CFC Business Financial Planning 1 — Questions and Answers
Question 1: Which business entity structure provides limited liability to all owners while allowing profits and losses to pass through to personal tax returns?
- C corporation
- Sole proprietorship
- Limited liability company (LLC) (Correct answer)
- General partnership
Correct answer: Limited liability company (LLC)
An LLC combines limited liability protection (like a corporation) with pass-through taxation (like a partnership), avoiding double taxation on corporate profits.
Question 2: A CFC advises a business owner on a Section 1031 exchange. This provision allows deferral of capital gains tax when:
- Selling appreciated stock and buying index funds
- Exchanging like-kind real property for other qualifying real property (Correct answer)
- Converting a C corp to an S corp
- Selling a business and reinvesting in an IRA
Correct answer: Exchanging like-kind real property for other qualifying real property
Section 1031 permits tax deferral on gains from the exchange of qualifying real property held for investment or business use, as long as strict identification and timing rules are met.
Question 3: Which business succession strategy allows a departing owner to receive installment payments over time while the business transfers to a buyer?
- Leveraged buyout
- Installment sale (Correct answer)
- ESOP leveraged buyout
- Charitable lead trust
Correct answer: Installment sale
An installment sale spreads the recognition of capital gain over the payment period, reducing the seller's tax liability compared to receiving all proceeds in a single year.
Question 4: An Employee Stock Ownership Plan (ESOP) allows a business owner to sell shares to the ESOP and, if certain conditions are met under Section 1042, defer capital gains by:
- Reinvesting proceeds into a Roth IRA
- Reinvesting into qualifying replacement property (QRP) like stocks and bonds (Correct answer)
- Donating shares to a charitable foundation
- Converting to an S corporation simultaneously
Correct answer: Reinvesting into qualifying replacement property (QRP) like stocks and bonds
Under IRC Section 1042, a C corporation owner selling at least 30% to an ESOP can defer capital gains by reinvesting proceeds in qualified replacement property within 12 months.
Question 5: A closely held business using the 'family limited partnership' (FLP) structure can transfer wealth by leveraging:
- Stepped-up basis for all transferred assets
- Valuation discounts for lack of control and lack of marketability (Correct answer)
- Annual gift tax exclusions only
- S corporation election rules
Correct answer: Valuation discounts for lack of control and lack of marketability
FLPs allow senior family members to gift limited partnership interests at discounted values (due to lack of control and marketability), transferring more wealth with less gift tax.
Question 6: Which financial planning consideration is most critical when a CFC advises a client on switching from a C corporation to an S corporation?
- The S corp must have exactly 100 shareholders on Day 1
- Built-in gains tax on appreciated C corp assets during a 5-year recognition period (Correct answer)
- Loss of limited liability protection upon conversion
- S corps cannot issue any class of stock
Correct answer: Built-in gains tax on appreciated C corp assets during a 5-year recognition period
C corporations converting to S status face built-in gains (BIG) tax on pre-conversion appreciated assets if those assets are sold within 5 years of the S election.
CFC Business Financial Planning 1
Which business entity structure provides limited liability to all owners while allowing profits and losses to pass through to personal tax returns?