Unit 5: Federal Taxation of Entities

• Topic 01

  C Corporations — Taxable Income Computation

  15 questions
• Topic 02

  C Corporations — Distributions, Liquidations, and Formation

  15 questions
• Topic 03

  S Corporations

  15 questions
• Topic 04

  Partnerships — Formation, Basis, and Distributive Share

  15 questions
• Topic 05

  Partnerships — Distributions, Retiring Partners, and Hot Assets

  15 questions
• Topic 06

  Limited Liability Companies (LLCs)

  15 questions
• Topic 07

  Trusts and Estates

  48 questions
• Topic 08

  Exempt Organisations

  15 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. A single-member LLC is owned by a C corporation. What is the default federal tax treatment of the LLC, and how is the LLC's income reported?

   • A
     The LLC is a grantor trust for tax purposes because it is wholly owned by a corporation
   • B
     The LLC files Form 1065 and the C corporation reports its distributive share on Schedule K-1
   • C
     The LLC is a partnership because it is owned by a corporation
   • D
     The LLC is a disregarded entity treated as a branch or division of the C corporation; all income and expenses are included directly in the C corporation's Form 1120
     Correct answer
   Explanation

   Under Treas. Reg. §301.7701-3(b)(1)(ii), a single-member LLC is a disregarded entity regardless of who the single owner is. If the owner is a C corporation, the LLC is treated as a branch, division, or department of the corporation for federal income tax purposes. All of the LLC's activities are included directly in the C corporation's Form 1120. The LLC retains its state-law limited liability protection. The LLC may still be treated as a separate entity for employment tax and other non-income tax purposes.

2. A C corporation has taxable income (before DRD) of \$80,000 and received \$50,000 in dividends from a 10%-owned domestic corporation (50% DRD). Compute the DRD considering the taxable income limitation.

   • A
     Tentative DRD = \$40,000 (50% of taxable income); limitation prevents the full \$25,000; taxable income = \$55,000
   • B
     Tentative DRD = \$25,000; taxable income limitation restricts it to \$20,000; taxable income = \$60,000
   • C
     Tentative DRD = \$25,000; taxable income limitation = 50% x \$80,000 = \$40,000; \$25,000 < \$40,000 so full \$25,000 DRD applies; taxable income = \$55,000
     Correct answer
   • D
     Tentative DRD = \$25,000; no limitation applies because there is net income; taxable income = \$55,000 (same correct answer, but reasoning that limitation never applies is wrong)
   Explanation

   Tentative DRD = 50% x \$50,000 = \$25,000. Taxable income limitation = 50% x \$80,000 (taxable income before DRD) = \$40,000. Because the tentative DRD (\$25,000) is less than the limitation (\$40,000), the full \$25,000 DRD applies. Taxable income = \$80,000 - \$25,000 = \$55,000. The limitation only restricts the DRD when the full DRD would create or increase an NOL.

3. A corporation has two classes of stock — voting common and non-voting common. Does this violate the one class of stock requirement?

   • A
     No — differences in voting rights alone do not violate the one class of stock rule
     Correct answer
   • B
     Yes — non-voting stock constitutes a 'second class' because it lacks the standard shareholder right to vote
   • C
     Yes — voting and non-voting stock are treated as separate classes regardless of economic rights
   • D
     Yes — any difference between stock classes violates the one class of stock rule
   Explanation

   Under §1361(b)(1)(D) and Treas. Reg. §1.1361-1(l)(1), the one class of stock rule requires that all shares confer identical rights to distribution and liquidation proceeds. However, differences solely in voting rights are permitted — an S corporation may have both voting and non-voting common stock without violating the one class of stock rule. This flexibility allows estate planning and management control arrangements while maintaining S corporation status.