the problem starts where it says problem and ends where its asking you to answer A-C
If corporations are often used by service providers to avoid the unclipped Medicare portion of employment taxes. Assume, for example, that Trail Lawyer, a single taxpayer, has %500,000 of net earnings from the employment and no other earned income. If she conducts her practice as a sole proprietor, her self-employment tax will consist of 12.4 percent on self employment income up to the applicable wage base and 2.9 percent on the entire $5000,000 ($14, 500)^21. Assume Trail Lawyer incorporates her practice using an S corporation which nets the same $500,000, pays the lawyer a salary of $150,000, and either retains the $350,000 balance or distributes it as a dividend. Some tax advisors take the position that as long as the compensation paid by the S corporation to a shareholder-employee is written a reasonable range, the Medicare tax can be avoided on that shareholder's remaining portion of S corporation income. If this is correct, Trail Lawyer would save $10, 150 in 2012 (the 2.9 percent Medicare tax on $350,000) and even more in 2013 and beyond. Whether or not the S corporation employment tax avoidance gambit should succeed is debatable, although anecdotal evidence suggests that it is widely used and often goes unchallenged. PROBLEM Boots, Inc is a "C" corporation engaged in the shoe manufacturing business. It also holds a small portfolio of securities. Boots is a calendar year, accrual method taxpayer with two equal shareholders, Emil and Betty, who are unrelated cash method taxpayers. Use the rates m sect 11 to determine Boots. Inc.'s tax liability, and assume for convenience that Emil and Betty each are taxable at a combined federal and state flat rate 40% on ordinary income and a combined flat rate of 20% on qualified dividends and long-term capital gains. During the current year, Boots has the following income and expense items and makes no distributions to its shareholders: Income: Gross profit-sale of inventory $2, 600,000 Capital gains 200,000 Municipal bond interest (not private activity bond) 10.000 Expenses and Losses: Operating Expenses (includes sect 199 deduction) 800.000 ACRE depredation (5-year property; $4,000,000 cost; all placed in service in current year) 800,000 Capital losses 220,000 In 2013 and thereafter, the Medicare tax for a single taxpayer on $500,000 of self-employment income would be $17, 200- 2.9 percent on the first $200,000 and 3.8 percent on the $300,000 that exceeds the $200,000 high-income threshold for single taxpayers. In egregious cases, such as where little or no compensation is paid and the S corporation distributes a large dividend to its sole owner, the Service likely will reclassify all or part of the dividend as wages for employment tax purposes. See Chapter 11H, infra. See Tax Gap; Actions Needed to Address Noncompliance with S Corporation Tax Rules (U.S. Government Accountability Office, GAO-10-195, Dec 2009). Legislation to close this loophole has been proposed but not yet enacted. Determine Boots, Inc's a taxable income and its regular tax visibility for the current year. What result in (a), above, if Boots distribution $320,000 each to Emil and Betty an qualified dividends? What results in (a), above, if instead of paying dividends Boots pays Emil and Betty salaries of $500,000 each? What other strategies could Emil and Betty employ to reduce the impact of the corporation "double tax"? In general, what are the risks of these strategies. See, e.g., sect sect 79; 105(a), (b), 106; 119; 162(a)(3); 163; 267; 1362(a); 1366(a)(1), c(c). CORPORATE CLASSIFICATION IN GENERAL Code: sect 7701(a)(3). The classification of a business relationship may have profound tax consequences. Entities classified as C corporation are subject to the double tax regime of Subchapter C, while the tax treatment of partnerships is governed by the single tax pass-through regime of Subchapter K. The classification area has a rich and textured history, as the stakes have changed in response to shifting tax incentives to utilize one form of business entity over another. After decades of strife, much confusion, and reams of boilerplate classification opinion letters issued by high-priced counsel, there is good news. The Internal Revenue Service has simplified this topic considerably (and shortened your reading assignment) by adopting a classification system that as a practical matter permits a closely held unincorporated business to elect its taxing regime. For tax purposes, section 7701 defines a corporation to include "associations, joint-stock companies, and insurance companies". Thus, if an entity is an unincorporated "association", it will be classified as a corporation. The longstanding, now related classification regulations did not define the term "association". Instead they listed characteristics ordinarily found in a "pure" corporation: (1) associates (i.e., two or more persons joining together in shares control and ownership of the venture); (2) An objective to carry on business and divide the gain there from; (3) continuity of life corporation continues in existence despite the death or withdrawal of or more shareholders); (4) Centralization of management (i.e., management responsibility is vested in directors and is not exercised directly by shareholders); (5) limited liability (shareholders are not personally for corporate debts); and (6) free transferability of interests (i.e., may dispose of their shares). The regulations then explained that organization will be treated as an association if the