ALAN R. SUMUTKA



ACC-410 FUNDAMENTALS OF FEDERAL TAXATION


CASE 12 - TAX ISSUES OF C CORPORATIONS, PARTNERSHIPS, LLCs AND S CORPORATIONS, TAX ACCOUNTING AND OBAMACARE

Bill is working his way up the corporate ladder, Lauren is 6 years old, and Pam is in the fourth year of her business. And business is booming, but problems are arising. Pam wants to determine how ObamaCare impacts her business and Kyle, her one employee, is becoming restless.

The business is still only Pam and Kyle, who has been with her for three years. Pam is making a very nice profit and although Kyle doesn't know how much, he knows that they're both very busy and the clients are "rolling in." Pam has given him a nice raise each year, but yesterday Kyle said something about becoming a partner. Kyle is an excellent worker and valued colleague and Pam doesn't want to lose him, but a 50% partner? Pam needs to do some thinking.

When she explained the situation to Bill, he said "that's your decision. But if you're thinking of taking on a partner, you can't be a sole proprietor any more. The usual choices are a C corporation, a partnership, an S corporation, or a limited liability company."

Pam realized that if she was to incorporate as a C corporation, she would have limited liability, a big advantage of incorporating. So for legal and tax purposes, she would be different from the corporation. Therefore, she would become an employee of the corporation, pay herself a salary and get a W-2 Form at year-end as any other employee, and pay payroll taxes on the salary. Her salary and payroll taxes would become an ordinary and necessary expense of the corporation. But because she was different from the corporation, she would no longer be self-employed and would no longer have to pay income or self-employment taxes on the profits. Now the C corporation, being a separate taxable entity, would have to pay corporate taxes on the profits. Pam could no longer just take a "draw" and reduce her capital.  Now if she took money, it was salary, or because she would be a shareholder, it could be a dividend.

Pam knew that if she became a general partnership, she was still personally liable for the partnership debts. Therefore, because she was viewed to be the same as the partnership from a liability perspective, the IRS, too, viewed Pam and the partnership as one.  Therefore, the partnership would be taxed as an individual taxpayer and Pam's 50% share of the profits would "pass-through" from the partnership to her Form 1040.  In fact, she would still be considered self-employed and have to pay self-employment tax. Generally, an LLC is taxed like a partnership (or sole proprietorship), but provides limited liability.

But the S corporation, that's different. It's a hybrid. Legally, an S corporation is a corporation, so Pam would again have limited liability. Legally, she would be different than the corporation, just like in a C corporation. Therefore, just like a C corporation, she would be an employee of the corporation, pay herself a salary, get a W-2 Form at year-end, and pay payroll taxes on the salary. And, again, her salary and payroll taxes would become ordinary and necessary expenses of the corporation. So where's the difference? Although an S corporation is a legal corporation, for tax purposes it elects to be taxed as an individual taxpayer. Of course, that means that the profits of the S corporation, after deducting Pam's salary and payroll taxes, pass through to Pam's Form 1040, just like in a partnership. Although the profits would be subject to income tax at individual rates, they would not be subject to self-employment tax, because Pam is not self-employed; she is an employee. Pam wondered, "why would anyone do something this complicated?"

Nonetheless, although Bill was the accountant, Pam was the one running the business.  She wanted to see numbers before she started changing her business. Pam pulled out her net income projection for this year for the proprietorship and added the effect if Pam and Kyle each took salary of $60,000 and/or shared profits equally in either of the above entities (see below).
 

Proprietorship

C Corporation

Partnership

S Corporation

Cash Receipts:

 

 

 

 

  Fees

$182,400

$182,400

$182,400

$182,400

  Taxable interest - checking account

120

120

120

120

  Dividends - Vanguard MMF

860

860

860

  860

  Gain on sale of equip - ordinary income

3640

3640

3640

3640

  Gain on sale of equip - Section 1231 gain

2050

2050

2050

2050

 

189,070

189,070

189,070

189,070

Cash Payments:

