and Nontax Characteristics
7. Corporations are legally better suited for taking a business public compared with LLCs and
general partnerships.
TRUE
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Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 1 Easy
Topic: Entity Legal Classification and Nontax Characteristics
15-34
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8. Both tax and nontax objectives should be considered when choosing an appropriate business
entity.
TRUE
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Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 2 Medium
Topic: Entity Legal Classification and Nontax Characteristics
9. Tax rules require that entities be classified the same way for tax purposes as they are classified
for legal purposes.
FALSE
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Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 1 Easy
Topic: Entity Tax Classification
10. C corporations and S corporations are separate taxpaying entities that pay tax on their own
income.
FALSE
S corporations are flow-through entities whose income "flows through" to their owners who are
responsible for paying tax on the income.
AACSB: Reflective Thinking
15-35
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Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
11. All unincorporated entities are generally treated as flow-through entities for tax purposes.
TRUE
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Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
12. In certain circumstances, C corporations can elect to be treated as flow-through entities.
TRUE
An S-Corporation election achieves this purpose.
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Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
15-36
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13. An unincorporated entity with more than one owner is, by default, taxed as a partnership.
TRUE
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Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 1 Easy
Topic: Entity Tax Classification
14. A single-member LLC is taxed as a partnership.
FALSE
Single-member LLCs are taxed as sole proprietorships.
AACSB: Reflective Thinking
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Blooms: Understand
Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
15. For tax purposes, only unincorporated entities can be considered to be disregarded entities.
TRUE
If an entity is incorporated it is a corporate entity for tax purposes and cannot be a disregarded
entity.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
15-37
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Blooms: Understand
Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
16. Unincorporated entities with only one individual owner are taxed as sole proprietorships.
TRUE
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Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
17. S corporations have more restrictive ownership requirements than other entities.
TRUE
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Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
18. Entities taxed as partnerships can use special allocations to reward owners based on their
responsibilities, contributions, and individual needs.
TRUE
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
15-38
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Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
19. Sole proprietors are subject to self-employment taxes on net income from their sole
proprietorships.
TRUE
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Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
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
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Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-39
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21. Losses from C corporations are never available to offset a shareholder's personal income.
TRUE
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Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 1 Easy
Topic: Entity Tax Characteristics
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
LLCs file articles of organization with the state to receive formal recognition from the state, but
general partnerships typically don't file their partnership agreements. Because sole
proprietorships are not treated as legal entities separate from their owners, sole proprietors
don't need to do anything to receive legal recognition from the state.
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15-40
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Blooms: Understand
Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 2 Medium
Topic: Entity Legal Classification and Nontax Characteristics
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
While a sole proprietorship can be organized with minimal time and cost, sole proprietorships
don't provide a shield for the individual owner. Legal flexibility to define the rights and
responsibilities of owners and the ability to go public are irrelevant because they are not
characteristics that pertain to sole proprietorships.
AACSB: Reflective Thinking
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Blooms: Understand
Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 2 Medium
Topic: Entity Legal Classification and Nontax Characteristics
15-41
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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.
Corporations and LLCs, rather than their owners, are responsible for their debts. General
partners are responsible for debts of general and limited partnerships.
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Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 2 Medium
Topic: Entity Legal Classification and Nontax Characteristics
25. Which legal entity provides the least flexible legal arrangement for owners?
A. Corporation
B. LLC
C. Partnership
D. Sole Proprietorship
State partnership and LLC statutes provide members and partners with a great deal of flexibility.
In contrast, corporate governance rules limit the flexibility of shareholders.
AACSB: Reflective Thinking
15-42
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Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 1 Easy
Topic: Entity Legal Classification and Nontax Characteristics
26. Which legal entity is generally best suited for going public?
A. Corporation
B. LLC
C. Limited Liability Partnership
D. General Partnership
E. All of these entities are equally suited for going public.
Corporations have the governance structure to successfully achieve an initial public offering.
The other entities would have to restructure to make this possible.
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Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 1 Easy
Topic: Entity Legal Classification and Nontax Characteristics
15-43
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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 do not have to file with the state to organize their business.
LLCs must file articles of organization with the state the LLC desires to organize its business in.
