- A technology startup plans to raise capital from venture capital investors and eventually go public. Which entity structure is most appropriate?
Answer: C corporation - VC investors and public markets require C corporation structure; C corps can have unlimited shareholders, multiple classes of stock, and are not subject to S corp eligibility restrictions.
VC investors and public markets require C corporation structure - S corps have shareholder restrictions that preclude VC investment. Answer B is correct.
- A business owner who qualifies for the Section 199A QBI deduction maximizes the deduction under which entity structure?
Answer: Any pass-through structure (sole proprietorship, partnership, S corporation) - as long as the owner is not a high-income owner of a specified service trade or business, the 20% QBI deduction applies to all qualifying pass-through income.
The QBI deduction applies equally to all qualifying pass-through structures. Answer A is correct.
- A business anticipates significant losses in its early years. Which entity structure best allows the owner to use those losses to offset other income?
Answer: Pass-through entity (S corporation, partnership, or sole proprietorship) - losses flow through to the owner's individual return and can offset other income, subject to basis, at-risk, and passive activity limitations.
Pass-through entities allow loss flow-through to owners for potential use against other income. C corp losses stay at the corporate level. Answer B is correct.
- An investor purchases a 30% interest in an LLC taxed as a partnership for $100,000. The LLC has $500,000 of nonrecourse debt. What is the investor's initial outside basis?
Answer: $250,000 - the $100,000 investment plus $150,000 (30% × $500,000 nonrecourse debt share), since partnership liabilities increase partners' outside basis.
Outside basis includes cash invested plus the partner's share of partnership liabilities: $100,000 + (30% × $500,000) = $250,000. Answer D is correct.
- A business owner considering entity choice should evaluate self-employment tax implications. Which entity structure has the lowest SE tax burden for an active owner who earns $300,000?
Answer: S corporation paying $100,000 in wages and $200,000 in distributions - FICA applies only to the $100,000 in wages, with distributions avoiding payroll tax; the actual savings depend on wage-base limits (Social Security caps at ~$168,600) and Medicare rates.
An S corporation with reasonable wages and high distributions minimizes payroll taxes because FICA applies only to wages, not to distributions. At $300,000 total with $100,000 in wages, the S corp avoids payroll tax on the $200,000 distribution. The actual tax savings are not a flat 15.3% on $200,000 - they depend on how much of the Social Security wage base ($168,600 for 2024) was covered by wages, and on the Medicare rates (2.9% on all wages, plus the additional 0.9% Medicare tax for wages over $200,000). Answer D is correct. Sole proprietorship (A) and general partnership (B) subject all net income to SE tax. Limited partnership (C) may reduce SE tax but lacks the wage-and-distribution structure and operational flexibility of an S corp.
- A real estate investment company wants to raise capital from multiple investors while avoiding double taxation and providing liability protection. The most common structure is:
Answer: A limited partnership or LLC taxed as a partnership - providing pass-through taxation, limited liability for passive investors, and flexibility in allocating income and losses.
LPs and LLCs taxed as partnerships are ideal for real estate - pass-through taxation, limited liability, and special allocation flexibility. Answer A is correct.
- A business owner converting from a C corporation to an S corporation may face:
Answer: The built-in gains (BIG) tax under Section 1374 - if the S corporation sells appreciated assets within 5 years after conversion, the gain attributable to pre-conversion appreciation is taxed at the 21% corporate rate.
The built-in gains tax applies for 5 years on gains from pre-conversion appreciation. Answer D is correct.
- A business owner comparing a C corporation to an S corporation should understand that the key difference in exit strategy is:
Answer: A C corporation asset sale results in double taxation (corporate gain + dividend/capital gain on distribution), while an S corporation asset sale results in a single level of tax passed through directly to shareholders.
The double taxation disadvantage of C corporations in asset sales is a primary reason sellers prefer S corporation status or stock sales. Answer B is correct.
- An S corporation has a significant advantage over a partnership for owners who want to limit payroll tax exposure because:
Answer: S corporation income allocated to shareholders beyond reasonable wages is not subject to FICA - unlike partnerships where active general partners may owe SE tax on their distributive share.
Active S corp shareholders pay FICA only on wages; distributions above wages avoid payroll taxes. General partners typically pay SE tax on their distributive share. Answer A is correct.
- An individual who converts their sole proprietorship to a corporation contributes all assets and liabilities. Under Section 351, the transfer is:
Answer: Tax-free if the transferors receive stock and control (at least 80%) of the corporation immediately after the transfer - with the corporation taking a carryover basis in the assets.
