Module 10 S Corporation/Corporation Workbook Introduction

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1 Module 10 Workbook Introduction Running your own business presents many challenges. One of the most difficult is complying with complex and ever-changing tax laws. This small-business tax education program is designed to help you meet this challenge. You will learn about several areas in which your responsibilities as a small-business person are especially complicated. Here you will find a variety of simple checklists and guidelines to help you. These materials put you in the role of a student: either in a classroom setting with the help of an instructor, or on your own using the materials themselves as your guide and resource. In either case, you will have the chance to select information that directly relates to the challenges you face. There are probably some sections of the program that don't apply to your unique situation. You can ignore these sections or save them for later reference. This means that the small-business tax education program is individualized: it is designed to give you just the information you need. Your small-business tax education materials consist of a study guide and a workbook. The study guide for each module contains a short section called"tax Whys" that explains how that module might fit your needs; a statement of objectives; a lesson covering the tax topic; at least one case study; and a list of key terms. At many points within the study guide, you will be referred to the workbook for an exercise or a case study that will let you "try out" what you have learned. Each workbook contains practice exercises, case studies, multiple choice assessments, and the solutions for all of these. The workbook is designed to be used as you work through the exercises and case studies. The study guide, on the other hand, can be kept for reference. Modules are available to cover the following small-business tax topics: Information for all Businesses 1. Business Assets: Depreciation and Selling Depreciated Property 2. Business Use of the Home 3. Employment Taxes 4. Excise Taxes 5. Starting a Business/Recordkeeping 6. Schedule C and SE, and Form 1040-ES Workbook 1

2 7. Self-Employed Retirement Plans 8. The Small Business as a Partnership 9. Tip Reporting and Allocation Rules 10. There may be other areas that present special tax-related challenges in your situation. In some cases, a professional tax preparer may be your best source of help. Additional help is available from the IRS's Toll-Free Telephone Tax Assistance at Forms and publications can be ordered by calling (Publication 910, Guide to Free Tax Services, contains a brief description of other types of assistance and can be ordered by calling this number.) Taxpayers who have been unable to resolve their problems through normal channels can be referred to the IRS Problem Resolution Program; call the above Tax Assistance number or write to your local IRS District Director and ask for Problem Resolution assistance. Written Practice Fill in the Blank About Corporations 1. The owners of a corporation are called. 2. A small-business corporation is called a(n) corporation. 3. Regular corporate income may be taxed twice, once at the level and again at the level. 4. S corporation income is taxed only at the level. 5. There cannot be more than shareholders in an S corporation. 6. Use Form to elect S corporation status. shareholders Workbook 2 S corporate shareholder shareholder

3 7. S corporations do not require IRS approval to elect a year ending on. December 31st 8. Use Form to report S corporation income or loss. 1120S Exercise 10-1 Adjusted Basis and Loss Limitations 1. Louise is one of four shareholders in Paige Corp., an S corporation formed in Louise materially participates in the conduct of the business and is at risk for all of the corporation debts. Louise paid $5,000 for her 25-percent share of the business. S corporation income for 1995 was $2,400. There was $400 in interest income. Louise received a $500 cash distribution in Compute Louise's adjusted basis at the end of In 1996 the S corporation loss was $36,000. Louise took no cash distributions. Interest income for the corporation was $240. What are the three types of loss limitations? Do any of them apply to Louise? 1. Which item is not separately stated on the S corporation return? contributions to charity interest income dividend income business interest expense 2. An S corporation shareholder does not report as taxable income. distributions from the S corporation interest received on partnership funds short-term capital gains gains from the sale of business property 3. S corporation shareholders are not at risk for. investments in the S corporation income retained by the S corporation Workbook 3

4 4. A shareholder's adjusted basis in an S corporation is increased by. corporation debt they are not personally liable for corporation debt they are personally liable for S corporation ordinary losses distributions charitable contributions S corporation ordinary income 5. Which interest expense is deducted when computing S corporation ordinary income and loss? interest on a loan to purchase a certificate of deposit interest on a mortgage for rental real estate property interest on a loan to purchase stock interest on a car loan; the car being used for S corporation business 6. Which statement is true? A sale of property between an S corporation and its shareholder may result in a deductible loss. An S corporation may deduct the payment of life insurance premiums for a 50-percent shareholder. An S corporation does not have to pay a salary to a shareholder who is active in the business. An S corporation does not have to obtain IRS approval for a December 31st year end. 7. Which is NOT a characteristic of the S corporation form of business? S corporation income is subject to double taxation. S corporation shareholders have limited liability. S corporations continue in existence after the death of a shareholder. S corporation transfer of ownership is easy to accomplish. Workbook 4

5 8. Which item is NOT included when computing S corporation ordinary income or loss? receipts from sales rent expense on an office building interest income compensation of corporation officers Solution Exercise Louise's adjusted basis at the end of 1995 is $5,200. Investment in stock $5,000 Plus Louise's share of business income ($2,400 multiplied by 25 percent) 600 Plus Louise's share of interest income ($400 multiplied by 25 percent) 100 Less cash distribution (500) Adjusted basis at the end of 1995 $5, The three types of loss limitations are: * adjusted basis * at-risk limitation * passive activity loss The adjusted basis limitation applies. Louise will not be able to deduct the loss amount that exceeds her adjusted basis. Adjusted basis at the beginning of 1995 $5,200 Plus interest income ($240 multiplied by 25 percent) 60 Adjusted basis before deducting the loss $5,260 Louise's share of loss ($36,000 multiplied by 25 percent) 9,000 Louise will be allowed to deduct only $5,260 of the loss. Workbook 5

6 The at-risk limitation does not apply to Louise because she is at risk for all the debts of the corporation. The passive activity loss limitation does not apply to Louise because she materially participates in the business. Multiple Choice Solutions 1. d - business interest expense Contributions to charity, interest income, and dividend income are all separately stated items. Business interest expense, however, is deducted on Form 1120S, page 1, line a - distributions from the S corporation Distributions from an S corporation are not taxable to the shareholder. The distributions, however, reduce the shareholder's adjusted basis. Interest income, shortterm capital gains, and gains from the sale of business property are taxable to the shareholder. 3. c - corporation debt they are not personally liable for S corporation shareholders are not at risk for corporation debt for which they are not personally liable. Shareholders are at risk for their investments in the S corporation, income retained by the S corporation, and corporation debt for which they are personally liable. 4. d - S corporation ordinary income A shareholder's adjusted basis is increased by ordinary business income. It is decreased by ordinary business losses, distributions, and charitable contributions. 5. d - interest on a car loan; the car being used for S corporation business The interest expense on a car loan, when the car is used in the business, is deducted when computing S corporation ordinary income or loss. Interest expense paid on loans to purchase certificates of deposit or stock or for rental real estate is separately stated on Schedule K-1 (Form 1120S). 6. d - An S corporation does not have to obtain IRS approval for a December 31st year end. Workbook 6

7 A loss incurred when property is sold between an S corporation and its shareholder may not be deducted. An S corporation may not deduct life insurance premiums paid on behalf of a shareholder who owns more than 2 percent of the corporation. Shareholders who are active in S corporation business should receive adequate compensation for their services. 7. a - S corporation income is subject to double taxation. S corporations are NOT subject to double taxation. S corporation shareholders have limited liability, S corporations continue in existence after the death of a shareholder, and S corporations allow ease of transfer of ownership. 8. c - interest income Interest income is not included when computing S corporation ordinary income or loss. It is a separately stated item. Receipts from sales, rent expense on an office building, and officer compensation are all included when computing S corporation ordinary income or loss. Workbook 7

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