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Blooms: Understand
Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Level of Difficulty: 2 Medium
Topic: Entity Legal Classification and Nontax Characteristics
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
While each circumstance is different, small business owners typically seek liability protection
while avoiding double taxation.
AACSB: Reflective Thinking
15-44
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Blooms: Understand
Learning Objective: 15-01 Discuss the legal and nontax characteristics of different types of legal entities.
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 1 Easy
Topic: Entity Legal Classification and Nontax Characteristics
Topic: Entity Tax Characteristics
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.
A single member LLC with one corporate owner is considered to be a disregarded entity. In
essence, the entity is treated like a division of its parent company. Thus, its income will be
reported on the Form 1120 of its parent corporation.
AACSB: Reflective Thinking
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Blooms: Apply
Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 3 Hard
Topic: Entity Tax Classification
15-45
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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
Single member LLCs, with one individual owner, follow the same filing guidelines as sole
proprietorships. Thus, their income is reported on Form 1040, Schedule C.
AACSB: Reflective Thinking
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Blooms: Understand
Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
31. On which tax form do 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
LLCs with more than one owner are taxed as partnerships and report their income on Form
1065.
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15-46
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Blooms: Understand
Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
32. Which tax classifications can potentially apply to LLCs?
A. S corporation
B. Partnership
C. Sole proprietorship
D. S corporation and Partnership
E. S corporation and Sole proprietorship
F. Partnership and Sole proprietorship
G. All of these
LLCs can elect to be taxed as corporations and then make an S election if they satisfy the
requirements for number and type of shareholder. The default tax status for LLCs with more
than one member is partnership, and the default tax status for single-member LLCs with an
individual owner is sole proprietorship.
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Blooms: Understand
Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
15-47
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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.
Owners of unincorporated entities may elect to have them treated as C corporations.
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Blooms: Understand
Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
15-48
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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
Limited liability companies and limited partnerships are generally taxed as partnerships. S
corporations are taxed under a separate set of rules applicable to S corporations (an S
corporation is not a legal entity). Sole proprietorships are not taxed separately from their
owners.
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Blooms: Understand
Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
15-49
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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
MNO will have to pay taxes on the amount of pre-tax income it earns. Then, if MNO pays a
dividend to PST, the income will be taxed a second time. If PST pays a dividend to its
shareholders, the income will be taxed a third time.
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Learning Objective: 15-02 Describe the different types of entities for tax purposes.
Level of Difficulty: 2 Medium
Topic: Entity Tax Classification
15-50
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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 pre-tax income?
A. 9.9%
B. 15.0%
C. 35.0%
D. 43.9%
E. 66.7%
Crocker and Company pays taxes of $187,000 ($550,000 × .34). Therefore $363,000 ($550,000 -
$187,000) will be distributed to the shareholder as a dividend. The shareholder pays taxes of
$54,450 ($363,000 × .15). The total taxes paid on Crocker and Company's pre-tax income are
$241,450 ($187,000 + $54,450), and the overall tax rate will be 43.9 percent
($241,450/$550,000).
AACSB: Analytical Thinking
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Blooms: Analyze
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 3 Hard
Topic: Entity Tax Characteristics
15-51
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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
Corporate shareholders generally pay taxes on corporate earnings when they sell their shares
or when they receive dividends.
AACSB: Reflective Thinking
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Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-52
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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
When income is shifted from a high tax rate corporation to a low rate shareholder, the double
tax is avoided and the income is taxed at a lower rate.
AACSB: Reflective Thinking
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Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-53
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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.
A C corporation may carry back an NOL two years and carry forward an NOL 20 years.
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Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 1 Easy
Topic: Entity Tax Characteristics
15-54
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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. $0
B. $3,750
C. $7,500
D. $11,250
Logan would pay $11,250 in taxes if Military Gear Inc. is a C corporation ($75,000 × 15 percent).
If it were an S corporation, he would have to pay $3,750 in taxes [($75,000 - $50,000) × 15
percent]. Thus, he has to pay $7,500 more in taxes ($11,250 - $3,750) currently if Military Gear,
Inc. is a C corporation.
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Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-55
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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.
Paying dividends actually triggers the double tax rather than avoid it.
AACSB: Reflective Thinking
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Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-56
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42. 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?