corporate Reg. Sect 301.7701-2(a)(1)(pre-1997). If corporations are often used by service providers to avoid the unclipped Medicare portion of employment taxes. Assume, for example, that Trail Lawyer, a single taxpayer, has %500,000 of net earnings from the employment and no other earned income. If she conducts her practice as a sole proprietor, her self-employment tax will consist of 12.4 percent on self employment income up to the applicable wage base and 2.9 percent on the entire $5000,000 ($14, 500)^21. Assume Trail Lawyer incorporates her practice using an S corporation which nets the same $500,000, pays the lawyer a salary of $150,000, and either retains the $350,000 balance or distributes it as a dividend. Some tax advisors take the position that as long as the compensation paid by the S corporation to a shareholder-employee is written a reasonable range, the Medicare tax can be avoided on that shareholder's remaining portion of S corporation income. If this is correct, Trail Lawyer would save $10, 150 in 2012 (the 2.9 percent Medicare tax on $350,000) and even more in 2013 and beyond. Whether or not the S corporation employment tax avoidance gambit should succeed is debatable, although anecdotal evidence suggests that it is widely used and often goes unchallenged. PROBLEM Boots, Inc is a "C" corporation engaged in the shoe manufacturing business. It also holds a small portfolio of securities. Boots is a calendar year, accrual method taxpayer with two equal shareholders, Emil and Betty, who are unrelated cash method taxpayers. Use the rates m sect 11 to determine Boots. Inc.'s tax liability, and assume for convenience that Emil and Betty each are taxable at a combined federal and state flat rate 40% on ordinary income and a combined flat rate of 20% on qualified dividends and long-term capital gains. During the current year, Boots has the following income and expense items and makes no distributions to its shareholders: Income: Gross profit-sale of inventory $2, 600,000 Capital gains 200,000 Municipal bond interest (not private activity bond) 10.000 Expenses and Losses: Operating Expenses (includes sect 199 deduction) 800.000 ACRE depredation (5-year property; $4,000,000 cost; all placed in service in current year) 800,000 Capital losses 220,000 In 2013 and thereafter, the Medicare tax for a single taxpayer on $500,000 of self-employment income would be $17, 200- 2.9 percent on the first $200,000 and 3.8 percent on the $300,000 that exceeds the $200,000 high-income threshold for single taxpayers. In egregious cases, such as where little or no compensation is paid and the S corporation distributes a large dividend to its sole owner, the Service likely will reclassify all or part of the dividend as wages for employment tax purposes. See Chapter 11H, infra. See Tax Gap; Actions Needed to Address Noncompliance with S Corporation Tax Rules (U.S. Government Accountability Office, GAO-10-195, Dec 2009). Legislation to close this loophole has been proposed but not yet enacted. Determine Boots, Inc's a taxable income and its regular tax visibility for the current year. What result in (a), above, if Boots distribution $320,000 each to Emil and Betty an qualified dividends? What results in (a), above, if instead of paying dividends Boots pays Emil and Betty salaries of $500,000 each? What other strategies could Emil and Betty employ to reduce the impact of the corporation "double tax"? In general, what are the risks of these strategies. See, e.g., sect sect 79; 105(a), (b), 106; 119; 162(a)(3); 163; 267; 1362(a); 1366(a)(1), c(c). CORPORATE CLASSIFICATION IN GENERAL Code: sect 7701(a)(3). The classification of a business relationship may have profound tax consequences. Entities classified as C corporation are subject to the double tax regime of Subchapter C, while the tax treatment of partnerships is governed by the single tax pass-through regime of Subchapter K. The classification area has a rich and textured history, as the stakes have changed in response to shifting tax incentives to utilize one form of business entity over another. After decades of strife, much confusion, and reams of boilerplate classification opinion letters issued by high-priced counsel, there is good news. The Internal Revenue Service has simplified this topic considerably (and shortened your reading assignment) by adopting a classification system that as a practical matter permits a closely held unincorporated business to elect its taxing regime. For tax purposes, section 7701 defines a corporation to include "associations, joint-stock companies, and insurance companies". Thus, if an entity is an unincorporated "association", it will be classified as a corporation. The longstanding, now related classification regulations did not define the term "association". Instead they listed characteristics ordinarily found in a "pure" corporation: (1) associates (i.e., two or more persons joining together in shares control and ownership of the venture); (2) An objective to carry on business and divide the gain there from; (3) continuity of life corporation continues in existence despite the death or withdrawal of or more shareholders); (4) Centralization of management (i.e., management responsibility is vested in directors and is not exercised directly by shareholders); (5) limited liability (shareholders are not personally for corporate debts); and (6) free transferability of interests (i.e., may dispose of their shares). The regulations then explained that organization will be treated as an association if the corporate Reg. Sect 301.7701-2(a)(1)(pre-1997)
