Chapter 04 - Entities Overview

Chapter 4 Entities Overview SOLUTIONS MANUAL Discussion Questions

1. [LO 1] What are the most common legal entities used or operating a !usiness" #ow are these entities treated similarl$ and di erentl$ or state law purposes" Answer: Corporations, limited liability companies (LLCs), general and limited partnerships, and sole proprietorships. These entities differ in terms of the formalities that must be observed to create them, the legal rights and responsibilities conferred on them and their owners, and the ta rules that determine how they and their owners will be ta ed. %. [LO 1] #ow do !usiness owners create legal entities" &s the process the same or all entities" & not' what are the di erences" Answer: The process of creating legal entities differs by entity type. !usiness owners legally form corporations by filing articles of incorporation in the state of incorporation while business owners create limited liability companies by filing articles of organi"ation in the state of organi"ation. #eneral partnerships may be formed either with or without written partnership agreements, and they typically can be formed without filing documents with the state. $owever, limited partnerships are usually organi"ed by written agreement and must typically file a certificate of limited partnership to be recogni"ed by the state. (. [LO 1] What is an operating agreement or an LLC" )re operating agreements re*uired or limited lia!ilit$ companies" & not' wh$ might it !e important to have one" Answer: An operating agreement is a written document among the owners of an LLC specifying the owners% legal rights and responsibilities for dealing with each other. #enerally, operating agreements are not re&uired by law for limited liability companies' however, it might be important to have one to spell out the management practices of the new entity as well as the rights and responsibilities of the owners. 4. [LO 1] E+plain how legal entities di er in terms o the lia!ilit$ protection the$ a ord their owners.

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Chapter 04 - Entities Overview

Answer: Corporations and LLCs offer owners limited liability. #eneral partners and sole proprietors may be held personally responsible for the debts of the general partnership and sole proprietorship. $owever, limited partners are not responsible for the partnership%s liabilities. ,. [LO 1] Wh$ are C corporations still popular despite the dou!le ta+ on their income" Answer: Corporations have an advantage in liability protection compared to sole proprietorships and partnerships. (n addition, corporations have an advantage if owners ever want to ta)e a business public. As a result, corporations remain desirable legal entities despite their ta disadvantages. -. [LO 1] Wh$ is it a nonta+ advantage or corporations to !e a!le to trade their stoc. on the stoc. mar.et" Answer: $aving the ability to issue stoc) in the stoc) mar)et provides corporations with a source of capital typically not available to other types of entities. (n addition, going public provides a mechanism for shareholders of successful closely*held corporations to sell their stoc) on an established e change. /. [LO 1] #ow do corporations protect shareholders rom lia!ilit$" & $ou ormed a small corporation' would $ou !e a!le to avoid repa$ing a !an. loan rom $our communit$ !an. i the corporation went !an.rupt" E+plain. Answer: A corporation is solely responsible for its liabilities. +ne e ception to this is for payroll ta liabilities. ,hareholders of closely*held corporations may be held responsible for these liabilities. (f a corporation were to go ban)rupt, the ban) may have priority in the corporation%s assets but it could not come to the shareholders to satisfy the outstanding ban) loan. The shareholders may lose their investment in the corporation but their personal assets would be safe from the ban). 0. [LO 1' LO %] Other than corporations' are there other legal entities that o er lia!ilit$ protection" )re an$ o them ta+ed as low-through entities" E+plain. Answer: -es. Limited liability companies provide their members with liability protection similar to that provided by corporations to their shareholders. Limited partnerships protect limited partners, but not general partners, from partnership liabilities. All of these alternatives to corporations are ta ed as flow*through entities. Limited liability companies are either ta ed as partnerships (if there are at least two members), sole proprietorships (if there is only one individual member), or as disregarded entities (if there is only one corporate member). Limited partnerships are generally ta ed as partnerships.

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Chapter 04 - Entities Overview

1. [LO %] &n general' how are unincorporated entities classi ied or ta+ purposes" Answer: .nincorporated entities are taxed as either partnerships, sole proprietorships, or disregarded entities (an entity that is considered to be the same entity as the owner). .nincorporated entities (including LLCs) with more than one owner are ta ed as partnerships. .nincorporated entities (including LLCs) with only one individual owner such as sole proprietorships and single*member LLCs are ta ed as sole proprietorships. 10. [LO %] Can unincorporated legal entities ever !e treated as corporations or ta+ purposes" Can corporations ever !e treated as low-through entities or ta+ purposes" E+plain. Answer: Treasury regulations permit owners of unincorporated legal entities to elect to have them treated as C corporations. +n the other hand, shareholders of certain eligible corporations may elect to have them receive flow*through ta treatment as , corporations. 11. [LO %] What are the di erences' i an$' !etween the legal and ta+ classi ication o !usiness entities" Answer: A business entity may be legally classified as a corporation, limited liability company (LLC), a general partnership (#/), a limited partnership (L/), or a sole proprietorship under state law. $owever, for ta purposes a business entity can be classified as either a separate ta paying entity or as a flow*through entity. ,eparate ta paying entities pay ta on their own income. (n contrast, flow*through entities generally don%t pay ta es because income from these entities flows through to their business owners who are responsible for paying ta on the income. C corporations are separate ta paying entities and if elected some flow*through entities may be treated as separate ta paying entities. 0low*through entities are usually ta ed as either partnerships, sole proprietorships, or disregarded entities. 1%. [LO %] What t$pes o !usiness entities does our ta+ s$stem recogni2e" Answer: Although there are more types of legal entities, there are really only four categories of business entities recogni"ed by our ta system: C corporations, treated as separate ta paying entities, , corporations, partnerships, and sole proprietorships, treated as flow*through entities. 1(. [LO (] Who pa$s the irst level o ta+ on a C corporation3s income" What is the ta+ rate applica!le to the irst level o ta+"

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Chapter 04 - Entities Overview

Answer: The C corporation files a ta return and pays ta es on its ta able income. The marginal ta rate depends on the amount of the corporation%s ta able income. The current marginal ta rates range from a low of 12 percent to a ma imum of 34 percent. The most profitable corporations are ta ed at a flat 32 percent rate. 14. [LO (] Who pa$s the second level o ta+ on a C corporation3s income" What is the ta+ rate applica!le to the second level o ta+ and when is it levied" Answer: A corporation%s shareholders are responsible for the second level of ta on corporate income. The applicable rate for the second level of ta depends on whether corporations retain their after*ta earnings and on the type of shareholder(s). The shareholders pay ta either when they receive dividends at the dividend ta rate or when they sell their stoc) at the capital gains ta rate (either long* or short*term, depending on how long they held the stoc)). (ndividual shareholders may also be re&uired to pay a 5edicare Contribution Ta of 3.67 on capital gains and dividends, depending on their income level. Corporate shareholders may be eligible for a dividends received deduction on dividends received from stoc) ownership. This deduction reduces the dividend ta rate for corporate shareholders. (nstitutional and ta *e empt shareholders also have special rules on the ta ation of dividends and capital gains. 1,. [LO (] &s it possi!le or shareholders to de er or avoid the second level o ta+ on corporate income" 4rie l$ e+plain. Answer: -es. The second level of ta can be avoided entirely to the e tent shareholder payments such as salary, rents, interest, and fringe benefits are ta deductible. The second level of ta is deferred to the e tent corporations don%t pay dividends and shareholders defer selling their shares. $owever, if a corporation retains earnings with no business purpose for doing so, it may be sub8ect to the accumulated earnings ta . This is a penalty ta that eliminates the ta incentive for retaining earnings to avoid the double ta 1-. [LO (] #ow does a corporation3s decision to pa$ dividends a ect its overall ta+ rate [5corporate level ta+ 6 shareholder level ta+78ta+a!le income]" Answer: A corporation%s double*ta rate includes the corporate ta rate on its income and the ta rate paid by shareholders on either distributed earnings or stoc) sales. Therefore, the double*ta rate increases with the proportion of earnings distributed as dividends to shareholders. The shareholder may choose to delay recogni"ing the second level of ta if it relates to stoc) sales because the shareholder can control the timing of that ta .

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Chapter 04 - Entities Overview

1/. [LO (] &s it possi!le or the overall ta+ rate on corporate ta+a!le income to !e lower than the ta+ rate on low-through entit$ ta+a!le income" & so' under what conditions would $ou e+pect the overall corporate ta+ rate to !e lower" Answer: -es, it is possible for the overall corporate ta rate to be lower than the ta rate on flow*through entity income under certain conditions. 9hen corporate marginal rates are substantially lower than individual shareholder marginal rates and dividends are ta ed at preferential rates, the combined effect of low corporate marginal rates and preferential dividend rates can produce an overall ta rate less than the individual shareholder%s marginal rate. 10. [LO (] )ssume Congress increases individual ta+ rates on ordinar$ income while leaving all other ta+ rates constant. #ow would this change a ect the overall ta+ rate on corporate ta+a!le income" #ow would this change a ect overall ta+ rates or owners o low-through entities" Answer: The overall ta rate on corporate ta able income would remain constant because Congress did not change the corporate rate, dividend rate, or capital gains rate. The ta rate for flow*through entities would increase because their individual owners would have a higher ta liability on the business income. 11. [LO (] )ssume Congress increases the dividend ta+ rate to the ordinar$ income rate while leaving all other ta+ rates constant. #ow would this change a ect the overall ta+ rate on corporate ta+a!le income" Answer: The overall corporate income ta rate would increase because the second level ta to shareholders on the dividend distributions would increase. The overall ta rate would also increase because individual shareholders would be ta ed at a higher rate due to the increase in the dividend rate. %0. [LO (] Evaluate the ollowing statement9 :When dividends and long-term capital gains are ta+ed at the same rate' the overall ta+ rate on corporate income is the same whether the corporation distri!utes its a ter-ta+ earnings as a dividend or whether it reinvests the a terta+ earnings to increase the value o the corporation.; Answer: This statement is incorrect because it ignores the time value of money. Although dividends and long*term capital gains are currently ta ed at the same rate for individual shareholders, this does not mean the present value of capital gains ta es paid when shares are sold will e&ual dividends ta es paid when dividends are received. As shareholders increase the holding period of their shares, capital gains ta es on