A. 30 different partnerships
B. 10 different C corporations
C. 90 nonresident individuals
D. 120 unrelated resident individuals
E. None of these.
S corporations have strict rules regarding the number and type of owners they may have. An S
corporation cannot have more than 100 unrelated shareholders. Furthermore, shareholders may
not be corporations, partnerships, nonresident aliens, or certain types of trusts.
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Blooms: Remember
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 1 Easy
Topic: Entity Tax Characteristics
15-57
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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
Owners of unincorporated entities can be either individuals or corporations. In either case, the
tax year-end of the entity must match the tax year-end of the owner.
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Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-58
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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. $31,250
B. $62,500
C. $75,000
D. $125,000
S corporations may not specially allocate income to shareholders; thus, the $125,000
companywide profit must be allocated to Roberto based on his ownership percentage in Bright
Light, Inc. Roberto would receive 25 percent of the total profits, or $31,250 ($125,000 × .25).
AACSB: Analytical Thinking
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Blooms: Analyze
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-59
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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. ($25,000)
B. ($17,500)
C. $5,000
D. $20,000
Because Bright Lights Enterprises is a partnership, the special allocation described is permissible.
Reagan would receive 70 percent of the loss from his store, or ($17,500) ($25,000 × 70 percent).
Additionally, Reagan will receive 25 percent of the remaining profits not specially allocated, or
$22,500 [.25 × (125,000 + 17,500 - ($75,000 × .7))] Thus, Reagan will be allocated a total of
$5,000 of income.
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Blooms: Analyze
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 3 Hard
Topic: Entity Tax Characteristics
15-60
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46. When an employee/shareholder receives an income allocation from an S corporation, what
taxes apply to the income allocation?
A. FICA tax only.
B. Self-employment tax only.
C. FICA and self-employment tax.
D. None of these. This income will never be taxed.
E. None of these. This income will be taxed, but another type of tax will apply.
An S corporation employee/shareholder must pay FICA tax on any salary received from an S
corporation; however, any S corporation ordinary business income allocated to them is not
subject to either FICA or self-employment tax. Rather, it will only be subject to the marginal
ordinary income tax rate of the shareholder.
AACSB: Reflective Thinking
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Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-61
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47. What is the tax impact to a C corporation or an S corporation when it makes a property
distribution to a shareholder?
A. Recognizes either gain or loss
B. Does not recognize gain or loss
C. Recognizes gain but not loss
D. Recognizes loss only
Gains must be recognized on distributed appreciated property for both taxable corporations
and S corporations. However, losses are not allowed if the distributed property has depreciated
in value.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-62
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48. 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?
A. C corporation
B. LLC
C. General partnership
D. S corporation
A C corporation is the least favorable entity choice because the losses from the first three years
of operations will not flow-through to you and be available to offset income from other
sources.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-63
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49. From a tax perspective, which entity choice is preferred when a liquidating distribution occurs
and the entity has assets that have declined in value?
A. Partnership
B. S corporation
C. LLC
D. Partnership and S corporation
E. S corporation and LLC
When assets that have declined in value are distributed in liquidation, S corporations may
immediately deduct losses from the assets whereas these losses are typically deferred if the
distributing entity is taxed as a partnership.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-64
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50. From a tax perspective, which entity choice is preferred when a liquidating distribution occurs
and the entity has appreciated assets?
A. Partnership
B. S corporation
C. LLC
D. Partnership and LLC
E. S corporation and LLC
Partnerships and their owners generally don't recognize any gain during a liquidating
distribution. Conversely, S corporations and their shareholders must recognize gain when
appreciated assets are distributed in a liquidating distribution.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-65
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51. 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?
A. C corporation
B. S corporation
C. Partnership
D. Sole proprietorship
These three tax considerations are most favorable for a company that chooses to be taxed as a
taxable corporation. There is no limit to the number of owners allowed, no restrictions on what
accounting period to use, and all of the gains from selling shares in a C corporation are capital
gains.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Accessibility: Keyboard Navigation
Blooms: Understand
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
15-66
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52. Which of the following is not an effective strategy for mitigating the double tax associated with
C corporations?
