T3

Question 1

List the three taxes that may be imposed if an S corporation was previously taxed as a C corporation

Answer 1

LIFO Recapture Tax
Built-in Gains Tax
Tax on Passive Investment Income

Question 2

LIFO Recapture Tax

Answer 2

For S corps that were previously taxed as a C corp

Excess of inventory computed using the FIFO method over the inventory computed using the LIFO method.

Question 3

Built-in Gains Tax

Answer 3

For S corps that were previously taxed as a C corp

Occurs when the FMV of a corporate asset exceeds the NBV. Tax only applies if property is sold within 5 years, resulting in tax on all property.

The tax is 21% of the lesser of:
-Recognized built-in gain for the current year
-Total net unrealized built-in gain at S election less net unrealized built-in gains recognized in previous years; or
-Taxable income of the S corp if it were a C corp

Question 4

Tax on Passive Investment Income

Answer 4

For S corps that were previously taxed as a C corp

21% tax on the lesser of net income or passive investment income if the following two tests are met:
1. The S corp has accumulated C corp earnings and profits
2. Passive investment income exceeds 25% of total gross receipts

Question 5

S Corp Shareholder Stock Basis Formula

Answer 5

Initial stock basis (cash, NBV property, FMV services)
+ Additional contributions
+ Income items (ordinary, ss, tax-exempt)
- Distributions to shareholders (cash, FMV property)
- Loss/deduction items (ordinary, ss, nondeductible expenses)
———————————
Ending basis in S corp stock

Question 6

Major difference between S corp and partnership stock basis

Answer 6

S corporation shareholders do not include any S corporation debt in their stock basis.

They have a separately stated debt basis.

Neither can be reduced below zero and debt basis is reinstated first

Question 7

Tax basis limitation vs. at-risk limitation for S corp shareholders

Answer 7

Tax basis includes share of nonrecourse debt (where the shareholder is personally liable) but at-risk basis excludes nonrecourse debt

Question 8

What happens when an S corp shareholder sells their interest?

Answer 8

It is allocated to shareholders on a per-share, per-day basis

Question 9

Accumulated Adjustments Account (AAA)

Answer 9

The accumulated earnings and profits during the years a corporation is an S corp.

Question 10

Increase/decrease rules for AAA

Answer 10

Increased by ordinary or separately stated income and gain items (other than tax-exempt income)

Decreased by ordinary or separately stated losses and deductions, nondeductible expenses (other than expenses related to tax-exempt income), and distributions.

Distributions may not reduce AAA below zero, but other items can.

Question 11

Other Adjustment Account (OAA)

Answer 11

An account that is designed to keep a cumulative record of items that affect S corporation shareholders’ stock basis but do not affect AAA

Basically AAA but including tax-exempt items.

Question 12

S corp with no C corp E&P nonliquidating distributions to shareholders order, tax result, and treatment.

Answer 12

1. Distribution to extent of AAA; Not subject to tax, reduces basis in stock; S corporation profits (already taxed)
2. To extent of OAA; Not subject to tax, reduces basis in stock; Nontaxable income/related expenses
3. To extent of stock basis; Not subject to tax, reduces basis in stock; Return of capital
4. In excess of stock basis; Taxed as long-term capital gain (if stock held for > one year); Capital gain distribution

Question 13

S corp with C corp E&P nonliquidating distributions to shareholders order, tax result, and treatment.

Answer 13

1. Distribution to extent of AAA; Not subject to tax, reduces basis in stock; S corporation profits (already taxed)
2. To extent of C corp E&P; Taxed as a dividend, does not reduce basis in stock; Prior C corporation taxable dividend distribution (double taxed)
3. To extent of OAA; Not subject to tax, reduces basis in stock; Nontaxable income/related expenses
4. To extent of stock basis; Not subject to tax, reduces basis in stock; Return of capital
5. In excess of stock basis; Taxed as long-term capital gain (if stock held for > one year); Capital gain distribution

Question 14

A nonliquidating S corp property distribution is valued at

Answer 14

FMV of the property

Question 15

S corp tax treatment of nonliquidating property distributions

Answer 15

Recognizes gain on appreciated property

AAA is reduced by the FMV of the property distributed

Question 16

Shareholder treatment of nonliquidating property distributions

Answer 16

Recognizes share of S corp’s gain on appreciated property

Stock basis is increased by share of the gain, decreased by FMV of the property distributed

Basis in property distributed is the FMV of the property.