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Chapter 04 - Entities Overview

share appreciation attributable to reinvested dividends are deferred, and the present value of these capital gains% ta es will decline relative to ta es paid currently on dividends. %1. [LO (] & <=> corporation is a shareholder o 4C? corporation' how man$ levels o ta+ is 4C?3s !e ore-ta+ income potentiall$ su!@ect to" #as Congress provided an$ ta+ relie or this result" E+plain. Answer: Ta es are paid first by !C: and then by ;-< when it receives !C:%s dividends. ;-< shareholders will also pay ta es on dividends received from ;-<. Thus, the before*ta income of !C: will be ta ed at least three times if both !C: and ;-< pay out all of their after*ta earnings as dividends. This potential for triple ta ation is mitigated somewhat by the dividends received deduction ;-< would receive on !C:%s dividends. %%. [LO (] #ow man$ times is income rom a C corporation ta+ed i a retirement und is the owner o the corporation3s stoc." E+plain. Answer: The income from a C corporation owned by a retirement fund is ta ed twice: once at the corporate level and another time at the retirees% level. The retirement fund isn%t ta ed on the earnings received, but those earnings are ta ed to the retirees when they receive the benefits. %(. [LO (] List our !asic ta+ planning strategies that corporations and shareholders can use to mitigate dou!le ta+ation o a ta+a!le corporation3s ta+a!le income. Answer: 1. /ay reasonable salaries to shareholders. =. Lease property from shareholders. 3. :efer or eliminate dividend payments. >. :efer capital gains ta es on shares by ma)ing lifetime gifts of appreciated stoc). %4. [LO (] E+plain wh$ pa$ing a salar$ to an emplo$ee-shareholder is an e ective wa$ to mitigate the dou!le ta+ation o corporate income. Answer: /aying salary (to the e tent it is reasonable) to an employee?shareholder is an effective way to mitigate the double ta ation of corporate income because it allows the corporation to ta)e a deduction for the salary paid thereby reducing the first level of ta on corporate income. The employee reports the salary as income and pays ta at ordinary rates. This ta rate is generally higher than the dividend ta rate but the salary is ta ed only once rather than twice. $owever, both the employer and employee must pay 0(CA ta on the salary.

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Chapter 04 - Entities Overview

%,. [LO (] What limits appl$ to the amount o deducti!le salar$ a corporation ma$ pa$ to an emplo$ee-shareholder" Answer: ,alary payments to employee*shareholders are only deductible to the e tent they are @reasonable.A The definition of reasonable salary depends on the facts and circumstances, but typically ta)es into account such factors as the nature of the shareholder%s duties, time spent, amounts paid to employees performing similar duties within the industry, etc. %-. [LO (] E+plain wh$ the &AB would !e concerned that a closel$ held C corporation onl$ pa$ its shareholders reasona!le compensation. Answer: Closely held corporations may have incentives to reduce the double ta on income by paying large salaries to its shareholder?employees. !y classifying distributions as salary rather than dividends, the overall double ta rate decreases because the salary is ta deductible at the corporate level. The (B, would be concerned that the closely*held corporation would be classifying too much as salary thereby reducing the corporate level ta by more than it would be entitled. %/. [LO (] CAesearchDWhen a corporation pa$s salar$ to a shareholder-emplo$ee !e$ond what is considered to !e reasona!le compensation' how is the salar$ in e+cess o what is reasona!le treated or ta+ purposes" &s it su!@ect to dou!le ta+ation" [Hint: See Reg. 1.1627(b)(1).] Answer: Beg. C1.1D=*E(b)(1) indicates that unreasonable salary payments will be treated as constructive dividends to shareholders. The corporation loses the ta deduction for the unreasonable salary. The shareholder has dividend income ta ed at the lower dividend ta rate. Any payroll ta paid on the unreasonable salary can be refunded. %0. [LO (] #ow can ringe !ene its !e used to mitigate the dou!le ta+ation o corporate income" Answer: /aying fringe benefits can be used to mitigate the double ta ation of corporate income in the same way as paying salaries to shareholder?employees. That is, paying fringe benefits produces a corporate ta deduction, reducing the corporate level ta . The shareholder may be ta ed on the benefit (if it is non*&ualified)' however, the ta is 8ust a single*level ta . (n some cases when the fringe benefit is &ualified, the shareholder would not pay ta on the benefit and it would escape ta altogether.

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Chapter 04 - Entities Overview

%1. [LO (] #ow man$ levels o ta+ation appl$ to corporate earnings paid out as *uali ied ringe !ene its" E+plain Answer: Corporate earnings paid to shareholders in the form of medical insurance, group*term life insurance or other &ualified fringe benefits are never ta able because they are deductible by the corporation paying for the benefits and are not ta able to the shareholder receiving them. (0. [LO (] #ow man$ levels o ta+ation appl$ to corporate earnings paid out as non*uali ied ringe !ene its" E+plain Answer: /aying corporate earnings out as non&ualified fringe benefits produces one level of ta . The corporation receives a deduction for the fringe benefit and the shareholder?employee pays ta at ordinary rates on the benefit. (1. [LO (] #ow can leasing propert$ to a corporation !e an e ective method o mitigating the dou!le ta+ on corporate income" Answer: Lease payments to shareholders are deductible by the corporation and ta able by shareholders. !ecause they are deductible at the corporate level, corporate earnings paid to shareholders as lease payments are only ta ed once at the shareholder level. This is a particularly useful strategy when shareholder marginal rates are lower than corporate marginal rates (note however, that the rental income received by the shareholder may be sub8ect to the 3.67 5edicare Contribution Ta , depending on the shareholder%s income level). (%. [LO (] When a corporation leases propert$ rom a shareholder and pa$s the shareholder at a higher than mar.et rate' how is the e+cess li.el$ to !e classi ied !$ the &AB" Answer: The e cess lease payment is li)ely to be classified as a dividend. That means that the corporation will not receive a deduction for the e cess lease payment, so it will pay ta on the e cess, and the shareholder will also pay ta on the deemed dividend. ((. [LO (] #ow do shareholder loans to corporations mitigate the dou!le ta+ o corporate income"

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Chapter 04 - Entities Overview

Answer: 9hen shareholders lend their money to their corporations, the corporations are allowed to deduct the interest they pay on the loan. ,hareholders are ta ed at ordinary rates on the interest income they receive from the corporation. As a result, shareholder loans to corporations provide yet another vehicle for corporations to get earnings out of the corporation and into shareholders% hands while avoiding a double ta on earnings. As with salary and rent payments, interest paid to shareholders in e cess of mar)et rates may be reclassified by the (B, as nondeductible dividend payments. (4. [LO (] Conceptuall$' what is the overall ta+ rate imposed on interest paid on loans rom shareholders to corporations" Answer: The overall effective ta rate imposed on interest paid on loans from shareholders to corporations is the shareholder%s marginal ta rate on ordinary income (as long as the interest is deemed to be reasonable in amount). (,. [LO (] & a corporation !orrows mone$ rom a shareholder and pa$s the shareholder interest at a greater than mar.et rate' how will the interest in e+cess o the mar.et rate !e treated !$ the &AB" Answer: The (B, is li)ely to argue that the interest paid in e cess of a mar)et rate should be treated as a constructive dividend. As such, it would not be deductible by the corporation and would be treated as dividend income by the shareholder. (-. [LO (] When a C corporation reports a loss or the $ear' can shareholders use the loss to o set their personal income" Wh$ or wh$ not" Answer: Fo. !ecause C corporations are treated as separate entities for ta purposes, their losses do not flow through to shareholders. #enerally, net operating losses of C corporations may be carried bac) two years and then forward =G years to offset the income of the C corporations. (/. [LO (] &s a current-$ear net operating loss o a C corporation availa!le to o set income rom the corporation in other $ears" Answer: 9hile F+Ls provide no ta benefit to a corporation in the year the corporation e periences the F+L, they may be used to reduce corporate ta es in other years. #enerally, C corporations with a F+L for the year can carry bac) the loss to offset the ta able income reported in the two preceding years and carry it forward for up to =G years.