A. Paying a salary to a shareholder-employee
B. Leasing property from a shareholder
C. Borrowing money from a shareholder
D. Paying fringe benefits to a shareholder-employee
E. All of these are effective strategies for mitigating double taxation
All of the strategies will reduce the amount of double taxation because they all shift income
from C corporations to their shareholders with payments that are deductible at the corporate
level.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 1 Easy
Topic: Entity Tax Characteristics
15-67
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53. 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?
A. 100; no limit; no limit
B. no limit; 100; 2
C. no limit; 100; no limit
D. 100; 100; no limit
An S corporation is the only type of entity that has a limit on the maximum number of owners it
may have. S corporations may have up to 100 unrelated shareholders.
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics
Essay Questions
15-68
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54. David would like to organize HOS as either an LLC or as a corporation generating a 12 percent
annual before-tax return on a $300,000 investment. Individual and corporate tax rates are both
30 percent and individual capital gains and dividend tax rates are 15 percent. HOS will pay out
its after-tax earnings every year to either its members or its shareholders.
a. Ignoring self-employment taxes, how much would David keep after taxes if HOS is organized
as either an LLC or a corporation?
b. Ignoring self-employment taxes, what are the overall tax rates (combined owner and entity
level) if HOS is organized as either an LLC or a corporation?
Answer to parts a and b:
a. LLC Description Corp. Description
(1) Pretax earnings $36,000 12% × $300,00 $36,000 12% × $300,000
(2) Entity level tax -0- 10,800 30% × (1)
(3) After-tax entity earnings $36,000 (1) – (2) $25,200 (1) –(2)
(4) Owner tax 10,800 (3) × 30% 3,780 (3) × 15%
(5) After-tax earnings $25,200 (3) – (4) $21,420 (3) – (4)
b. LLC Corp.
Overall tax rate 30% (4)/(1) 40.50% [(2) + (4)]/(1)
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: 1 Easy
Topic: Entity Tax Characteristics
15-69
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55. 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?
Answer to parts a and b:
a. LLC Description Corp. Description
(1) Pretax earnings $12,000 6% × $200,000 $12,000 6% × $200,000
(2) Entity level tax -0- 4,800 40% × (1)
(3) After-tax entity earnings $12,000 (1) – (2) $7,200 (1) – (2)
(4) Owner tax $4,800 (3) × 40% $720 (3) × 10%
(5) After-tax earnings $7,200 (3) – (4) $6480 (3) – (4)
b. LLC Corp.
Overall tax rate 40% (4)/(1) 46% [(2) + (4)]/(1)
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: 1 Easy
Topic: Entity Tax Characteristics
15-70
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56. Emmy would like to organize PRK as either an LLC or as a C corporation generating a 15
percent annual before-tax rate of return on a $100,000 investment. Individual ordinary rates are
25 percent, corporate rates are 15 percent, and individual capital gains and dividends tax rates
are 5 percent. PRK will distribute its earnings annually to either its members or shareholders.
a. Ignoring self-employment taxes, how much would Emmy keep after taxes if PRK is organized
as either an LLC or as a C corporation?
b. Ignoring self-employment taxes, what are the overall tax rates (combined entity and owner
level) if PRK is organized as either an LLC or a corporation?
Answer to parts a and b:
a. LLC Description Corp. Description
(1) Pretax earnings $15,000 15% ×
$100,000 $15,000
15% ×
$100,000
(2) Entity level tax -0- 2,250 15% × (1)
(3) After-tax entity
earnings $15,000 (1) – (2) $12,750 (1) – (2)
(4) Owner tax 3,750 (3) × 25% $637.50 (3) × 5%
(5) After-tax earnings $11,250 (3) – (4) 12,112.50 (3) – (4)
b. LLC Corp.