Section 351 provides nonrecognition for property contributions to a controlled corporation. Answer C is correct.
- A business owner is deciding between operating as a sole proprietorship or an S corporation. The primary tax advantage of the S corporation structure for an active owner-employee is:
Answer: S corporation distributions beyond reasonable wages are not subject to FICA/self-employment taxes, potentially reducing the owner's payroll tax burden compared to a sole proprietorship where all net income is subject to SE tax.
The primary S corp advantage is FICA savings on distributions above reasonable wages. Sole proprietors pay SE tax on all net income. Answer A is correct.
- An entity that elects S corporation status must meet ongoing eligibility requirements. Which of the following would terminate S corporation status?
Answer: Having more than 100 shareholders, having an ineligible shareholder (such as a non-resident alien or a C corporation), or having more than one class of stock.
S corp eligibility violations (too many shareholders, ineligible shareholder, more than one class of stock) terminate the election. Answer A is correct.
- A business owner who wants to provide significant retirement plan contributions should consider which entity structure?
Answer: Any entity structure can establish retirement plans (SEP-IRA, SIMPLE IRA, 401(k), defined benefit) - the key is net earned income or compensation, not entity type.
Retirement plan options are available across all entity structures. The contribution limits depend on compensation, not entity type. Answer D is correct.
- A business owner with significant business losses wants to use those losses to offset their W-2 income from a separate job. Which entity structure best enables this?
Answer: Pass-through entity where the owner materially participates - losses flow through to the owner's return and can offset non-passive income like W-2 wages, subject to basis, at-risk, and passive activity rules.
Pass-through entities where the owner materially participates allow losses to offset W-2 income subject to applicable limitations. Answer B is correct.
- Which entity structure provides the most flexibility in allocating income, losses, and distributions among owners?
Answer: A partnership (including multi-member LLC taxed as a partnership) - special allocations with substantial economic effect are permitted.
Partnerships allow special allocations as long as they meet the substantial economic effect test. Answer A is correct.
- A single-member LLC that has not made a check-the-box election is treated for federal income tax purposes as:
Answer: A disregarded entity - the LLC is ignored for tax purposes and all income and expenses are reported directly on the owner's individual return.
A single-member LLC is a disregarded entity by default - treated as a sole proprietorship. Answer D is correct.
- A professional service provider (attorney, physician, consultant) considering entity structure should be aware that:
Answer: High-income professionals in specified service trades or businesses (SSTBs) lose the Section 199A QBI deduction above the applicable income thresholds - making C corporation structure potentially more attractive when the QBI deduction is unavailable.
SSTB owners above income thresholds lose the QBI deduction - at that point, the C corp's 21% rate may be more attractive. Answer C is correct.
- A business owner wants to provide health insurance to themselves and deduct the premiums. Which entity structure provides the most favorable treatment?
Answer: C corporation - the corporation can deduct premiums as a business expense, and the shareholder-employee pays no income tax on the premium benefit, making it fully tax-advantaged.
A C corporation can deduct health insurance premiums and the employee-shareholder pays no tax on the benefit. Answer C is correct.
- A business with international operations should consider which entity structure to minimize the impact of GILTI rules?
Answer: C corporation - GILTI rules apply to C corporations with CFCs; the 50% GILTI deduction and FTC planning are available at the corporate level.
GILTI (Global Intangible Low-Taxed Income) applies to all U.S. shareholders of controlled foreign corporations (CFCs), including individuals, partnerships, S corporations, and C corporations - not only C corporations. However, a C corporation is generally the most advantageous structure for GILTI planning because C corporations can claim the Section 250 deduction (currently 50% of GILTI) and foreign tax credits at the corporate level, potentially reducing the effective GILTI rate substantially. Individuals who are direct CFC shareholders do not have access to the Section 250 deduction (though they may make a Section 962 election to be taxed as if a corporation). Answer B is correct as the preferred planning entity for GILTI. S corporations (A) and sole proprietorships (D) are not exempt from GILTI. Partnerships (C) cannot elect to exclude GILTI.
- A C corporation offers which of the following tax advantages over pass-through entities for certain high-income business owners?
Answer: The 21% flat corporate rate may be lower than the individual rate on the same income, and C corporations can retain earnings for growth at the corporate rate before triggering individual-level tax.
The 21% corporate rate can be beneficial when the owner's individual rate would be higher. Answer C is correct.