Question 17

What are the events where S corporation status is terminated?

Answer 17

1. > 50% of shareholders consent to a voluntary revocation
2. S corp fails to meet any of the qualifications
3. Excess passive income: >25 % of the corporation’s gross receipts are from passive investment income for 3 consecutive years (Only applies if the S corp has prior C corp E&P)

Question 18

Gain/loss recognized by an S corp for a liquidating distribution of property formula

Answer 18

FMV of assets distributed
(Basis in assets)
———————–
Taxable gain/loss

Question 19

Gain/loss recognized by a shareholder for a liquidating distribution of property formula

Answer 19

Cash received
FMV of property received
(Liabilities assumed)
—————————-
Amount realized
(Basis in stock)
—————————–
Taxable gain (loss)

Question 20

In the absence of an election to adopt an annual accounting period, the required tax year for a partnership is:

Answer 20

A tax year of one or more partners with a more than 50% interest in profits and capital.

Question 21

Gain/loss recognized on a contribution of property to a partnership in return for a partnership interest rules

Answer 21

Generally, no gain or loss is recognized (No 80%/boot rule)

Question 22

Partnership interest consists of

Answer 22

Capital interest: A right to share in the net assets of the partnership when it liquidates.
and
Profits interest: A right to share in the future profits or losses of the partnership.

Question 23

When is a gain recognized for contributions to a partnership?

Answer 23

1. When a partner provides services to a partnership in exchange for a capital interest (not a profits interest)
2. When property is contributed that is subject to a liability, the excess of the liabilities assumed by the other partners over the contributed basis is treated as taxable boot and is a gain to the partner

Question 24

Partner’s Basis in Partnership Interest (“Outside Basis”) formula and details

Answer 24

Cash contributed
+ NBV property contributed
+ FMV services provided
- Liabilities assumed by other partners
+ Partner’s share of partnership liabilities
————————————–
Partner’s initial basis in partnership interest

Same as S corp shareholder’s initial stock basis but includes share of partnership liabilities

Question 25

Allocation of Partnership Debt to Partners Type of owner; Recourse Debt; Nonrecourse Debt

Answer 25

General partner; Yes (personal liability); Based on profit-sharing ratio Limited partner; Only if personal guarantee; Based on profit-sharing ratio LLC member; Only if personal guarantee; Based on profit-sharing ratio

Question 26

Holding period for a partnership interest

Answer 26

If the property contributed was previously was a capital asset or Section 1231 asset in the hands of the partner, the partner's holding period includes the holding period of the property contributed. If the property is an ordinary income asset (ex. inventory), the holding period begins on the date the property is contributed to the partnership.

Question 27

How are built-in gains treated for partnership interests

Answer 27

Upon subsequent sale of the property, the built-in gain/loss (FMV - NBV) that existed at the date of contribution is allocated to the contributing partner. Any post built-in gain/loss are allocated among all the partners in the partnership.

Question 28

Partnership's Basis in Contributed Property ("Inside Basis")

Answer 28

The partnership's basis in the contributed property is the contributor's basis (plus any gain recognized by the incoming partner, if a special election is made) The partnership's holding period includes the time held by the partner regardless of type of property.

Question 29

Partner's Tax Basis in Partnership Interest formula

Answer 29

Beginning Capital Account (Cash, FMV services, NBV assets - liability transferred to partnership) + % All income (Ordinary, SS, T-E) - % All losses/deductions (Ordinary, SS, T-E) - Distributions - % Partnership liabilities (recourse and nonrecourse) --------------------------- Ending tax basis in partnership interest

Question 30

Differences between tax basis and at-risk basis for partnerships

Answer 30

Qualified nonrecourse financing (QNF) plays a part unlike for S corps Tax basis includes: Recourse debt (if general partner or personal guarantee), qualified nonrecouse financing, and other nonrecourse debt At-risk basis includes: Recourse debt (if general partner or personal guarantee), qualified nonrecourse financing, but NO nonrecourse debt.

Question 31

Related party details for partnerships

Answer 31

Losses between a controlling partner (>50%) and their controlled partnership from the sale or exchange of property are not allowed Gains between the two are treated as taxable ordinary income if the property is not a capital asset in the hands of the transferee.