  Salary - Kyle

$40,000

$60,000

N/A

$60,000

  Payroll taxes - Kyle

4390

5283

N/A

5283

  Salary - Pam

N/A

60,000

N/A

60,000

  Payroll taxes - Pam

N/A

5283

N/A

5283

  Depreciation

6412

6412

6412

6412

  Charitable contributions

500

500

500

500

  Interest expense

2200

2200

2200

2200

  Repairs and maintenance

822

822

822

 822

  Meals

690

690

690

690

  Insurance

4640

4640

4640

4640

  Other expense

11,621

11,621

11,621

11,621

71,275

157,451

26,885

157,451

Pre-tax income per financial statements

117,795

31,619

162,185

31,619

 

Pre-tax cash flow to Pam if Kyle becomes partner:

N/A

- Salary

N/A

60,000

0

60,000

- 50% distributed profit

N/A

0*

81,093

15,810

60,000

81,093

75,810

*Profits retained in corporation.

REQUIRED:
PART A: C Corporation Issues
1. Using the broad tax formula for a C Corporation, calculate the gross tax liability if Pam incorporated as a C corp.
2. In handwriting, prepare Form 1120 US Corporation Income Tax Return, pages 1 and 3.
3. What is the after-tax income of the C corp?  Why does it differ from Form 1120, line 28-"taxable income before NOL deduction and special deductions?" Complete Form 1120, Schedule M-1 (page 5): Reconciliation of Income (Loss) per Books With Income per Return.

4. How much of Pam's interest expense is deductible (a) using Case #11 facts? (b) if Pam's average gross receipts for three preceding years exceeded $25million and interest expense was $22,000?
5.  How are dividends paid by a corporation taxed twice?
6.  Explain the nature and purpose of the dividends received deduction?
7. Assume that Pam was the only employee of her C Corporation and her salary was $62,400. How much would she be able to save this year in the following different retirement plans: (a) SIMPLE, (b) SEP, (c) Keogh: unpaired profit sharing plan, (d) Solo 401(k) plan? (Hint: See Chapter 14.)

PART B: Partnership Issues:
1.  Define separately and non-separately stated items.
2.  Identify the separately and non-separated stated items as they relate to Pam's proposed partnership.
3.  In handwriting, prepare Form 1065 US Partnership Return of Income, pages 1, 3 and page 4-"Analysis of Net Income (Loss)."
4.  Complete Form 1065, Schedule M-1 (page 4): Reconciliation of Income (Loss) per Books With Income (Loss) per Return.
5.  Complete Schedule K-1, Partner's Share of Income, Credits, Deductions, etc. for Pam only.
 

PART C: S Corporation Issues:
1.  Identify the separately and non-separately stated items as they relate to Pam's proposed incorporation as an S corporation.
2.  In handwriting, prepare Form 1120S US Income Tax Return for an S Corporation, pages 1 and 3.
3.  Complete Form 1120S, Schedule M-1 (page 4) Reconciliation of Income (Loss) per books With Income (Loss) per Return.
4.  Complete Schedule K-1, Shareholder's Share of Income, Credits, Deductions, etc. for Pam only.

PART D: Tax Accounting Issues:
Any new business owner (e.g., Pam) must address several important tax accounting issues before the business begins.  Each issue can have a significant impact on the future tax liabilities of the business.
Tax Year
1.  Distinguish between a calendar year, a fiscal year, and a "short year."
2.  What is Pam's "natural business year"? Explain.
3.  Generally, what determines the tax year for a (a) sole proprietorship, (b) partnership, (c) S corporation, or (d) C corporation?
4.  What tax year should Pam use and how does your decision impact the form of organization she should select?  Explain.
Accounting Methods
5.  Generally, which accounting method must be used for tax purposes?
6.  Generally, who must use the accrual method?
7.  What accounting method should Pam use? Explain.
8.  What is the difference between the percentage-of-completion method and the completed-contract method and which is generally required for tax purposes?
Inventories
9.  What is the purpose of the UNICAP rules and generally, how is the purpose accomplished?

PART E: Corporate Tax Planning Issues:

Read "G.E.s Strategies Let It Avoid Taxes Altogether,"which is in the "Outside Readings"section of Canvas. Answer the following questions.