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Chapter 04 - Entities Overview

(0. [LO (] ) C corporation has a current $ear loss o E100'000. Fhe corporation had paid estimated ta+es or the $ear o E10'000 and e+pects to have this amount re unded when it iles its ta+ return. &s it possi!le that the corporation ma$ receive a re und larger than E10'000" & so' how is it possi!le" & not' wh$ not" Answer: !ecause the C corporation may carry bac) its current year net operating loss to the prior two ta years, it may re&uest an additional refund of ta es paid in the carry bac) years to the e tent the ta liabilities related to those years are reduced by the net operating loss carrybac). +f course, if the C corporation also had net operating losses in the prior two years, it would not be able to carry bac) its net operating loss and receive an additional refund. (t could also carry forward the net operating loss for up to =G years. (1. [LO (] What happens to a C corporation3s net operating loss carr$over a ter %0 $ears" Answer: (f a corporation is unable to utili"e its F+L carryforwards in the =G years following its creation, the F+L will e pire unused. That is, the corporation will forever lose the benefit of the F+L. 40. [LO (] ?oes a C corporation gain more ta+ !ene it !$ carr$ing orward a net operating loss to o set other ta+a!le income two $ears a ter the GOL arises or !$ carr$ing the GOL !ac. two $ears" E+plain. Answer: C corporations generally prefer to utili"e net operating loss carryforwards as soon as possible. 0rom a time value of money perspective, e&uivalent refunds received sooner are worth more than refunds received later. This suggests a C corporation would prefer to carrybac) a net operating loss. $owever, if the corporation%s marginal ta rate in the carry bac) and carry forward years differ, it may be preferable to carry the loss to the ta year with the higher marginal ta rate. 41. [LO (] &n its irst $ear o e+istence' HEB' an B corporation' reported a !usiness loss o E10'000. Him' HEB3s sole shareholder' reports E,0'000 o ta+a!le income rom sources other than HEB. What must $ou .now in order to determine whether she can deduct the E10'000 loss against her other income" E+plain.

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Answer: !ecause an , corporation is a flow*through entity, the business loss from HI, is allocated to Him. $owever, the loss must clear certain limitations in order for Him to deduct this loss against her other income. 0irst, Him may deduct the loss to the e tent of her ta basis in her HI, stoc). The second limitation is the @at*ris)A amount. (n general, the at ris) amount is similar to her basis in her HI, stoc) so the at*ris) limitation will li)ely not be any more binding than the basis limitation. (f Him has ade&uate basis and at*ris) amounts she can deduct the loss if she is involved in wor)ing for HI,. (f Him is a passive investor in HI,, the loss is a passive activity loss and Him may only deduct the loss to the e tent she has income from other passive investments (businesses in which she is a passive investor). 4%. [LO (] Wh$ are B corporations less avora!le than C corporations and entities ta+ed as partnerships in terms o owner-related limitations" Answer: , corporations may not have more than 1GG shareholders and they may not have corporations, partnerships, nonresident aliens, or certain trusts as shareholders. The only ownership restrictions for C corporations and partnerships is that C corporations must have a least one shareholder and a partnership (or entity ta ed as a partnership) must have at least two owners. 4(. [LO (] )re C corporations or low-through entities 5B corporations and entities ta+ed as partnerships7 more le+i!le in terms o selecting a ta+ $ear-end" Wh$ are the ta+ rules in this area di erent or C corporations and low-through entities" Answer: C corporations provide greater fle ibility when selecting ta years*ends. #enerally, corporations can choose a ta year that ends on the last day of any month of the year. (n contrast, , corporations must typically adopt a calendar year*end while partnerships are generally re&uired to adopt year*ends consistent with the partners% year*ends. The ta laws attempt to re&uire flow*through entities to have the same year end as their owners to limit the owners% ability to defer reporting income. C corporation income does not flow through to owners so the year end does not matter from a ta perspective. 44. [LO (] Which entit$ t$pes are generall$ ree to use the cash method o accounting" Answer: The ta laws restrict the entities that may use the cash method. C corporations are generally re&uired to use the accrual method of accounting (smaller C corporations may use the cash method). , corporations and entities ta ed as partnerships generally may use the cash method of accounting. The cash method provides a ta advantage for entities because it allows the entities to have better control of when they recogni"e income and e penses.

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4,. [LO (] )ccording to the ta+ rules' how are pro its and losses allocated to LLC mem!ers" #ow are the$ allocated to B corporation shareholders" Which entit$ permits greater le+i!ilit$ in allocating pro its and losses" Answer: LLC profits and losses are allocated according to the LLC operating?partnership agreement. The LLC operating agreement may provide for special allocations that are different from LLC members% actual ownership percentages. (n contrast, , corporation profits must be allocated to shareholders pro rata according to their ownership percentages. Thus, LLCs provide for greater fle ibility in allocating profits and losses. 4-. [LO (] Compare and contrast the I&C) ta+ !urden o B corporation shareholder-emplo$ees and LLC mem!ers receiving compensation or wor.ing or the entit$ 5guaranteed pa$ments7 and !usiness income allocations to B corporation shareholders and LLC mem!ers assuming the owners are activel$ involved in the entit$3s !usiness activities. #ow does $our anal$sis change i the owners are not activel$ involved in the entit$3s !usiness activities" Answer: ,hareholder*employees of , corporations pay 0(CA ta on the shareholder%s salary. $owever, the shareholder%s allocation of the , corporation%s business income for the year is not sub8ect to 0(CA or self*employment ta . (f shareholders are actively involved in the entity%s business activities, the income allocations are not sub8ect to the 5edicare Contribution Ta . (ncome allocations to shareholders who are not active in the entity%s business activities may be sub8ect to the 5edicare Contribution Ta , depending on the shareholder%s income level. LLC members pay self*employment ta on any guaranteed payments they receive and on their share of business income from the LLC if they are actively involved in the LLC%s business activities. An LLC member may also pay an additional .47 of 5edicare ta on guaranteed payments and business*income allocations, depending on the member%s income level. 0urther an LLC member who are not actively involved in the entity%s business activity does not pay self*employment ta on the member%s share of operating income from the LLC. $owever, the member%s share of business income may be sub8ect to the 5edicare Contribution Ta depending on the member%s income level. 4/. [LO (] E+plain how lia!ilities o an LLC or an B corporation a ect the amount o ta+ losses rom the entit$ that limited lia!ilit$ compan$ mem!ers and B corporation shareholders ma$ deduct. ?o the ta+ rules avor LLCs or B corporations"

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Chapter 04 - Entities Overview

Answer: LLC liabilities are included as part of a member%s ta basis while , corporation liabilities (other than loans from the shareholder) are not included in an , corporation shareholder%s ta basis. This distinction is important because the amount of loss a member or shareholder may deduct is limited to his or her ta basis in either his or her LLC interest or shares. Thus, in this regard ta rules favor LLCs. 40. [LO (] Fo what e+tent are gains and losses on distri!uted assets recogni2ed when C corporations' B corporations' or partnerships li*uidate" ?o the ta+ rules in this area alwa$s avor certain entities over others" Wh$ or wh$ not" Answer: #enerally, corporate built*in gains and losses must be recogni"ed on li&uidationJ twice when ta able corporations li&uidate and once when , corporations li&uidate. (n contrast, partnership built*in gains and losses are generally deferred when partnerships li&uidate. Thus, ta rules tend to favor partnerships if there are built*in gains at the time of li&uidation and corporations if there are built*in losses at the time of li&uidation. 41. [LO (] & limited lia!ilit$ companies and B corporations are !oth ta+ed as low-through entities or ta+ purposes' wh$ might an owner pre er one orm over the other or ta+ purposes" List separatel$ the ta+ actors supporting the decision to operate as either an LLC or B corporation. Answer: Although LLCs and , corporations are both ta ed as flow*through entities, several differences e ist between the two types of entities. Advantages of , corporations include the ability for shareholders to wor) as employees of the business and not pay employment ta es on income allocations (self*employment and 0(CA ta benefit), and the ease of selling their stoc). (n contrast, the advantages to operate as an LLC are more numerous and include 1) no restrictions on the number and type of allowable owners, =) few restrictions on ta *free contributions, 3) special allocations are allowed, >) owner basis for LLC debt, and 2) ease of converting to other entity types. These advantages are summari"ed in the following table:

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Fote: ; represents which entity is more favorable on that particular ta characteristic.

, Corporations Ta Characteristics: Limitations on num!er and t$pe o owners Contri!utions to entit$ Bpecial allocations I&C) and sel -emplo$ment ta+es 4asis computations ?educti!ilit$ o entit$ losses Belling ownership interest Converting to other entit$ t$pes Intities Ta ed as /artnerships ; ; ; ; ; ; ; ;

,0. [LO (] What are the ta+ advantages and disadvantages o converting a C corporation into an LLC" Answer: The ma8or disadvantage of converting a ta able corporation into an LLC is that the appreciation in corporate assets must be ta ed once at the corporate level and again at the shareholder level as part of the conversion to an LLC. After converting to an LLC, the advantage will be that the entity avoids the double ta going forward. (n the absence of a large F+L carry forward to absorb the gain, the present value of this advantage is typically overwhelmed by the ta es that must be paid at the time of conversion. Thus, ma)ing the , election is typically the only viable method for converting a ta able corporation into a flow*through entity. /B+!LI5, ,1. [LO 1] CAesearchD Jisit $our state3s o icial We! site and review the in ormation there related to orming and operating !usiness entities in $our state. Write a short report e+plaining the steps or organi2ing a !usiness in $our state and summari2ing an$ ta+-related in ormation $ou ound. Answer: The items students mention are li)ely to vary from state to state but should include a description of the formalities re&uired to organi"e an entity in the state as well as a general description of the federal (and perhaps state) rules applicable to the entity. ,%. [LO (] Evon would li.e to organi2e B#O as either an LLC or as a C corporation generating an 11 percent annual !e ore-ta+ return on a E%00'000 investment. )ssume individual and corporate ta+ rates are !oth (, percent and individual capital gains and dividend ta+ rates are 1, percent. B#O will pa$ out its a ter-ta+ earnings ever$ $ear as a dividend i it is ormed as