Question 32

Nonliquidating partnership payments to a retired partner are treated as

Answer 32

Ordinary income to the recipient and deductions to the partnership.

Question 33

Nonliquidating distributions to a partner treatment

Answer 33

Generally nontaxable, both to the partner and the partnership. Reduce basis in the partnership, first by cash and then by NBV of the property.

Question 34

What happens to nonliquidating partnership distributions when basis reaches zero?

Answer 34

Basis of the property received is reduced to keep the basis from becoming negative. Cash basis can't be changes so the partner recognizes a capital gain for the excess (boot)

Question 35

Nonliquidating partnership distributions when stock basis is less than the distributions and there are multiple assets

Answer 35

Basis is assigned first to cash, then "hot assets" (assets that result in ordinary income when sold, including inventory and unrealized receivables), then other property.

Question 36

Three ways in which a partner may liquidate a partnership interest:

Answer 36

1. Complete withdrawal (liquidating distribution) 2. Sale of partnership interest 3. Retirement or death

Question 37

Partnership liquidating distribution rules if just cash is received

Answer 37

Gain/loss is realized on the amount of adjusted basis left over after receiving the cash.

Question 38

Partnership liquidating distribution rules if just land or similar asset is received

Answer 38

No gain/loss realized After subtracting cash, basis in the asset is the remaining partnership basis Zero out

Question 39

Partnership liquidating distribution rules if just hot assets are received

Answer 39

If multiple hot assets, the partner's basis in the partnership is allocated to the assets only if the inside basis is greater than the outside basis. If the outside basis is greater than the inside basis, the partner recognizes a loss and the partner's basis in the assets are the same as the basis in the hands of the partnership.

Question 40

Partnership liquidating distribution rules if multiple assets (hot assets and land) and inside basis > outside basis

Answer 40

1. Assign a basis to all assets equal to the partnership's basis 2. Adjust the basis of any assets in the last property category (other property, or hot assets if no other property) that have depreciated in value down to fair market value. 3. Allocate any basis in the partnership interest remaining after Step 2 among all the assets in the last property category based on relative adjusted basis of the assets after the Step 2 adjustment.

Question 41

Partnership liquidating distribution rules if multiple assets (hot assets and land) and outside basis > inside basis

Answer 41

If only hot assets are distributed, recognize a loss 1. Assign a basis to all assets equal to the partnership's basis in the assets. 2. Adjust the basis of any assets in the last property category (other property) that have appreciated in value up to FMV. 3. Allocate any basis in the partnership interest remaining after Step 2 among all the assets in the last property category based on relative FMV.

Question 42

Sale of Partnership Interest Gain/Loss formula and classification

Answer 42

Adjusted basis in partnership interest (Amount realized) ------------------------------- Gain/loss Can either include liabilities in both basis and amount realized or exclude it from both. Capital Gain or loss most of the time Only ordinary for the part that represents a partner's share of "hot assets."

Question 43

Section 754 Election and Section 743(b) adjustment definitions

Answer 43

Partnerships have the option to make a Section 754 election when there is a transfer of a partnership interest and there is a difference between a partner's share of inside basis in the partnership assets and the partner's outside basis in their partnership interest Section 743(b) basis adjustment is the difference between the purchase price and the partner's share of the partnership's inside basis of the assets. Makes the transferee have an inside basis equal to outside basis. Only required if there is a difference of $250,000 or more.

Question 44

Section 743(b) adjustment formula

Answer 44

Difference between Purchase price + Share of partnership debt (outside basis); and % basis of partnership's assets (inside basis)

Question 45

What business entity has the most flexibility in choosing an accounting period?

Answer 45

C corporations

Question 46

Tax treatment for LLC

Answer 46

2 or more owners: Default treatment is partnership One owner: -If the owner is an individual, the default treatment is a Schedule C sole proprietorship -If the owner is not an individual, the income/loss is included in the owner's taxable income However, any unincorporated entity can elect to be treated as C corp/S corp

Question 47

Tax treatment of contribution of appreciated property by owners for the 4 entities and which one is the most favored

Answer 47

C Corp: No gain/loss recognized only if Sec. 351 requirements met S Corp: No gain/loss recognized only if Sec. 351 requirements met Partnership: No gain/loss recognized Sole Proprietorship: Nontaxable event Favors partnerships or sole proprietorships because the taxpayer is not required to meet the 80% rule

