Sole Proprietorship
Why are sole proprietorships considered the simplest business entity?
Less paperwork to get started.
Easier processes and fewer requirements for business taxes. (reported on Schedule C of 1040)
Fewer registration fees.
What is the default tax classification for an LLC with four members?
Partnership
What is the defining negative characteristic of owning a C-corp and explain the mechanics behind downside?
Double Taxation - Corporation is taxed on the profits and then the individual is then taxed on any dividend received from the corporation.
Describe two ways in which a business could create income tax nexus in a state.
Which entities are potentially subject to SE tax?
Sole Proprietorships (Always)
Partnerships(depending on partner status)
For a sole proprietorship, how are income and losses treated, with respect to the individual tax return?
Income is included on the individuals income tax return on Schedule C of the form 1040
Net losses from sole proprietorships are typically deductible against other income. However, recall that a limitation on “excess business losses” applies to noncorporate taxpayers. If aggregate deductions from all of a taxpayer’s trades or businesses exceed their aggregate business income, the amount over a threshold amount is not currently deductible
o2024 threshold amounts: $610k (MFJ) or $305k (all others)
oMust carry excess loss forward and treat it like part of NOL carryforward
Pine Corp is considering electing S corporation status. All of Pine’s 150 shareholders are individuals who are US citizens. Pine issues only one class of stock. Can Pine elect S corporation status, and why/why not?
No, Pine has too many shareholders
Brumhilda is trying to decide whether to organize her new business as an LLC or a C Corporation. In either case, she will be the sole owner/shareholder. Brumhilda estimates the business will earn a pretax profit of $170,000 per year and will distribute all post-tax profits to herself at the end of each year. Assuming that the corporate tax rate is 21%, ordinary income tax rate is 32%, and the dividend tax rate is 20%, calculate the combined (entity + individual) tax on Brumhilda’s business income for each scenario (ignore the QBI deduction and self-employment tax implications).
If the business is organized as an LLC: She will report the $170,000 flow-through income on her personal tax return at her ordinary income tax rate of 32% = $54,400 tax
If the business is organized as a C corporation:
oThe business will first pay corporate tax of 21% on the $170,000 income = $35,700 tax
oBrumhilda will then receive a $134,300 dividend from the corporation ($170,000 - $35,700)
oBrumhilda pays tax on the dividend: 20% * $134,300 = $26,860
oThus, total tax will be $35,700 + $26,860 = $62,560 tax
Your client has income tax nexus in Colorado. They have provided the following information related to the location of their activities:
Sales factor=2M/5M = 40%
What is the general formula for calculating basis?
Beginning Basis
+ Owner Contributions
+/- Net Income or Loss
- Owner Withdrawals (Distributions)
- Nondeductible expenses
Ending Basis
Brittany is a single taxpayer who earns a salary $150K from her employer and also conducts her own business through a sole proprietorship which resulted in a $275K loss. What is her AGI for 2024?
Brittany’s business loss is not subject to the excess business loss limitation since it is less than the $305,000 limit.
$150,000 - $275,000 = ($125,000) AGI
Brittany’s taxable income would also be negative, so she would have a net operating loss (NOL) to carry forward to future years
Malia is a partner in M&M Partnership. At the beginning of this year, her partnership basis was $100,000. During this year, Malia’s allocated share of partnership business income was $15,000 and she was also allocated a $5,000 long-term capital gain. Malia also received a $12,000 cash distribution. What is Malia’s partnership basis at the end of the year?
100,000 + 15,000 + 5,000 – 12,000 = $108,000
Explain the Dividend Received Deduction in your own words.
The DRD is a reduction to the taxes paid on dividends if the dividend is paid from one c-corp to another another c-corp. The great the Ownership % the larger the reduction.
Describe the difference between allocation and apportionment for state income tax purposes.
Distributions are nontaxable and reduce the partners basis.
Guaranteed payments are included in taxable income and do not directly reduce a partners basis.
Which of the following taxes is not applicable to Sole Proprietorships?
-Social security and Medicare taxes
-Unemployment taxes on employees’ compensation
-Self-employment tax
-Income Tax
-None of the above
None of the above, they could all be applicable
Parker is a general partner in PQR Partnership. Parker’s K-1 from PQR Partnership for the current year showed ordinary business income allocated to Parker of $60,000, guaranteed payment to Parker of $45,000, and long-term capital gain allocated to Parker of $5,000. Parker’s tax rate on ordinary income is 24% and his tax rate on qualified dividends and long-term capital gains is 15%. Ignore SE tax and QBID for purposes of this problem. How much federal income tax will Parker owe related to his income from PQR Partnership?
Ordinary income tax = .24 * (60k + 45k) = 25,200
Tax on LTCG = .15 * 5k = 750
Total federal income tax = $25,950
Which of the following is not a deductible business expense for a C-corp?
- Owner's Salary
- Rent
- Interest Expense
-Dividends
Dividends
Cranberry Corp., a Massachusetts-based seller of kitchen goods, regularly sends sales representatives to Pennsylvania to solicit sales. Orders are approved at Cranberry’s Massachusetts headquarters, and goods are shipped via common carrier from outside Pennsylvania. Cranberry also provides warranty services to purchasers in Pennsylvania. Is Cranberry protected from Pennsylvania income tax under P.L. 86-272? Why or why not?
No. Although Cranberry sells tangible personal property, approves orders outside PA, and ships goods from outside PA, they are not protected under P.L. 86-272 because they provide warranty services in the state. P.L. 86-272 does not apply if the out-of-state seller’s activities extend beyond solicitation of sales of tangible personal property.
Jorge, an individual, owns 60% of the stock of Asteroid Corporation. This year, Asteroid paid Jorge a $200,000 dividend. How much of this dividend is taxable to Jorge?
All 200,000 is taxable, DRD only applies to corporations who own other companies stock.
Christopher operates a sole proprietorship that earned a net profit of $300,000 during the year. Calculate the self-employment tax on his income from the sole proprietorship and the above the line deduction for half of the SE Tax.
SE Tax Base = $300,000 * 92.35% = $277,050 (This is greater than the $168,600 max subject to Social Security tax, so Social Security tax only applies to a portion of the income while Medicare tax applies to the full amount)
($168,600 * 12.4%) + ($277,050 * 2.9%) = 20,906.40 + 8,034.45 = $28,940.85 SE Tax
Note: Chris will get an above-the-line deduction for half of the SE tax (28,940.85 * 50% = $14,470.43 deduction)
Derrick is a shareholder in an S corporation. This year his allocated share of the S Corp’s business income was $30,000 and he was also allocated $500 of interest income. How much self-employment tax does Derrick owe related to his income from the S corp?
$0. Business income allocation and separately stated items from an S Corp are not subject to self-employment tax.
Explain the tax differences between NOLs for C-corps and Pass-thru entities?
Pass-thru entities=losses from flow-through entities are reported on owners’ tax returns and are generally deductible in the year the loss is incurred (subject to some limitations such as the excess business loss limitation)
C corporation losses do not flow through to shareholders, and instead create an NOL carryforward at the corporate level to be used when (or if?) the business eventually becomes profitable
Your client has income tax nexus in Illinois. They have provided the following information related to the location of their sales, property, and payroll:
Sales factor=1M/4M = 0.25
Property factor=200k/1.6M = 0.125
Payroll factor=$1M/$5M = 0.20
Illinois apportionment percentage = (0.25 + 0.125 + 0.20)/3 = 19%
Which of the following could be a shareholder in an S corporation?
A. An individual who is a citizen and resident of France
B. A partnership organized in the United States
c. Both of the above
D. Neither of the above
Neither