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Chapter 04 - Entities Overview

a C corporation. )ssume Evon is the sole owner o the entit$. &gnore sel -emplo$ment ta+es and the Kedicare Contri!ution Fa+. a. #ow much would Evon .eep a ter ta+es i B#O is organi2ed as either an LLC or as a C corporation" !. What are the overall ta+ rates i B#O is organi2ed as either an LLC or a C corporation" Answer: a. (1) /reta earnings (=) Intity level ta (3) After*ta entity earnings (>) +wner ta (2) After*ta earnings b. +verall ta rate LLC :escription K==,GGG 117 K=GG,GGG *G* K==,GGG (1) M (=) E,EGG (3) 327 K1>,3GG (3) M (>) LLC 327 (>)?(1) C Corp. K==,GGG E,EGG K1>,3GG :escription 117 L K=GG,GGG 327 L (1) (1) M (=)

=,1>2 (3) 127 K1=,122 (3) M (>) Corp. >>.E27 N(=) O (>)P?(1)

,(. [LO (] Evon would li.e to organi2e B#O as either an B corporation or as a C corporation generating a 1 percent annual !e ore-ta+ return on a E%00'000 investment. )ssume individual and corporate ta+ rates are !oth (, percent and individual capital gains and dividend ta+ rates are %0 percent. B#O will pa$ out its a ter-ta+ earnings ever$ $ear as a dividend i it is ormed as a C corporation. )ssume Evon is the sole owner o the entit$ and ignore sel -emplo$ment ta+es. Iinall$' assume Evon is activel$ involved in the !usiness. a. #ow much would Evon .eep a ter ta+es i B#O is organi2ed as either an B corporation or as a C corporation" !. What are the overall ta+ rates i B#O is organi2ed as either an B Corporation or as a C corporation"

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Chapter 04 - Entities Overview

Answer: a. (1) /reta earnings (=) Intity level ta (3) After*ta entity earnings (>) +wner ta (2) After*ta earnings b. +verall ta rate , Corp. :escription K16,GGG 47 L K=GG,GGG *G* K16,GGG (1) M (=) D,3GG (3) 327 K11,EGG (3) M (>) LLC 327 (>)?(1) C Corp. K16,GGG D,3GG K11,EGG :escription 47 L K=GG,GGG 327 L (1) (1) M (=)

1,E22 (3) 127 K4,4>2 (3) M (>) Corp. >>.E27 N(=) O (>)P?(1)

,4. [LO(] Lac. would li.e to organi2e MMB as either an LLC or as a C corporation generating an 11 percent annual !e ore-ta+ return on a E100'000 investment. )ssume individual ordinar$ rates are (, percent' corporate rates are 1, percent' and individual capital gains and dividends ta+ rates are %0 percent. MMB will distri!ute its a ter-ta+ earnings ever$ $ear as a dividend i is ormed as a C corporation. )ssume Lac. is the sole owner o the entit$ and is activel$ involved in the !usiness. &gnore sel -emplo$ment ta+es. a. #ow much would Lac. .eep a ter ta+es i MMB is organi2ed as either an LLC or as a C corporation" !. What are the overall ta+ rates i MMB is organi2ed as either an LLC or as a C corporation" Answer: a. (1) /reta earnings (=) Intity level ta (3) After*ta entity earnings (>) +wner ta (2) After*ta earnings b. +verall ta rate LLC :escription K11,GGG 117 L K1GG,GGG *G* K11,GGG (1) M (=) 3,62G (3) 327 KE,12G (3) M (>) LLC 327 (>)?(1) C Corp. K11,GGG 1,D2G K4,32G :escription 117 L K1GG,GGG 127 L (1) (1) M (=)

1,6EG (3) =G7 KE,>6G (3) M (>) Corp. 3=7 N(=) O (>)P?(1)

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Chapter 04 - Entities Overview

,,. [LO (] CAesearchD Nsing the We! as a research tool' determine which countries lev$ a dou!le-ta+ on corporate income. 4ased on $our research' what seem to !e the pros and cons o the dou!le-ta+" Answer: 5any countries levy a double ta on corporate income' however, several have developed various techni&ues to offset or mitigate the double ta . 0or e ample, an imputation system (Australia, Few <ealand) allows the corporation to allocate its ta es paid as a ta credit to its shareholders. (n other countries, dividends may be partially or totally e empt from ta (Austria, #ermany, Fetherlands, and Canada). (reland, ,wit"erland, and the ., do not relieve double ta ation through one of these methods. +ne disadvantage of double ta ation on corporate income is that the ta system may distort the economic decisions made. That is, if the avoidance of double ta ation is an important factor in a business decision, but otherwise it is desirable for the business to organi"e as a corporation, the ta system may unduly influence the entity form choice. ,ome claim that a ta on dividends creates an incentive for corporations to retain income rather than distribute it to shareholders. 0inally, double ta ation may encourage higher debt usage in corporations. ,ome proponents of the double ta argue that the dividend ta prevents the wealthy from en8oying ta *free income from corporate investments. Nhttp:QQwww.ta foundation.org, www.cato.org, http:QQwww.answers.com?topic?double* ta ationP ,-. [LO (] CFa+ IormsD Karathon &nc. 5a C corporation7 reported E1'000'000 o ta+a!le income in the current $ear. ?uring the $ear it distri!uted E100'000 as dividends to its shareholders as ollows9 E,'000 to Ou$ a ,P individual shareholder. E1,'000 to Little Aoc. Corp. a 1,P shareholder 5C corporation7 E00'000 to other shareholders.

a. #ow much o the dividend pa$ment did Karathon deduct in determining its ta+a!le income" KG. A corporation is not allowed to deduct dividend distributions it ma)es to its shareholders. !. )ssuming Ou$3s marginal ordinar$ ta+ rate is (,P' how much ta+ will he pa$ on the E,'000 dividend he received rom Karathon &nc." KE2G. #uy would pay ta on the dividend at a 127 ta rate.

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Chapter 04 - Entities Overview

c. )ssuming Little Aoc. Corp.3s marginal ta+ rate is (4P' what amount o ta+ will it pa$ on the E1,'000 dividend it received rom Karathon &nc. 5/0P dividends received deduction7"

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Chapter 04 - Entities Overview

K1,23G ta . K12,GGG dividend M K1G,2GG dividends received deduction R K>,2GG ta able portion of dividend L 3>7 marginal ta rate R K1,23G. d. Complete Iorm 11%0 Bchedule C or Little Aoc. Corp. to re lect its dividends received deduction.

e. On what line o Little Aoc. Corp.3s Iorm 11%0 page 1 is the dividend rom Karathon &nc. reported and on what line o Little Aoc. Corp.3s Iorm 11%0 is its dividends received deduction reported. Little Boc) Corp will report the K12,GGG dividend on 0orm 11=G, page 1, line >. Little Boc) Corp. will report its K1G,2GG dividend on 0orm 11=G, page 1, line =4b. ,/. [LO (] CAesearchD ) ter several $ears o pro ita!le operations' Lavell' the sole shareholder o L4? &nc.' a C corporation' sold 10 percent o her L4? stoc. to >GO &nc.' a C corporation in a similar industr$. ?uring the current $ear L4? reports E1'000'000 o a ter-ta+ income. L4? distri!utes all o its a ter-ta+ earnings to its two shareholders in proportion to their stoc.holdings. )ssume >GO3s marginal ta+ rate is (, percent. #ow much ta+ will >GO pa$ on the dividend it receives rom L4?" What is >GO3s overall ta+ rate on its dividend income" [Hint: see IRC 243(a)]

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Chapter 04 - Entities Overview

Answer: According to (BC C=>3(a), corporations are generally entitled to a EG percent dividends received deduction. ,ubsections (b) and (c) go on to provide for a larger dividends received deduction if a corporation owns =G percent or more of the dividend* paying corporation. (n this situation, <F+, (nc. will receive a EG percent dividend received deduction on dividends received from S!:, (nc. since <F+ only owns 16 percent of S!:, (nc. <F+, (nc.%s ta liability of the dividend it receives from S!:, (nc. is calculated in the following table: :escription (1) S!:%s after*ta income (=) :ividend paid to <F+ (3) :ividends received deduction (>) <F+%s ta able dividend (2) <F+%s marginal ta rate (D) <F+%s ta on dividend <F+%s overall ta rate on dividend K1,GGG,GG G 16G,GGG K1=D,GGG 2>,GGG 327 K16,4GG 1G.27 167 L (1) (=) L EG7 (=) M (3) (>) (2) (D)?(=)

,0. [LO (] Ior the current $ear' Custom Cra t Bervices &nc. 5CCB7' a C corporation' reports ta+a!le income o E%00'000 !e ore pa$ing salar$ to Laron the sole shareholder. Laron3s marginal ta+ rate on ordinar$ income is (, percent and 1, percent on dividend income. )ssume CCB3s ta+ rate is (, percent. a. #ow much total income ta+ will Custom Cra t Bervices and Laron pa$ 5com!ining !oth corporate and shareholder level ta+7 on the E%00'000 ta+a!le income or the $ear i CCB doesn3t pa$ an$ salar$ to Laron and instead distri!utes all o its a ter-ta+ income to Laron as a dividend" !. #ow much total income ta+ will Custom Cra t Bervices and Laron pa$ 5com!ining !oth corporate and shareholder level ta+7 on the E%00'000 o income i CCB pa$s Laron a salar$ o E1,0'000 and distri!utes its remaining a ter-ta+ earnings to Laron as a dividend" c. Wh$ is the answer to part ! lower than the answer to part a"

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Chapter 04 - Entities Overview

Answer: a. 9ithout :escription ,alary K =GG,GGG G K =GG,GGG (1) M (=) EG,GGG (3) 327 K13G,GGG (3) M (>) 14,2GG (2) 127 K 64,2GG (>) O (D) b. 9ith ,alary K =GG,GGG :escription