Overall tax rate 25% (4)/(1) 19.25% [(2) + (4)]/(1)
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: 1 Easy
Topic: Entity Tax Characteristics
15-71
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57. Jerry would like to organize FBC as either an LLC or as a C corporation generating an 8 percent
annual before-tax rate of return on a $400,000 investment. Individual and corporate tax rates
are both 35 percent and individual capital gains and dividends tax rates are 15 percent. FBC will
pay out its after-tax earnings every year to either its members or its shareholders.
a. How much would Jerry keep after taxes if FBC is organized as either an LLC or as a C
corporation (ignore self-employment taxes)?
b. Ignoring self-employment taxes, what are the overall tax rates (combined owner and entity
level) tax rates if FBC is organized as either an LLC or as a C corporation?
a. LLC Description Corp. Description
(1) Pretax earnings $32,000 8% × $400,000 $32,000 8% × $400,000
(2) Entity level tax -0- 11,200 35% × (1)
(3) After-tax entity earnings $32,000 (1) – (2) $20,800 (1) – (2)
(4) Owner tax 11,200 (3) × 35% 3,120 (3) × 15%
(5) After-tax earnings $20,800 (3) – (4) $17,680 (3) – (4)
b. LLC Corp.
Overall tax rate 35% (4)/(1) 44.75% [(2) + (4)]/(1)
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: 2 Medium
Topic: Entity Tax Characteristics
15-72
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58. Taylor would like to organize DRK as either an LLC or as a C corporation generating a 13
percent annual before-tax rate of return on a $250,000 investment. Individual and corporate tax
rates are both 30 percent and individual capital gains and dividends tax rates are 5 percent.
DRK will distribute its earnings annually to either its members or shareholders.
a. Ignoring self-employment taxes, how much would Taylor keep after taxes if DRK is organized
as either an LLC or as a C corporation?
b. Ignoring self-employment taxes, what are the overall (combined owner and entity level) tax
rates if DRK is organized as either an LLC or as a C corporation?
Answer to parts a and b:
a. LLC Description Corp. Description
(1) Pretax earnings $32,500 13% ×
$250,000 $32,500
13% ×
$250,000
(2) Entity level tax -0- 9,750 30% × (1)
(3) After-tax entity
earnings $32,500 (1) – (2) $22,750 (1) – (2)
(4) Owner tax 9,750 (3) × 30% 1,137.50 (3) × 5%
(5) After-tax earnings $22,750 (3) – (4) $21,612.50 (3) – (4)
b. LLC Corp.
Overall tax rate 30% (4)/(1) 33.50% [(2) + (4)]/(1)
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: 1 Easy
Topic: Entity Tax Characteristics
15-73
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59. 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?
Answer to parts a and b:
a. LLC Description Corp. Description
(1) Pretax earnings $18,000 4% × $450,000 $18,000 4% × $450,000
(2) Entity level tax -0- 2,700 15% × (1)
(3) After-tax entity earnings $18,000 (1) – (2) $15,300 (1) – (2)
(4) Owner tax 5,040 (3) × 28% 2,295 (3) × 15%
(5) After-tax earnings $12,960 (3) – (4) $13,005 (3) – (4)
b. LLC Corp.
Overall tax rate 28% (4)/(1) 27.75% [(2) + (4)]/(1)
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: 1 Easy
Topic: Entity Tax Characteristics
15-74
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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:
a. Description
(1) SNL taxable
income $400,000
(2) SNL level tax $140,000 35% × (1)
(3) After SNL-
level tax
earnings
available for
dividends
$260,000 (1) – (2)
b.
(4) Keegan's tax $61,880 (3) × (20% +
3.8%)
(5) After-tax
earnings $198,120 (3) – (4)
(6) Combined
taxes $201,880 (2) + (4)
Overall tax rate 50.47% (6)/(1)
15-75
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Because Keegan is in the 39.6% marginal tax bracket, his capital gains rate is 20%. He also is
subject to the additional 3.8% Net Investment Income Tax because his dividend income was
over the threshold amount.
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: 1 Easy
Topic: Entity Tax Characteristics
15-76
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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
(he is not subject to the net investment income tax), what is the overall tax rate (combined
corporate level and shareholder level) on DNS's $600,000 of taxable income?
Description
(1) DNS
taxable
income
$600,000
(2) DNS
level tax 228,000 38% × (1)
(3) After
DNS-level
tax earnings
available for
dividends
$372,000 (1) – (2)
(4) Daniels’s
tax 55,800 (3) × 15%
(5) After-tax
earnings $316,200 (3) – (4)
(6)
Combined
taxes
$283,800 (2) + (4)
Overall tax
rate 47.3% (6)/(1)
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Blooms: Apply
Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
15-77
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Level of Difficulty: 1 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 2 if it reports taxable income from operations
of $35,000 in year 2 before any loss carryovers?