Question 48

Tax treatment of gain/loss on sale of contributed property for the 4 entities

Answer 48

C Corp: Gain/loss recognized by corporation S Corp: Gain/loss allocated among shareholders Partnership: Built-in gains allocated to contributing partner and the post-gains are allocated among all partners Sole Proprietorship: Gain/loss recognized by owner

Question 49

Taxation of business entity income for the 4 entities and which one is the most favored

Answer 49

C Corp: Taxed at entity level when earned, taxed again at owner level when distributed as dividends S Corp: Allocated among shareholders, taxed once at individual owner level when earned. Partnership: Allocated among partners, taxed once at individual owner level when earned. Sole Proprietorship: Taxed once at individual owner level when earned C corp is most advantageous if earnings are not distributed to shareholders as dividends and/or if the individual tax rates are higher than the C corp 21%. Flow-through entity is more advantageous if the business does distribute earnings as dividends and/or the individual tax rates are lower than the 21%.

Question 50

Self-employment tax rules for the four entities

Answer 50

C Corp: No SE taxes S Corp: No SE taxes Partnership: SE taxes if active partner Sole Proprietorship: SE taxes

Question 51

Net Investment income tax rules for the four entities

Answer 51

C Corp: NII tax if AGI exceeds $200,000 ($250,000 MFJ) S Corp: NII tax if passive shareholder Partnership: NII tax if passive partner Sole Proprietorship: No NII tax

Question 52

QBI deduction by owner rules for the four entities

Answer 52

C Corp: No QBI deductions allowed S Corp: QBI deduction allowed if qualifications met Partnership: QBI deduction allowed if qualifications met Sole Proprietorship: QBI deduction allowed if qualifications met

Question 53

Deduction of Business Entity Losses for the 4 entities and which one is the most favored

Answer 53

C Corp: NOL limitations S Corp: Basis, PAL, and excess business loss limitations Partnership: Basis, PAL, and excess business loss limitations Sole Proprietorship: PAL and excess business loss limitations Flow-throughs are favored because they can flow through losses to the owner-taxpayer and offset income from other sources at the individual level. Partnerships have the edge over S corps because their basis is bigger which allows them to deduct more losses.

Question 54

Compensation and qualifying fringe benefits of owners for the 4 entities and which one is the most favored

Answer 54

C Corp: Salary is ordinary income to the employee. Corporation pays one half of Social Security and Medicare. Corporation deducts 1/2 of the Social Security and Medicare. Qualifying fringe benefits are deductible by the corporation and nontaxable to employees S Corp: Salary is ordinary income to the employee. Corporation pays one half of Social Security and Medicare. Corporation deducts 1/2 of the Social Security and Medicare. Qualifying fringe benefits are deductible by the corporation, but are only nontaxable to the employees if they own 2% or less of the S corp. Partnership: Guaranteed Payment is deducted by the partnership and taxable ordinary income to the partner. Partnership doesn't pay 1/2 of Social Security and Medicare. Qualifying fringe benefits like health insurance and life insurance are included in guaranteed payments, making them deductible by the partnership and taxable ordinary income to the partner. Sole Proprietorship: No fringe benefits C corps are the most advantageous because they can deduct half of the SS and Medicare taxes and fringe benefits are nontaxable for employees.

Question 55

Operating (nonliquidating) distributions to owners for the 4 entities and which one is the most favored

Answer 55

C Corp: Recognize gain (not loss) on property distributed S Corp: Recognize gain (not loss) on property distributed Partnership: No gain/loss recognized on property distributed Sole Proprietorship: Nontaxable event Favors partnerships, especially if it is a distribution of appreciated property

Question 56

Liquidating distributions to owners for the 4 entities and which one is the most favored

Answer 56

C Corp: Recognize gain OR loss on property distributed S Corp: Recognize gain OR loss on property distributed Partnership: No gain/loss recognized on property distributed Sole Proprietorship: Nontaxable event Favors partnerships if appreciated property, favors corporations if depreciated property because losses can be recognized at the time of the distribution.

Question 57

Conversion from one type of entity to another details

Answer 57

It is way harder and more taxable to go from a C corp to a flow-through entity than vice versa. C corp to flow through involves making S election or liquidating the whole corporation.