(1) Ta able income before salary (=) ,alary (3) Ta able income (>) Intity ta (2) After*ta entity earnings (D) Saron%s ta on dividends and salary Combined ta

12G,GGG K 2G,GGG (1) M (=) 1E,2GG (3) 327 K 3=,2GG (3) M (>) 2E,3E2 N(=) 327P O N(2) 127P K E>,6E2 (>) O (D)

c. The combined ta es are lower under part b because the ma8ority of the corporation%s earnings are only sub8ect to one level of ta (the individual ta on the salary). (n part a the ta able income after salary is K=GG,GGG but in part b it is K2G,GGG since the deduction of K12G,GGG is ta)en and this leads to only K2G,GGG that is ta ed twice in part b. ,1. [LO (] Ior the current $ear' Kaple Corporation' a C corporation' reports ta+a!le income o E%00'000 !e ore pa$ing salar$ to its sole shareholder ?iane. ?iane3s marginal ta+ rate on ordinar$ income is (, percent and 1, percent on dividend income. & Kaple pa$s ?iane a salar$ o E1,0'000 !ut the &AB determines that ?iane3s salar$ in e+cess o E00'000 is unreasona!le compensation' what is the amount o the overall ta+ 5corporate level 6 shareholder level7 on Kaple3s E%00'000 pre-salar$ income" )ssume Kaple3s ta+ rate is (, percent and it distri!utes all a ter-ta+ earnings to ?iane. Answer: K61,EGG overall ta (combined ta for corporation and shareholder) computed as follows: 9ith K6G,GGG ,alary K =GG,GGG :escription

(1) Ta able income before salary (=) ,alary (3) Ta able income (>) Intity ta (2) After*ta entity earnings (D) :iane%s ta on dividends (E) :iane%s ta on salary

6G,GGG K 1=G,GGG (1) M (=) K>=,GGG (3) 327 KE6,GGG (3) M (>) K11,EGG (2) 127 K=6,GGG (=) 327
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Chapter 04 - Entities Overview

+verall ta

K61,EGG (>) O (D) O (E)

(n calculating the overall ta on 5aple Corp%s pre*salary ta able income, the K6G,GGG amount the (B, will allow 5aple to deduct is ta)en into account rather than the K12G,GGG amount it would prefer to deduct. -0. [LO (] Band$ Corp. pro@ects that it will have ta+a!le income o E1,0'000 or the $ear !e ore pa$ing an$ ringe !ene its. )ssume Haren' Band$3s sole shareholder' has a marginal ta+ rate o (, percent on ordinar$ income and 1, percent on dividend income. )ssume Band$3s ta+ rate is (, percent. a. What is the amount o the overall ta+ 5corporate level 6 shareholder level7 on Band$3s E1,0'000 o pre-!ene it income i Band$ Corp. does not pa$ out an$ ringe !ene its and distri!utes all o its a ter-ta+ earnings to Haren" !. What is the amount o the overall ta+ on Band$3s E1,0'000 o pre-!ene it income i Band$ Corp. pa$s Haren3s adoption e+penses o E10'000 and the pa$ment is considered to !e a nonta+a!le ringe !ene it" Band$ Corp. distri!utes all o its a ter-ta+ earnings to Haren. c. What is the amount o the overall ta+ on Band$3s E1,0'000 o pre-!ene it income i Band$ Corp. pa$s Haren3s adoption e+penses o E10'000 and the pa$ment is considered to !e a ta+a!le ringe !ene it" Band$ Corp. distri!utes all o its a ter-ta+ earnings to Haren. Answer: a. 9ithout :escription 0ringe !enefits K 12G,GGG G K 12G,GGG (1) M (=) 2=,2GG (3) 327 K4E,2GG (3) M (>) 1>,D=2 (2) 127 K DE,1=2 (>) O (D) b.9ith 0ringe !enefits K 12G,GGG :escription

(1) Ta able income before fringes (=) 0ringe benefits (3) Ta able income (>) Intity ta (2) After*ta entity earnings (D) Haren%s ta on dividends +verall ta

1G,GGG K 1>G,GGG (1) M (=) >4,GGG (3) 327 K 41,GGG (3) M (>) 13,D2G (2) 127 K D=,D2G (>) O (D)

b. Haren is not ta ed on the K1G,GGG payout of adoption e penses because this is considered a &ualified fringe benefit (see above).

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Chapter 04 - Entities Overview

c. 9ith non*&ualified fringe benefits (1) Ta able income before fringes (=) 0ringe benefits (3) Ta able income (>) Intity ta (2) After*ta entity earnings (D) Haren%s ta on dividends (E) Haren%s ta on fringe benefit +verall ta K 12G,GGG 1G,GGG K 1>G,GGG >4,GGG K 41,GGG 13,D2G 3,2GG K DD,12G :escription

(1) M (=) (3) 327 (3) M (>) (2) 127 (=) 327 (>) O (D) O (E)

-1. [LO (] La!ar Corporation' a C corporation' pro@ects that it will have ta+a!le income o E(00'000 !e ore incurring an$ lease e+penses. La!ar3s ta+ rate is (, percent. )!dul' La!ar3s sole shareholder' has a marginal ta+ rate o (1.- percent on ordinar$ income and %0 percent on dividend income. La!ar alwa$s distri!utes all o its a ter-ta+ earnings to )!dul. a. What is the amount o the overall ta+ 5corporate level 6 shareholder level7 on La!ar Corp.3s E(00'000 pre-lease e+pense income i La!ar Corp. distri!utes all o its a ter-ta+ earnings to its sole shareholder )!dul 5include the Kedicare Contri!ution Fa+ on dividend rental income7" !. What is the amount o the overall ta+ on La!ar Corp.3s E(00'000 pre-lease e+pense income i La!ar leases e*uipment rom )!dul at a cost o E(0'000 or the $ear 5include the Kedicare Contri!ution Fa+ on dividend and rental income7" c. What is the amount o the overall ta+ on La!ar Corp.3s E(00'000 pre-lease e+pense income i La!ar Corp. leases e*uipment rom )!dul at a cost o E(0'000 or the $ear !ut the &AB determines that the air mar.et value o the lease pa$ments is E%,'000 5include Kedicare Contri!ution ta+ on rental income7" Answer: a. Fo Lease /ayment (1) Ta able income before lease payment (=) Lease payment (3) Ta able income (>) Intity ta K 3GG,GGG G K 3GG,GGG 1G2,GGG b. K3G,GGG Lease :eduction K 3GG,GGG 3G,GGG K =EG,GGG K4>,2GG c. K=2,GGG Lease :eduction K3GG,GGG :escription

=2,GGG K=E2,GGG (1) M (=) K4D,=2G (3) 327

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Chapter 04 - Entities Overview

(2) After*ta entity earnings (D) Abdul%s ta on dividends (E) Abdul%s ta on lease payment +verall ta

K142,GGG K>D,>1G G K 121,>1G

K 1E2,2GG K>1,ED4 K13,G=G K 1>4,=64

1E6,E2G (3) M (>) K>=,2>3 (2) (=G7 O 3.67) K1G,62G (=) (34.D7 O 3.67) K 1>4,D>3 (>) O (D) O (E)

-%. [LO (] Gutt Corporation pro@ects that it will have ta+a!le income or the $ear o E400'000 !e ore incurring an$ interest e+pense. )ssume Gutt3s ta+ rate is (, percent. a. What is the amount o the overall ta+ 5corporate level 6 shareholder level7 on the E400'000 o pre-interest e+pense earnings i #a2el' Gutt3s sole shareholder' lends Gutt Corporation E(0'000 at the !eginning o the $ear' Gutt pa$s #a2el E0'000 o interest on the loan 5interest is considered to !e reasona!le7' and Gutt distri!utes all o its a ter-ta+ earnings to #a2el" )ssume her ordinar$ marginal rate is (, percent and dividend ta+ rate is 1, percent. !. )ssume the same acts as in part a e+cept that the &AB determines that the air mar.et value o the interest should !e E-'000. What is the amount o the dou!le-ta+ on Gutt Corporation3s pre-interest e+pense earnings" Answer: a. Beasonable interest (1) Ta able income before interest (=) Beasonable interest (3) Ta able income (>) Intity ta (2) After*ta entity earnings (D) $a"el%s ta on dividends (E) $a"el%s ta on interest (6) :ouble ta +verall ta rate b. .nreasonable interest K >GG,GGG K >GG,GGG (6,GGG) K 34=,GGG 13E,=GG K=2>,6GG 36,==G =,6GG K 1E6,==G >>.2D7 (D,GGG) K 34>,GGG (1) M (=) 13E,4GG (3) 327 K =2D,1GG (3) M (>) 36,>12 (2) 127 =,1GG (=) 327 K 1E6,>12 (>) O (D) O (E) >>.D7 (6)?(1) :escription

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Chapter 04 - Entities Overview