None. BYC's loss in year 1 of ($40,000) will be available to offset income generated by BYC in
year 2. Since BYC earned $35,000 of taxable income in year 2 before any loss carryovers, it can
use ($35,000) of the loss carryover from year 1 to offset its entire taxable income. BYC will have
a ($5,000) loss carryover available for year 3 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: 1 Easy
Topic: Entity Tax Characteristics
15-78
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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.
Description
(1) Year 3
taxable
income
$120,000
(2) Year 1
NOL
carryforward
($50,000)
(3) Year 2
NOL
carryforward
($30,000)
(4) Taxable
income
reported
40,000 (1) – (2) –
(3)
(5) Tax Rate 15%
See
corporate
tax rate
table
(6) Taxes
Paid $6,000 (4) × (5)
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: 2 Medium
Topic: Entity Tax Characteristics
15-79
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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 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.
Answer to parts a and b:
Part a: $144,450 total taxes
Part b: $124,300 total taxes
a. Without
Salary Description
b. With
Salary Description
(1) Taxable income
before salary $300,000 $300,000
(2) Salary -0- (100,000)
(3) Taxable income $300,000 (1) – (2) $200,000 (1) – (2)
(4) Entity tax 117,000 (3) × 39% 78,000 (3) × 39%
(5) After-tax entity
earnings $183,000 (3) – (4) $122,000 (3) – (4)
(6) Ben’s tax on
dividends 27,450 (5) × 15% 18,300 (5) × 15%
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(7) Ben’s tax on salary Not applicable 28,000 (2) × 28%
(8) Combined tax $144,450 (4) + (6) $124,300 (4) + (6) +
(7)
Overall tax rate 48.15% (8)/(1) 41.43% (8)/(1)
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: 3 Hard
Topic: Entity Tax Characteristics
15-81
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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.
With $100,000 Salary Description
(1) Taxable income before
salary $400,000
(2) Salary 100,000
(3) Taxable income $300,000 (1) – (2)
(4) Entity tax $105,000 (3) × 35%
(5) After-tax entity earnings $195,000 (3) – (4)
(6) Elaine’s tax on
dividends $29,250 (5) × 15%
(7) Elaine’s tax on salary $33,000 (2) × 33%
(8) Combined tax $167,250 (4) + (6) + (7)
Overall tax rate 41.81% (8)/(1)
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: 2 Medium
Topic: Entity Tax Characteristics
15-82
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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:
a.
Without
fringe
benefits
Description
b. With
fringe
benefits
Description
(1) Taxable
income before
fringes
$250,000 $250,000
(2) Fringe
benefits 0 (50,000)
(3) Taxable
income $250,000 (1) – (2) $200,000 (1) – (2)
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(4) Entity tax 85,000 (3) × 34% 68,000 (3) × 34%
(5) After-tax
entity
earnings
$165,000 (3) – (4) $132,000 (3) – (4)
(6) Stacey’s
tax on
dividends
24,750 (5) × 15% 19,800 (5) × 15%
(7) Combined
tax $109,750 (4) + (6) $87,800 (4) + (6)
Overall tax
rate 43.9% (7)/(1) 35.12% (7)/(1)
Stacey is not taxed on the $50,000 payout of adoption expenses because this is considered a
qualified fringe benefit.
Answer to part c:
With non-
qualified
fringe
benefits
Description
(1) Taxable
income
before
fringes
$250,000
(2) Fringe
benefits (50,000)
(3) Taxable
income $200,000 (1) – (2)
(4) Entity
tax 68,000 (3) × 34%
(5) After-tax
entity $132,000 (3) – (4)
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earnings
(6) Stacey’s
tax on
dividends
19,800 (5) × 15%
(7) Stacey’s
tax on fringe
benefit
16,500 (2) × 33%
(8)
Combined
tax
$104,300 (4) + (6) +
(7)
Overall tax
rate 41.72% (8)/(1)
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: 3 Hard
Topic: Entity Tax Characteristics
15-86
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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 (ignore the 3.8% net investment income tax)?
