CTC Business Taxation & Entity Structures 3 — Questions and Answers
Question 1: When a corporation distributes appreciated property to its shareholders, what is the tax consequence to the corporation?
- No tax consequence to the corporation
- The corporation recognizes gain as if it sold the property at fair market value (Correct answer)
- The corporation recognizes a loss equal to the depreciation taken
- The corporation can defer gain recognition for five years
Correct answer: The corporation recognizes gain as if it sold the property at fair market value
Under IRC Section 311, a corporation must recognize gain when it distributes appreciated property as if it had sold it at fair market value.
Question 2: What happens to a partner's outside basis when the partnership takes on additional recourse debt?
- Outside basis decreases by the partner's share of the new debt
- Outside basis increases by the partner's share of the new debt (Correct answer)
- Outside basis is unaffected by partnership-level debt
- Outside basis only changes when debt is personally guaranteed
Correct answer: Outside basis increases by the partner's share of the new debt
A partner's outside basis increases by their allocable share of any new partnership recourse debt under IRC Section 752.
Question 3: Which corporate formation requirement under IRC Section 351 must be met to defer gain recognition?
- The transferors must receive only voting stock
- The transferors must control at least 80% of the corporation immediately after the transfer (Correct answer)
- The transferred property must have a fair market value under $1 million
- The corporation must have been formed within the last 12 months
Correct answer: The transferors must control at least 80% of the corporation immediately after the transfer
IRC Section 351 requires that the transferors own at least 80% of the total combined voting power and 80% of all other classes of stock immediately after the exchange.
Question 4: For federal income tax purposes, how is a single-member LLC treated by default?
- As an S corporation
- As a C corporation
- As a disregarded entity (sole proprietorship) (Correct answer)
- As a limited partnership
Correct answer: As a disregarded entity (sole proprietorship)
A single-member LLC is treated as a disregarded entity by default, meaning its activities are reported on the owner's individual tax return as a sole proprietorship.
Question 5: What is the primary tax benefit of making a qualified subchapter S subsidiary (QSub) election?
- The subsidiary avoids all state income taxes
- The subsidiary is treated as a disregarded entity, simplifying consolidated reporting (Correct answer)
- The subsidiary can have non-US citizen shareholders
- The subsidiary qualifies for lower dividend tax rates
Correct answer: The subsidiary is treated as a disregarded entity, simplifying consolidated reporting
A QSub election causes the subsidiary to be treated as a disregarded entity owned by the parent S corporation, eliminating a separate filing requirement.
Question 6: When a C corporation has an accumulated earnings and profits (E&P) deficit, how are distributions to shareholders classified?
- As ordinary dividends subject to the 15% or 20% rate
- As return of capital reducing the shareholder's basis (Correct answer)
- As capital gains at the long-term rate
- As guaranteed payments taxed as ordinary income
Correct answer: As return of capital reducing the shareholder's basis
When a corporation has no E&P, distributions are first treated as a return of capital reducing the shareholder's stock basis, with any excess treated as capital gain.
Question 7: A professional service corporation (PSC) is subject to what special federal income tax rate?
- 21% flat rate (Correct answer)
- 25% flat rate
- 35% flat rate
- The same graduated rate as individuals
Correct answer: 21% flat rate
Since the Tax Cuts and Jobs Act of 2017, professional service corporations are taxed at the same flat 21% rate as all other C corporations.
CTC Business Taxation & Entity Structures 3
When a corporation distributes appreciated property to its shareholders, what is the tax consequence to the corporation?