-(. [LO (] CAesearchD Nltimate Com ort 4lan.ets &nc. has had a great couple o $ears and wants to distri!ute its earnings while avoiding dou!le ta+ation on its income. &t decides to give its sole shareholder' Laura' a salar$ o E1',00'000 in the current $ear. What actors would the courts e+amine to determine i LauraQs salar$ is reasona!le" [#int9 Bee Elliotts' &nc. v. Commissioner' /1- I.%d 1%41 51th Cir. 110(7]. Answer: (f Laura%s salary is reasonable under the circumstances, it will be deductible by .ltimate Comfort !lan)ets (nc. and will be treated as salary income by Laura. The definition of reasonable salary depends on the facts and circumstances, but typically ta)es into account such factors as the nature of the shareholder%s duties, time spent, salaries paid to employees performing similar duties within the industry, etc. The decision in Illiotts (nc. v. Commissioner, E1D 0.=d 1=>1 (4th Cir. 1463) indicates that unreasonable salary payments to Laura will be treated as constructive dividends payments to Laura. -4. [LO (] )lice' the sole shareholder o RLM' decided that she would purchase a !uilding and then lease it to RLM. Bhe leased the !uilding to RLM or E1'0,0 per month. #owever' the &AB determined that the air mar.et value o the lease pa$ment should onl$ !e E1'-00 per month. #ow would the lease pa$ment !e treated with respect to !oth )lice and RLM" Answer: +f the total K1,62G lease payment to Alice, K1,DGG would be treated as a deductible rent e pense to TL/ and as ordinary income to Alice. The remaining K=2G would be treated as a non*deductible dividend to TL/ and a ta able dividend to Alice. -,. [LO (] &n its irst $ear o e+istence 5$ear 17' BCC corporation 5a C corporation7 reported a loss or ta+ purposes o E(0'000. Nsing the corporate ta+ rate ta!le' determine how much ta+ BCC will pa$ in $ear % i it reports ta+a!le income rom operations o E%0'000 in $ear % !e ore an$ loss carr$overs. Answer: Fone. ,CCs% loss in year 1 of (K3G,GGG) will be available to offset income generated by ,CC in year =. ,ince ,CC earned K=G,GGG of ta able income in year = before any loss carryovers, it can use (K=G,GGG) of the loss carryover from year 1 to offset its entire ta able income and will pay no ta . ,CC will have a (K1G,GGG) loss carryover available for year 3 and beyond. --. [LO (] &n its irst $ear o e+istence 5$ear 17' Willow Corp. 5a C corporation7 reported a loss or ta+ purposes o E(0'000. &n $ear % it reports a E40'000 loss. Ior $ear (' it reports ta+a!le income rom operations o E100'000 !e ore an$ loss carr$overs. Nsing the corporate ta+ rate ta!le' determine how much ta+ Willow Corp. will pa$ or $ear (.

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Chapter 04 - Entities Overview

Answer: K>,2GG. (1) -ear 3 ta able income (=) -ear 1 F+L carryforward (3) -ear = F+L carryforward (>) Ta able income reported (2) Ta rate Ta es paid in year 3 :escription K1GG,GGG (K3G,GGG) (K>G,GGG) 3G,GGG (1) M (=) M (3) 127 ,ee corporate ta rate table K>,2GG (>) L (2)

-/. [LO (] C Fa+ IormsD CMlanningD &n its irst $ear o e+istence 5$ear 17 WCC corporation 5a C corporation7 reported ta+a!le income o E1/0'000 and paid E41',,0 o ederal income ta+. &n $ear %' WCC reported a net operating loss o E40'000. WCC pro@ects that it will report E000'000 o ta+a!le income rom its $ear ( activities. a. 4ased on its pro@ections' how much will WCC corporation save in ta+es i it elects to orgo the GOL carr$!ac. and carries its $ear % GOL orward to $ear (" 9CC should carrybac) the year = loss to year 1. (f it carries bac) the loss, the loss will offset income that was ta ed a 347 marginal rate. (n contrast, if it carries the loss forward, the loss will offset income that would be ta ed at a 3>7 rate. Thus 9CC will save K=,GGG more in ta es if it carries the loss bac). 0urther, it will get the ta savings immediately. !. CIormsD )ssuming WCC corporation carries !ac. its $ear % GOL to $ear 1' prepare a Iorm 11(1 :Corporation )pplication or Fentative Ae und; or WCC corporation to re lect the GOL carr$!ac.. Nse reasona!le assumptions to ill in missing in ormation.

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Chapter 04 - Entities Overview

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Chapter 04 - Entities Overview

-0. [LO (] ?amarcus is a ,0P owner o #oop 5a !usiness entit$7. &n the current $ear' #oop reported a E100'000 !usiness loss. )nswer the ollowing *uestions associated with each o the ollowing alternative scenarios. a. #oop is organi2ed as a C corporation and ?amaracus wor.s ull time as an emplo$ee or #oop. ?amarcus has a E%0'000 !asis in his #oop stoc.. #ow much o #oop3s loss is ?amarcus allowed to deduct this $ear" KG. Losses of C corporations do not flow through to shareholders. !. #oop is organi2ed as an LLC. Ii t$ percent o #oop3s loss is allocated to ?amarcus. ?amarcus wor.s ull time or #oop 5he is not considered to !e a passive investor in #oop7. ?amarcus has a E%0'000 !asis in his #oop ownership interest and he also has a E%0'000 at ris. amount in his investment in #oop. ?amarcus does not report income or loss rom an$ other !usiness activit$ investments. #ow much o the E,0'000 loss allocated to him !$ #oop is ?amarcus allowed to deduct this $ear" K=G,GGG. K2G,GGG of $oop%s loss is allocated to :amarcus. $owever, because his basis and at ris) amounts are K=G,GGG, he is allowed to deduct only K=G,GGG of the loss. The remaining K3G,GGG is suspended until :amarcus increases his basis and at*ris) amount. The passive activity limitations do not apply because :amarcus is not considered to be a passive investor in $oop. c. #oop is organi2ed as an LLC. Ii t$ percent o #oop3s loss is allocated to ?amarcus. ?amarcus does not wor. or #oop at all 5he is a passive investor in #oop7. ?amarcus has a E%0'000 !asis in his #oop ownership interest and he also has a E%0'000 at ris. amount in his investment in #oop. ?amarcus does not report income or loss rom an$ other !usiness activit$ investments. #ow much o the E,0'000 loss allocated to him !$ #oop is ?amarcus allowed to deduct this $ear" KG. K2G,GGG of $oop%s loss is allocated to :amarcus. $owever, because :amarcus is a passive investor and he does not have any other sources of passive income he is not allowed to deduct any of the loss allocated to him this year. d. #oop is organi2ed as an LLC. Ii t$ percent o #oop3s loss is allocated to ?amarcus. ?amarcus wor.s ull time or #oop 5he is not considered to !e a passive investor in #oop7. ?amarcus has a E/0'000 !asis in his #oop ownership interest and he also has a E/0'000 at ris. amount in his investment in #oop. ?amarcus does not report income or loss rom an$ other !usiness activit$ investments. #ow much o the E,0'000 loss allocated to him !$ #oop is ?amarcus allowed to deduct this $ear"

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Chapter 04 - Entities Overview

K2G,GGG. :amarcus had ade&uate basis and at ris) amounts to absorb the loss and the passive activity limits do not apply because he is not a passive investor in $oop. Conse&uently, :amarcus can deduct all of the loss allocated to him. e. #oop is organi2ed as an LLC. Ii t$ percent o #oop3s loss is allocated to ?amarcus. ?amarcus does not wor. or #oop at all 5he is a passive investor in #oop7. ?amarcus has a E/0'000 !asis in his #oop ownership interest and he also has a E/0'000 at ris. amount in his investment in #oop. ?amarcus does not report income or loss rom an$ other !usiness activit$ investments. #ow much o the E,0'000 loss allocated to him !$ #oop is ?amarcus allowed to deduct this $ear" KG. 9hile :amarcus has ade&uate basis and at ris) amount to absorb the loss, he is not allowed to deduct any of the loss because he is a passive investor in $oop and he does not have any other sources of passive income. . #oop is organi2ed as a LLC. Ii t$ percent o #oop3s loss is allocated to ?amarcus. ?amarcus does not wor. or #oop at all 5he is a passive investor in #oop7. ?amarcus has a E%0'000 !asis in his #oop ownership interest and he also has a E%0'000 at ris. amount in his investment in #oop. ?amarcus reports E10'000 o income rom a !usiness activit$ in which he is a passive investor. #ow much o the E,0'000 loss allocated to him !$ #oop is ?amarcus allowed to deduct this $ear" K1G,GGG. :amarcus has K=G,GGG basis and K=G,GGG of at ris) amounts to absorb K=G,GGG of the loss. $owever, because :amarcus is a passive investor in $oop, he is allowed to deduct only K1G,GGG of the loss. $e is allowed to deduct K1G,GGG because he has K1G,GGG or passive activity income. (f :amarcus had K3G,GGG passive activity income, he would have been able to deduct only K=G,GGG of the loss because that is the basis and at ris) amount he had. -1. [LO (] CAesearchD Kic.e$' Kic.a$la' and Fa$lor are starting a new !usiness 5KKF7. Fo get the !usiness started' Kic.e$ is contri!uting E%00'000 or a 40P ownership interest' Kic.al$a is contri!uting a !uilding with a value o E%00'000 and a ta+ !asis o E1,0'000 or a 40P ownership interest' and Fa$lor is contri!uting legal services or a %0P ownership interest. What amount o gain is each owner re*uired to recogni2e under each o the ollowing alterative situations" [#int9 Loo. at S(,1 and S/%1.] a. KKF is ormed as a C corporation. .nder C321, 5ic)ey and 5ic)alya do not recogni"e any gain. $owever, because Taylor is contributing services (and services are not property) Taylor must recogni"e K1GG,GGG of ordinary income on the receipt of the K1GG,GGG worth of stoc) she receives from 55T.