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 (ignore the 3.8% net investment income tax)?
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 (ignore the 3.8% net investment income tax)?
Answer to parts a, b, and c:
a. No Lease
Payment
b. $120,000 Lease
Deduction
c. $80,000 Lease
Deduction Description
(1) Taxable income
before lease payment $500,000 $500,000 $500,000
(2) Lease payment 0 (120,000) (80,000)
(3) Taxable income $500,000 $380,000 $420,000 (1) – (2)
(4) Entity tax 170,000 $129,200 $142,800 (3) × 34%
(5) After-tax entity
earnings $330,000 $250,800 277,200 (3) – (4)
(6) Ali’s tax on dividends $49,500 $37,620 $41,580 (5) × 15%
(7) Ali’s tax on lease 0 $39,600 $26,400 (2) × 33%
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payment
(8) Combined tax $219,500 $206,420 210,780 (4) + (6) +
(7)
Overall tax rate 43.9% 41.28% 42.16% (8)/(1)
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: 2 Medium
Topic: Entity Tax Characteristics
15-88
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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:
a. With
unreasonable
interest
Description
b. With
reasonable
interest
Description
(1)
Taxable
income
before
interest
$300,000 $300,000
(2)
Reasonable
interest
(10,000) (8,000)
(3)
Taxable
income
$290,000 (1) – (2) $292,000 (1) – (2)
(4) Entity
tax 101,500 (3) × 35% 102,200 (3) × 35%
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(5) After-tax
entity earnings $188,500 (3) – (4) $189,800 (3) – (4)
(6) Ruth’s tax
on dividends 28,275 (5) × 15% 28,470 (5) × 15%
(7) Ruth’s tax
on Interest 3,300 (2) × 33% 2,640 (2) × 33%
(8)
Combined
tax
$133,075 (4) × (6) +
(7) $133,310
(4) + (6) +
(7)
Overall tax
rate 44.36% (8)/(1) 44.44% (8)/(1)
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: 2 Medium
Topic: Entity Tax Characteristics
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: 2 Medium
15-90
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Topic: Entity Tax Characteristics
70. Rodger owns 100% of the shares in Trevor Inc., a C corporation. Assume the following for the
current year:
Trevor Inc.’s pre-tax income =
$16,000
Trevor Corp’s marginal tax rate = 35%
Percentage of after-tax earnings
retained by Trevor Corp = 0% (i.e. all
after-tax earnings distributed)
Rodger’s dividend tax rate = 5%
Given these assumptions, how much cash does Rodger have from the dividend after all taxes
have been paid?
Description Amount Explanation
(1) Trevor Inc.’s pre-
tax income $16,000
(2) Dividend to
Rodger $10,400
(1) × (1 –
.35)
(3) Rodger’s tax on
dividend $520 (2) × .05
(4) Cash remaining
after tax on dividend $9,880 (2) – (3)
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: 1 Easy
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Topic: Entity Tax Characteristics
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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% (the net investment tax does not apply)] 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:
Description Amount Explanation
(1) Dividend
from
Corporation C
$13,200,000 $200,000,000 ×
(1 – .34) × 10%
(2) Tax on
dividend from
Corporation C
$1,346,400 (1) × 34% ×
30%
(3) Cash
remaining after $11,853,600 (1) – (2)
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tax on dividend
Answer to part b:
Description Amount Explanation
(1) Cash
received from
Partnership P
$100,000,000 $500,000,000
× 20%
(2) Tax on share
of income
from
partnership P
$34,000,000 (1) × 34%
(3) Cash
remaining from
distribution
after taxes
$66,000,000 (1) – (2)
Answer to part c:
Description Amount Explanation
(1) Dividend
from
Corporation C
$13,200,000 $200,000,000 ×
(1 – .34) × 10%
(2) Tax on
dividend from
Corporation C
$1,980,000 (1) × 15%
(3) Cash
remaining after
tax on dividend
$11,220,000 (1) – (2)
AACSB: Reflective Thinking
AICPA BB: Critical Thinking
Blooms: Apply
15-94
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Learning Objective: 15-03 Identify fundamental differences in tax characteristics across entity types.
Level of Difficulty: 2 Medium
Topic: Entity Tax Characteristics