Question 58

Grantor vs. Trustee vs. Beneficiary for trusts

Answer 58

Grantor: Transferor of property to the trust and identifies the terms of the trust agreement Trustee: Manages the trust property for the benefit of the beneficiaries and administers the trust in according to the terms of the trust agreement Beneficiary: The people who receive property from the trust.

Question 59

Grantor trusts and example(s)

Answer 59

Trusts in which the grantor retains certain ownership powers or control over the property transferred to the trust. A common example is a revocable living trust, which assigns assets while the grantor is still alive.

Question 60

Non-grantor trusts and example(s)

Answer 60

Separate taxpaying entities. Trust income is taxable either to the trust or to the beneficiaries, depending on the amount of distributions to the beneficiaries, the type of income, and the type of trust. Examples include simple and complex trusts.

Question 61

Simple Trust requirements

Answer 61

Non-grantor trust 1. Required to distribute all of its income to beneficiaries annually; 2. Cannot make distributions from trust principal (corpus); and 3. Cannot make distributions (contributions) to charitable organizations

Question 62

Complex Trust requirements

Answer 62

Non-grantor trust 1. Does not distribute all of its income to beneficiaries annually; 2. Makes distributions from trust principal (corpus); and 3. Makes distributions (contributions) to charitable organizations

Question 63

Can a trust be a complex trust and a simple trust?

Answer 63

Can change each year but not as the same time.

Question 64

Taxation of non-grantor trust income

Answer 64

Trust taxable income is taxable to either the trust or the beneficiaries, but not both.

Question 65

Trust Accounting Income (TAI)

Answer 65

The book income of the trust. Used to determine the amount required to be distributed to beneficiaries each year.

Question 66

What trust income and expenses is allocated to principal (corpus) vs. Trust Accounting Income (TAI)

Answer 66

Principal (corpus): Capital gains and losses on the disposition of trust assets and casualty gains and losses TAI: Most income and expense items, including operating income, operating expenses, taxable and tax-exempt interest, dividends, rents, and royalties. Trust administrative expenses such as trustee fees are allocated between both as stipulated in the trust agreement, or according to state law if there is no stipulation.

Question 67

Nondeductible trust administration expenses =

Answer 67

Total trust administration expenses x (Nontaxable income / trust accounting income)

Question 68

Trust exemption amounts:

Answer 68

Simple trust: $300 exemption Complex trust: $100 exemption

Question 69

Trust taxable income formula

Answer 69

Trust taxable gross income (including capital gains) - Deductible trust expenses ------------------------------- Adjusted total income - Exemption amount ------------------------------- Trust taxable income before income distribution deduction (income distribution deduction) ------------------------------- Trust taxable income

Question 70

Trust Distributable Net Income (DNI) Formula

Answer 70

Trust taxable income (before income distribution deduction) + Exemption - Capital gains allocated to corpus + Capital losses allocated to corpus + Tax-exempt interest - Expenses allocated to tax-exempt interest ------------------------------- Distributable net income (DNI) *Includes both taxable and nontaxable income and expenses, including 100% of trust admin. expenses, but generally excludes capital gains and losses

Question 71

A beneficiary of a complex or simple trust must include in income:

Answer 71

The taxable amount of distributions received, but only to the extent of the trust's DNI

Question 72

A trust is allowed to take a deduction for taxable distributions to beneficiaries for what amount?

Answer 72

The lesser of total distributions to beneficiaries or trust DNI

Question 73

What type of business entity must a 501(c)(3) be?

Answer 73

Must be organized as a corporation, LLC, unincorporated association, or trust

Question 74

Unrelated Business Income (UBI)

Answer 74

Income from a 501(c)(3) organization that may be subject to income tax. It is income that is: -Derived from an activity that constitutes a trade or business; -Regularly carried on; and -Not substantially related to the organization's tax-exempt purpose

Question 75

Key examples and non-examples of UBI

Answer 75

Examples: Hospital gift shop (selling merch not related to the mission) Non-examples: Dividends, royalties, interest, annuities, rent from real property (unless personal services also provided), bingo games, activity where substantially all the work is performed by unpaid volunteer workers.

Question 76

Certain membership organizations (social clubs and homeowners' associations) are usually taxed on:

Answer 76

All gross income less deductions directly connected with producing that income, but not including exempt function income (gross income from dues, fees, charges, paid by members for goods, facilities, or services provided to members and their families and guests)