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Chapter 04 - Entities Overview

!. KKF is ormed as an B corporation. ,ame answer as part a. .nder C321, 5ic)ey and 5ic)alya do not recogni"e any gain. $owever, because Taylor is contributing services (and services are not property) Taylor must recogni"e K1GG,GGG of ordinary income on the receipt of the K1GG,GGG worth of stoc) she receives from 55T. c. KKF is ormed as an LLC. .nder CE=1, neither 5ic)y nor 5ic)ayla recogni"e any gain on the transfer. $owever, because Taylor has a twenty percent interest in 55T, she recogni"es K1GG,GGG of ordinary income on the transaction. /0. [LO (] CAesearchD ?ave and his riend Btewart each own ,0 percent o H4B. ?uring the $ear' ?ave receives E/,'000 compensation or services he per orms or H4B during the $ear. #e per ormed a signi icant amount o wor. or the entit$ and he was heavil$ involved in management decisions or the entit$ 5he was not a passive investor in H4B7. ) ter deducting ?ave3s compensation' H4B reports ta+a!le income o E(0'000. #ow much I&C) and8or sel -emplo$ment ta+ is ?ave re*uired to pa$ on his compensation and his share o the H4B income i H4B is ormed as a C corporation' B corporation' or a limited lia!ilit$ compan$"
:escription (1) 0(CA (=) ,elf*employment income from entity compensation (3) ,elf*employment income from portion of entity business income (>) Total ,elf M employment income (2) Fet earnings from self* employment (D) ,elf*employment ta Total 0(CA?,elf* employment ta paid by :ave C Corporation K2,E36 G G G G G K2,E36 , Corporation K2,E36 G G G G G K2,E36 LLC KG KE2,GGG K12,GGG 4G,GGG 63,112 1=,E1E 1=,E1E I planation KE2,GGG salary E.D27

K3G,GGG L 2G7 (=) O(3) (>) L .4=32 (2) L 12.37 (1) O (D)

/1. [LO (] CAesearchD Aondo and his !usiness associate' Larr$' are considering orming a !usiness entit$ called ATL !ut the$ are unsure a!out whether to orm it as a C corporation' an B corporation or as an LLC. Aondo and Larr$ would each invest E,0'000 in the !usiness. Fhus' each owner would ta.e an initial !asis in his ownership interest o E,0'000 no matter which entit$ t$pe was ormed. Bhortl$ a ter the ormation o the entit$' the !usiness

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Chapter 04 - Entities Overview

!orrowed E(0'000 two owners.

rom the !an.. & applica!le' this de!t is shared e*uall$ !etween the

a. ) ter ta.ing the loan into account' what is Aondo3s ta+ !asis in his ATL stoc. i ATL is ormed as a C corporation" K2G,GGG. C corporation shareholders do not include entity debt in the ta basis of their stoc) in the corporation. !. ) ter ta.ing the loan into account' what is Aondo3s ta+ !asis in his ATL stoc. i ATL is ormed as an B corporation" K2G,GGG. , corporation shareholders do not include entity debt in the ta basis of their stoc) in the corporation. c. ) ter ta.ing the loan into account' what is Aondo3s ta+ !asis in his ATL ownership interest i ATL is ormed as an LLC" KD2,GGG (K2G,GGG O K12,GGG). The owner of an LLC includes his share of the LLC%s liabilities in his ownership interest. $ere Bondo includes K12,GGG in his basis (his share of the K3G,GGG LLC debt). /%. [LO (] CAesearchD Hevin and 4o! have owned and operated BO) as a C corporation or a num!er o $ears. When the$ ormed the entit$' Hevin and 4o! each contri!uted E100'000 to BO). Fhe$ each have a current !asis o E100'000 in their BO) ownership interest. &n ormation on BO)3s assets at the end o $ear , is as ollows 5BO) does not have an$ lia!ilities79 Assets Cash &nventor$ Land and !uilding Fotal 05U E%00'000 00'000 %%0'000 E,00'000 Ad8usted !asis E%00'000 40'000 1/0'000 !uilt*in #ain E0 40'000 ,0'000

)t the end o $ear ,' BO) li*uidated and distri!uted hal o the land' hal o the inventor$' and hal o the cash remaining a ter pa$ing ta+es 5i an$7 to each owner. )ssume that' e+cluding the e ects o the li*uidating distri!ution' BO)3s ta+a!le income or $ear , is E0. )lso' assume that i BO) is re*uired to pa$ ta+' it pa$s at a lat (0P ta+ rate. a. What is the amount and character o gain or loss BO) will recogni2e on the li*uidating distri!ution" !. What is the amount and character o gain or loss Hevin will recogni2e when he receives the li*uidating distri!ution o cash and propert$" Aecall that his stoc. !asis is E100'000 and he is treated as having sold his stoc. or the li*uidation proceeds.

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Chapter 04 - Entities Overview

Answer: a. !y ma)ing a li&uidating distribution, ,+A is treated as though it sold its assets for their fair mar)et value. +n the distribution, ,+A will recogni"e ordinary income of K>G,GGG on the distribution of the inventory (the built in gain) and K2G,GGG of ,ec. C1=31 gain?ordinary income (depending on accumulated depreciation) on the distribution of the land and building. b. K13D,2GG long*term capital gain. ,+A must pay ta on the K4G,GGG of income it recogni"es in the distribution. !ecause its marginal rate is 3G7 it pays K=E,GGG ta on the distribution. The ta payment reduces ,+A%s cash to K1E3,GGG (K=GG,GGG * K=E,GGG). The fair mar)et value of the assets ,+A distributes to its shareholders is K>E3,GGG (K2GG,GGG total value minus K=E,GGG ta es). +ne*half of the K>E3,GGG (K=3D,2GG) is distributed to Hevin. Conse&uently, Hevin%s long*term capital gain on the distribution is K13D,2GG (K=3D,2GG received minus K1GG,GGG basis in his stoc)). The gain is long*term capital gain because the stoc) is a capital asset and Hevin held the stoc) for more than a year before the li&uidating distribution. C+5/BI$IF,(UI /B+!LI5, /(. CAesearchU MlanningD ?awn Fa$lor is currentl$ emplo$ed !$ the state Cham!er o Commerce. While she en@o$s the relativel$ short wor.wee.s' she eventuall$ would li.e to wor. or hersel rather than or an emplo$er. &n her current position' she deals with a lot o success ul entrepreneurs who have !ecome role models or her. ?awn has also developed an e+tensive list o contacts that should serve her well when she starts her own !usiness. &t has ta.en a while !ut ?awn !elieves she has inall$ developed a via!le new !usiness idea. #er idea is to design and manu acture coo.ware that remains cool to the touch when in use. Bhe has had several riends tr$ out her protot$pe coo.ware and the$ have consistentl$ given the coo.ware rave reviews. With this encouragement' ?awn started giving serious thoughts to ma.ing :Cool Fouch Coo.ware; 5CFC7 a mone$ma.ing enterprise. ?awn had enough !usiness !ac.ground to reali2e that she is em!ar.ing on a ris.$ path' !ut one' she hopes' with signi icant potential rewards down the road. ) ter creating some initial income pro@ections' ?awn reali2ed that it will ta.e a ew $ears or the !usiness to !ecome pro ita!le. ) ter that' she hopes the s.$3s the limit. Bhe would li.e to grow her !usiness and perhaps at some point :go pu!lic; or sell the !usiness to a large retailer. Fhis could !e her tic.et to the rich and amous. ?awn' who is single' decided to *uit her @o! with the state Cham!er o Commerce so that she could ocus all o her e orts on the new !usiness. ?awn had some savings to support her or a while !ut she did not have an$ other source o income. ?awn was a!le to recruit Linda and Ki.e to @oin her as initial e*uit$ investors in CFC. Linda has an K4) and a law degree. Bhe was emplo$ed as a !usiness consultant when she decided to leave that @o! and wor. with ?awn and Ki.e. Linda3s hus!and earns around E(00'000 a $ear as an engineer

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Chapter 04 - Entities Overview

5emplo$ee7. Ki.e owns a very pro ita!le used car !usiness. 4ecause !u$ing and selling used cars ta.es all his time' he is interested in !ecoming onl$ a passive investor in CFC. #e wanted to get in on the ground loor !ecause he reall$ li.es the product and !elieves CFC will !e wildl$ success ul. While CFC originall$ has three investors' ?awn and Linda have plans to grow the !usiness and see. more owners and capital in the uture. Fhe three owners agreed that ?awn would contri!ute land and cash or a (0 percent interest in CFC' Linda would contri!ute services 5legal and !usiness advisor$7 or the irst two $ears or a (0 percent interest' and Ki.e would contri!ute cash or a 40 percent interest. Fhe plan called or ?awn and Linda to !e activel$ involved in managing the !usiness while Ki.e would not !e. Fhe three e*uit$ owners3 contri!utions are summari2ed as ollows9 Ad8usted !asis E/0'000 +wnership (nterest (0P

:awn Contributed Land 5held as investment7 Cash Linda Contributed Bervices 5i)e Contributed Cash

05U E1%0'000 E(0'000 E1,0'000 E%00'000

(0P 40P

Wor.ing together' ?awn and Linda made the ollowing ive-$ear income and loss pro@ections or CFC. Fhe$ anticipate the !usiness will !e pro ita!le and that it will continue to grow a ter the irst ive $ears. Cool Touch Coo)ware 2*-ear (ncome and Loss /ro8ections -ear 1 % ( 4 , (ncome (Loss) 5E%00'0007 5E00'0007 5E%0'0007 E-0'000 E100'000

With plans or ?awn and Linda to spend a considera!le amount o their time wor.ing or and managing CFC' the owners would li.e to develop a compensation plan that wor.s or all parties. ?own the road' the$ plan to have two !usiness locations 5in di erent cities7. ?awn would ta.e responsi!ilit$ or the activities o one location and Linda would ta.e