1. How much profit did GE make in 2010? How much was from the US and from overseas?

2. How much corporate income tax did GE pay on those 2010 profits?

3. What is the current maximum US corporate income tax rate?

4. How did GE accomplish paying the amount of taxes it paid in 2010?

5. When are overseas profits taxed in the US?

6. How does GE get many of its tax breaks?

7. What does GEs contribution to the NYC public schools appear to be?

8. What countries are cited as "low-tax countries"?

9. What is the mission of the GE tax department?

10. How much has GE spent on lobbying during the last decade?

11. What does it appear that GEs strategy will be if congress attempts to reduce corporate tax breaks?

 

PART F: ObamaCare:

1. Read "Overview of Major Provisions of ObamaCare,"which is in the "Outside Readings" section of Canvas. Briefly describe how it appears that ObamaCare will impact (a) you, and (b) a business. You do not have to make any specific calculations.

 

Re: Tax Penalty for Uninsured Individuals pursuant to the "Individual Mandate"

2. Assume Pam is not married. If she does not have health insurance for herself, determine the amount of the annual penalty for failure to maintain "minimum essential health coverage" for an unmarried individual for each of the following scenarios.

 

(a)

(b)

(c)

(d)

(e)

Year

2014

2015

2016

2016

2016

Household income

$65,000

$68,250

$71,663

$200,000

$2,000,000

Unmarried standard deduction

6,200

6,400

6,600

6,600

6,600

Personal exemption

4,000

4,200

4,400

4,400

4,400

Bronze level premium for one

5,000

5,500

6,050

6,050

6,050

 

3. Assume Pam is married. Determine her tax penalty for 2018 is she has one dependent child over age 18 and 3 dependent children under 18, has household income from her and Bill of $115,000, and $6,000 from one child under age 18. Assume the standard deduction for M-J is $13,000, each personal exemption is $4,000, and the bronze level premium cost for a family of six is $19,000.

 

Re: Premium Assistance Credit

4. Pam wants to know if the government will subsidize the purchase of health insurance for her and/or her family. Using the following assumptions, calculate (a) the "affordable premium amount" and (b) the "premium assistance credit" for each scenario.

 

Family Size

Cost of Silver Plan

Household Income

(a)

1

$4,500

$44,680

(b)

1

$4,500

$27,925

(c)

1

$4,500

$14,855

(d)

1

$4,500

$14,856

(e)

4

$15,400

$69,150

 

Re: Tax Penalty for "Large Employers" pursuant to the "Employer Mandate"

5. In May 2018, Pam employs 48 full-time employees and five part-time employees (i.e., work less than 30 hours per week). If the part-time employees work an aggregate of 360 hours during that month, is Pam a "large employer" for purposes of ObamaCare?

 

6. In 2018, Pam fails to offer "minimum essential coverage" to her employees. If she employs 100 full-time employees and 20 receive a tax credit for the year for enrolling in a state Exchange plan, how much is the tax penalty to Pam's business? How much of the penalty is deductible?

 

7. In 2018, Pam offers health insurance coverage to her employees. If she employs 100 full-time employees and 20 receive a tax credit for the year for enrolling in a state Exchange plan, how much is the penalty to Pam's business? How much of the penalty is deductible?

 

Re: Small Business Health Care Tax Credit

8. In 2018, Pam buys health insurance coverage for her employees from an Exchange for $70,000. How much is the tax credit that her business earns under each of the following scenarios:

a. If Pam had 10 employees and their total average annual wages was $250,000?

b. Same facts as (a), but in 2015 (assumes Pam continued the coverage from 2014)?

c. Same facts as (a), but in 2016 (assumes Pam continued the coverage from 2014 and 2015)?

d. Same facts as (a), but if Pam's gross tax liability was only $5,000?

e. Same facts as (d): how much is her credit "carryback" or "carryforward"?

f. Same facts as (d): how much is the tax deduction for health insurance?

 

Re: "Cadillac Plans"

9. In 2022, to attract and retain her six employees, Pam provides them a high quality health insurance plan and pays the following premiums: $15,000 for each "single" plan and $30,000 for each "family" plan. If Pam purchased two single plans and four family plans, what is the amount of the tax penalty that Pam must pay for providing these plans to her employees? How much of the tax penalty is deductible?

 

 



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