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Lecture 12

ACCT 40610 Lecture 12: Chapter 12
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by Katie Farrell , Fall 2017
3 Pages
45 Views
Fall 2017

Department
Accountancy
Course Code
ACCT40610
Professor
O' Brien
Lecture
12

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Chapter 12
Pass-Through Entities
o Partnerships (includes LLCs) and S Corps are not taxed as entities;
investors pay tax on their share of entity income.
o This treatment results in a single level of taxation.
o Cash distributions are generally not taxable.
The cash represents a return of investment and does not affect
the income or loss reported by the owner.
o Benefits
Pass-through losses are generally deductible in the year the
loss is generated, producing a tax benefit at the individual’s
marginal tax rate (i.e., immediate tax savings!).
For start-up corporations, loss must be carried forward and
used to offset income in a taxable year where profits are
reported.
NOL deduction provides a benefit at the corporation’s
tax rate in the year the NOL offsets profits.
Family Income Shifting
o Goal - have income taxed at lower rates e.g. children’s rates or avoid
estate tax.
o Remember, income shifting is the result of shifting property
ownership - can’t assign income.
o If children or other relatives are made partners or co-shareholders,
they own part of the business and are entitled to their share of any
cash distributions from the business.
o The transfer of ownership may have gift taxconsequences if relatives
don’t pay FMV.
o Limits
Family members cannot be partners in a personal service
business unless they can perform the services.
In contrast, a family member can be a partner in a
business in which property is a material income-
producing factor.
Family members providing services must first receive
guaranteed payments that constitute reasonable compensation
before net income is
allocated.
Income of family partnerships is allocated according to
proportionate interests in partnership capital.
Income of all S corporations is allocated according to the
proportionate shares of stock held by each shareholder.
The potential tax savings of operating a pass-through entity must be
compared to the legal and accounting costs of creating and operating the
business.
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Description
Chapter 12 Pass-Through Entities o Partnerships (includes LLCs) and S Corps are not taxed as entities; investors pay tax on their share of entity income. o This treatment results in a single level of taxation. o Cash distributions are generally not taxable. The cash represents a return of investment and does not affect the income or loss reported by the owner. o Benefits Pass-through losses are generally deductible in the year the loss is generated, producing a tax benefit at the individuals marginal tax rate (i.e., immediate tax savings!). For start-up corporations, loss must be carried forward and used to offset income in a taxable year where profits are reported. NOL deduction provides a benefit at the corporations tax rate in the year the NOL offsets profits. Family Income Shifting o Goal - have income taxed at lower rates (e.g. childrens rates) or avoid estate tax. o Remember, income shifting is the result of shifting property ownership - cant assign income. o If children or other relatives are made partners or co-shareholders, they own part of the business and are entitled to their share of any cash distributions from the business. o The transfer of ownership may have gift taxconsequences if relatives dont pay FMV. o Limits Family members cannot be partners in a personal service business unless they can perform the services. In contrast, a family member can be a partner in a business in which property is a material income- producing factor. Family members providing services must first receive guaranteed payments that constitute reasonable compensation before net income is allocated. Income of family partnerships is allocated according to proportionate interests in partnership capital. Income of all S corporations is allocated according to the proportionate shares of stock held by each shareholder. The potential tax savings of operating a pass-through entity must be compared to the legal and accounting costs of creating and operating the business.
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