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Chapter 04 - Entities Overview

responsi!ilit$ or the other. Iinall$' the$ would li.e to arrange or some per ormance-!ased inancial incentives or each location. Fo get the !usiness activities started' ?awn and Linda determined CFC would need to !orrow E000'000 to purchase a !uilding to house its manu acturing acilities and its administrative o ices 5at least or now7. )lso in need o additional cash' ?awn and Linda arranged to have CFC !orrow E(00'000 rom a local !an. and to !orrow E%00'000 cash rom Ki.e. CFC would pa$ Ki.e a mar.et rate o interest on the loan !ut there was no i+ed date or principal repa$ment. Be&uired: &denti $ signi icant ta+ and nonta+ issues or concerns that ma$ di er across entit$ t$pes and discuss how the$ are relevant to the choice o entit$ decision or CFC. Answer: ,everal issues or concerns e ist in forming a new business and choosing an entity. ,ome of the non*ta issues are: The time and cost to organi"e the entity. Corporations (both ta able and , corporations) generally are more cumbersome to form. #eneral partnerships tend to be among the easier entities to form. Corporations and LLCs provide better liability protection for their owners than do general partnerships. (n this case, :awn is concerned about the ris)iness of the business and may want to consider this factor. :awn, Linda and 5i)e seem concerned about fle ibility in the business structure. That is, they want to be able to provide :awn and Linda performance*based compensation based on how their business locations perform. Typically, these issues favor entity formation as a partnership. 0inally, :awn is planning for the future with an initial public offering. (/+s are most easily accomplished with a ta able corporation' although partnerships and LLCs can be fairly easily converted to ta able corporations to accomplish an (/+. !ased on the given ownership percentages, the scenario fails the 6G*percent control test since Linda contributes only services. Thus, it is a ta able transaction if a C or , corporation is formed. :awn, Linda, and 5i)e would li)e to be able to utili"e any losses to reduce their individual ta liabilities in the early years of the business. 0low*through entities provide the most favorable organi"ational form for this purpose. 5ore specifically, LLCs and partnerships allow owners to benefit by increasing their ta basis by the business debt so that they may be able to deduct larger losses than can , corporation shareholders. +nce the business becomes profitable in

,ome of the ta issues or concerns include:

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year >, using an LLC, partnership or , corporation form eliminates the double* ta problem of the ta able corporation form. (f the owners want the fle ibility of special allocations to reward the owners, entities ta ed as partnerships provide the more favorable form. The owners may be concerned about paying the lowest possible 0(CA and self* employment ta es. (n general, ta able corporations and , corporations are favored because the employee?shareholder only pays E.D2 percent (1?=) of the 0(CA ta on any salary. (n addition, ,*corporation shareholders do not pay self*employment ta on the business income allocated to them. (n contrast, LLCs and partnership owners must pay self*employment ta on their business income allocations (if they are considered general partners). (f :awn, Linda, and 5i)e would li)e to consider adding new owners to the business, operating as a ta able corporation or , corporation may be costly because of the 6G percent control test applicable to contributions to the business. (n general, contributions to LLCs and partnerships are usually ta * free regardless of whether it is the initial contribution or a later addition of an owner.

/4. CAesearchD Cool Fouch Coo.ware 5CFC7 has !een in !usiness or a!out 10 $ears now. ?awn and Linda are each ,0 percent owners o the !usiness. Fhe$ initiall$ esta!lished the !usiness with cash contri!utions. CFC manu actures uni*ue coo.ware that remains cool to the touch when in use. CFC has !een airl$ pro ita!le over the $ears. ?awn and Linda have !oth !een activel$ involved in managing the !usiness. Fhe$ have developed ver$ good personal relationships with man$ customers 5!oth wholesale and retail7 that' ?awn and Linda !elieve' .eep the customers coming !ac.. On Beptem!er (0 o the current $ear' CFC had all o its assets appraised. 4elow is CFC3s !alance sheet' as o Beptem!er (0' with the corresponding appraisals o the air mar.et value o all o its assets. Gote that CFC has several depreciated assets. CFC uses the h$!rid method o accounting. &t accounts or its gross margin-related items under the accrual method and it accounts or ever$thing else using the cash method o accounting.

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Chapter 04 - Entities Overview

Assets Cash )ccounts receiva!le &nventor$V E*uipment &nvestment in <=> stoc. Land 5used in the !usiness7 4uilding Fotal )ssets Liabilities )ccounts pa$a!le 4an. loan Kortgage on !uilding E*uit$ Fotal lia!ilities and e*uit$

Ad8usted Ta !asis E1,0'000 %0'000 10'000 1%0'000 40'000 00'000 %00'000 E/00'000 E 40'000 -0'000 100'000 ,00'000 E/00'000

05U E1,0'000 1,'000 (00'000 100'000 1%0'000 /0'000 100'000 E1(,'000VV

VCFC uses the L&IO method or determining the ad@usted !asis o its inventor$. &ts !asis in the inventor$ under the I&IO method would have !een E110'000. VV&n addition' ?awn and Linda had the entire !usiness appraised at E1'1(,'000' which is E%00'000 more than the value o the identi ia!le assets. Irom Lanuar$ 1 o the current $ear through Beptem!er (0' CFC reported the ollowing income9 Ordinar$ !usiness income9 E,(0'000 ?ividends rom <=> stoc.9 E1%'000 Long-term capital losses9 E1,'000 &nterest income9 E ('000 ?awn and Linda are considering changing the !usiness orm o CFC. Be&uired: a. )ssume CFC is organi2ed as a C corporation. &denti $ signi icant ta+ and nonta+ issues associated with converting CFC rom a C corporation to an B corporation. [Hint: see IRC 1374 an 1363( )] !. )ssume CFC is organi2ed as a C corporation. &denti $ signi icant ta+ and nonta+ issues associated with converting CFC rom a C corporation to an LLC. )ssume CFC converts to

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Chapter 04 - Entities Overview

an LLC !$ distri!uting its assets to its shareholders who then contri!ute the assets to a new LLC. [Hint: see IRC 331! 336! an 721(a)] c. )ssume that CFC is a C corporation with a net operating loss carr$ orward as o the !eginning o the $ear in the amount o E%'000'000. &denti $ signi icant ta+ and nonta+ issues associated with converting CFC rom a C corporation to an LLC. )ssume CFC converts to an LLC !$ distri!uting its assets to its shareholders who then contri!ute the assets to a new LLC. [Hint: see IRC 172(a)! 331! 336! an 721(a)] Answer: a. The following significant issues should be considered when converting CTC from a C corporation to an , corporation: The built*in gains ta may be due under (BC C13E> if CTC sells any of its appreciated assets. The C corporation F+L cannot be carried forward to the , corporation. $owever, it can be used to offset the built*in gains ta . Additionally, the =G*year F+L carry forward period continues to run during the life of the , corporation. (f the enterprise never operates as a C corporation again, the F+L is lost. According to (BC C13D3(d), the difference between CTC%s L(0+ inventory basis of K4G,GGG and what would have been its 0(0+ basis of K11G,GGG must be reported as ordinary income on the last return CTC files as a C corporation. (f CTC would need to switch to a calendar year*end under (BC C13E6(b) if it had been using a month other than :ecember as its C corporation year*end. As an , corporation, CTC would become sub8ect to limits on the number and type of shareholders under (BC C13D1(b). As a result, CTC would be unable to go public or operate certain types of businesses. !ecause , corporations are flow*through entities, CTC%s dividends, interest, and long*term capital gains and losses will flow*through to :awn and Linda and will be ta able at potentially lower rates under the individual rather than corporate ta rules. 0urther, CTC%s income will now only be ta ed once.

b. The following significant issues should be considered when converting CTC from a C corporation to an LLC: !ecause LLCs are flow*through entities, CTC%s dividends, interest, and long*term capital gains and losses will flow through to :awn and Linda and will be ta able at potentially lower rates under the individual rather than corporate ta rules. 0urther, CTC%s income will now only be ta ed once.

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Chapter 04 - Entities Overview

Converting CTC into an LLC will trigger a deemed li&uidation of CTC corporation resulting in gains and losses being recogni"ed and ta ed at both the corporate and shareholder level under (BC C33D and (BC C331. #iven the appreciation in CTC%s assets, these ta es are li)ely to be significant if not prohibitive. After converting to an LLC, CTC%s operations and its owners will be sub8ect to state LLC statutes rather than state corporation laws. This will li)ely have an impact on the rights, responsibilities, and legal arrangement among the owners as well as the rights of outsiders with respect to CTC and its owners. CTC must switch to a calendar year*end if it had previously been using some other year*end

c. 5ost of the considerations mentioned in part b. remain relevant e cept for the following items: CTC%s K=,GGG,GGG net operating loss carryforward will entirely eliminate the K>32,GGG gain on li&uidation (K1,132,GGG fair mar)et value of CTC assets less KEGG,GGG ta basis in CTC assets) CTC would otherwise have to report under (BC C33D. .nfortunately, the remaining net operating loss carryforward disappears with the corporation because it is a corporate ta attribute. Although CTC%s net operating loss will eliminate li&uidation ta es at the corporate level, :awn and Linda must pay capital gains ta es on the difference between the fair mar)et of CTC%s assets and the ta basis they have in their CTC shares under (BC C331. These ta es, although lower than the combined li&uidation ta es described in part b., would still li)ely deter :awn and Linda from converting CTC to an LLC.

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