Sole Proprietorship
Which of the following taxes are potentially applicable to Sole Proprietorships?
-Payroll taxes on employees’ compensation
-Self-employment tax
-Income Tax
They could all be applicable
What is the default tax classification for an LLC with four members?
Partnership
What is the defining characteristic of C corp income taxation that makes it different from the other entity types we studied?
Double Taxation - Corporation pays an entity-level tax on its profits, and shareholders are taxed on any dividends they receive from the corporation.
For sole proprietorships, partnerships, and S corps, there is generally only one level of taxation. (i.e., profits are taxed at just the owner level. Flow-through entities typically don't have an entity level tax.)
Describe two ways in which a business could create income tax nexus in a state.
Business income from which of the following entity types is potentially subject to self-employment tax:
- Sole Proprietorship
- Partnership
- S Corp
- C Corp
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 individual's income tax return (Schedule C of Form 1040)
Net losses from sole proprietorships are typically deductible against other income. However, 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 (2024 threshold amounts are $610k for MFJ; $305k for all others). Must 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
Which of the following is not a deductible business expense for a C corp?
- Owner's Salary
- Rent
- Interest Expense
-Dividends
Dividends
Your client has income tax nexus in Colorado, and provided the following information related to the location of their activities:
Sales factor=2M/5M = 40%
What is the default tax entity type for a single member LLC with an individual owner?
Sole proprietorship
Brittany is a single taxpayer who earns a salary of $350K from her employer and also conducts her own business through a sole proprietorship which resulted in a $310K loss. Assuming no other income or above-the-line deductions, what is her AGI for 2024?
Brittany’s business loss is subject to the excess business loss limitation since it is greater than the $305,000 limit for her filing status.
$350,000 - $305,000 = $45,000 AGI
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
AB Corp is a C corporation. This year, AB received a $5,000 dividend from Alphabet Inc, another C corp. What additional information do you need to know in order to calculate AB's dividends received deduction?
What is AB's ownership percentage of Alphabet? The greater the receiving corporation's ownership percentage in the corporation paying the dividend, the greater the DRD (50%, 65%, or 100% deduction).
Describe the difference between allocation and apportionment for state income tax purposes.
Name two differences between partner distributions and guaranteed payments to partners.
1. Distributions are nontaxable to the receiving partner. Guaranteed payments are taxable compensation income to the receiving partner.
2. Distributions are not a deductible expense for the partnership. Guaranteed payments are a deductible expense for the partnership when calculating the partnership's business income.
3. Distributions directly reduce the receiving partner's partnership basis. Guaranteed payments do not directly reduce partnership basis (but since guaranteed payments are deductible, there is an indirect effect).
Ana runs her business through a sole proprietorship. Business income this year is $100,000, and Ana's deduction for half of self-employment tax is $7,065. Assuming Ana qualifies for the full QBI deduction, what is her QBI deduction amount this year?
QBID = 20% of qualified business income (after taking the deduction for half of SE tax).
20% * (100,000-7,065) = $18,587 QBI deduction
Parker is a general partner in PQR Partnership. Parker’s K-1 from PQR 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 & long-term capital gains is 15%. Ignore SE tax and QBID for this problem. How much federal income tax will Parker owe related to his income from PQR?
Ordinary income tax = .24 * (60k + 45k) = 25,200
Tax on LTCG = .15 * 5k = 750
Total federal income tax = $25,950
Bea is considering whether to organize her business as an LLC or a C Corp. In either case, she will be the sole owner/shareholder. Bea 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%, Bea's ordinary income tax rate is 32%, and her dividend tax rate is 20%, calculate the combined (entity + individual) tax on Bea’s business income for each scenario (ignore QBID and SE tax).
LLC (sole proprietorship): She will report the $170,000 business income on her personal tax return at her ordinary income tax rate of 32% = $54,400 tax
C corporation:
The business will first pay corporate tax of 21% on the $170,000 income = $35,700 tax
Bea then receives a $134,300 dividend ($170,000 - $35,700)
Bea pays tax on the dividend: 20% * $134,300 = $26,860
Total tax= $35,700 + $26,860 = $62,560
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.
Which business entity type(s) are generally subject to an entity-level federal income tax on their business income?
C Corporation
Chris 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 (Note that this is greater than the $168,600 max subject to Social Security tax)
($168,600 * 12.4%) + ($277,050 * 2.9%) = 20,906.40 + 8,034.45 = $28,940.85 SE Tax
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 versus pass-through entities.
Losses from pass-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, and provided the following information related to the location of their activities:
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%
Sam is a shareholder in an S corporation. This year their allocated share of business income is $50,000 and they received a cash distribution of $20,000. Assuming they are eligible for the maximum QBI deduction, what is Sam’s QBI deduction related to the S corporation for this year?
$50,000 business income * 20% = $10,000 QBI Deduction