Business structures — CPA REG practice questions

Under §336, a liquidating corporation that distributes appreciated property to its shareholders in complete liquidation generally must:

1. Recognize no gain, since liquidating distributions are nontaxable to the corporation
2. Recognize gain only if the distributee is unrelated to the corporation
3. Defer recognition of gain until the shareholder disposes of the property
4. Recognize gain (or loss, subject to certain limitations) as if the property were sold to the distributee at its fair market value

Answer: D — Recognize gain (or loss, subject to certain limitations) as if the property were sold to the distributee at its fair market value

A) Liquidating distributions of appreciated property are generally taxable events to the corporation, not nontaxable. B) Gain recognition under §336 does not hinge on whether the distributee is related to the corporation (though related-party loss limitations can apply in some cases). C) The corporation recognizes gain at the time of the distribution; it is not deferred until the shareholder later disposes of the property. D) Correct — §336 generally treats the liquidating distribution as a deemed sale of the property at fair market value, requiring the corporation to recognize gain (subject to loss-limitation rules in related-party and certain built-in-loss situations).

In a complete liquidation of a corporation not qualifying for §332 parent-subsidiary nonrecognition, a shareholder receiving a liquidating distribution generally recognizes:

1. Ordinary income equal to the full amount of cash and property received
2. Capital gain or loss equal to the difference between the fair market value of assets received and the shareholder's stock basis
3. No gain or loss, because liquidating distributions are treated as a return of capital
4. Gain only, since losses may never be recognized in a complete liquidation

Answer: B — Capital gain or loss equal to the difference between the fair market value of assets received and the shareholder's stock basis

A) The distribution is treated as full payment in exchange for the stock, generally producing capital gain or loss rather than ordinary income. B) Correct — under §331, the shareholder treats the liquidating distribution as received in full payment for the stock, recognizing capital gain or loss based on the difference between fair market value received and stock basis. C) The distribution is a taxable exchange of stock, not a tax-free return of capital. D) A shareholder can recognize a capital loss in liquidation if the value received is less than stock basis.

Compared to a partnership, an S corporation offers pass-through taxation similar in concept but is LESS flexible because it:

1. May have an unlimited number of shareholders of any type
2. Permits special allocations of income and loss disproportionate to ownership
3. Is limited to one class of stock and generally no more than 100 eligible shareholders, restricting special allocations and certain ownership structures
4. Is taxed at both the entity and shareholder levels, unlike a partnership

Answer: C — Is limited to one class of stock and generally no more than 100 eligible shareholders, restricting special allocations and certain ownership structures

A) S corporations face a shareholder-number cap (generally 100, with family aggregation rules) and eligibility restrictions on who may be a shareholder, unlike this choice's unlimited claim. B) Unlike partnerships, S corporations generally cannot make special (disproportionate) allocations, because allocations must follow stock ownership under the one-class-of-stock rule. C) Correct — the one-class-of-stock requirement and the roughly 100-shareholder, eligible-shareholder-type limits are the core structural constraints that make the S corporation less flexible than a partnership. D) An S corporation, like a partnership, is generally a single-level pass-through entity (subject to limited built-in gains or passive income taxes), not doubly taxed like a C corporation.

Compared to a limited partnership, a multi-member LLC electing partnership tax treatment is often preferred for choice-of-entity purposes primarily because it offers:

1. Automatic C corporation tax treatment with no election required
2. Liability protection only for its managing members
3. Mandatory double taxation similar to a C corporation
4. Limited liability protection for all members (not just limited partners) while retaining partnership pass-through taxation and flexible income allocations

Answer: D — Limited liability protection for all members (not just limited partners) while retaining partnership pass-through taxation and flexible income allocations

A) An LLC electing partnership treatment is taxed as a partnership, not automatically as a C corporation. B) LLC liability protection generally extends to all members, including those who participate in management, unlike a limited partnership where a general partner retains personal liability. C) An LLC taxed as a partnership avoids entity-level double taxation; it does not mandate C corporation-style taxation. D) Correct — the multi-member LLC's key advantage over a limited partnership is that all members can enjoy limited liability (even if actively involved in management) while the entity still benefits from partnership pass-through taxation and the flexibility of special allocations.

Which of the following is the PRIMARY federal income tax distinction between a C corporation and a partnership as a choice-of-entity matter?

1. Only C corporations can have more than one owner
2. A C corporation is subject to entity-level tax with a potential second layer of tax on distributions, while a partnership is a pass-through entity generally taxed only once at the partner level
3. Partnerships, unlike C corporations, may never allocate income disproportionately to ownership percentages
4. C corporations, unlike partnerships, cannot deduct ordinary and necessary business expenses

Answer: B — A C corporation is subject to entity-level tax with a potential second layer of tax on distributions, while a partnership is a pass-through entity generally taxed only once at the partner level

A) Partnerships routinely have multiple owners; ownership structure is not the defining C corp/partnership distinction. B) Correct — the central choice-of-entity distinction is double taxation (entity-level tax plus a second tax on dividends) for C corporations versus single-level pass-through taxation for partnerships. C) Partnerships may generally make special allocations of income and loss (subject to the §704(b) substantial economic effect rules), unlike this choice's absolute claim. D) Both C corporations and partnerships may deduct ordinary and necessary business expenses under §162; that is not a distinguishing feature.

Which of the following is an eligible S corporation shareholder?

1. A qualified subchapter S trust (QSST) that meets the statutory requirements
2. A domestic C corporation
3. A partnership formed by three individual investors
4. A nonresident alien individual

Answer: A — A qualified subchapter S trust (QSST) that meets the statutory requirements

A) Correct — a QSST that satisfies the statutory income-distribution and election requirements is an eligible S corporation shareholder. B) Corporations (other than certain other S corporations in a QSub arrangement) are not eligible S corporation shareholders. C) Partnerships are not eligible S corporation shareholders, even if all of the partnership's own owners would individually qualify. D) Nonresident aliens are expressly disqualified as S corporation shareholders.

Under §337, a subsidiary corporation recognizes NO gain or loss on distributing property to its parent corporation in a complete liquidation if:

1. The parent owns at least 80% of the subsidiary's stock (by vote and value) and the liquidation qualifies under §332
2. The subsidiary is insolvent at the time of liquidation
3. The distribution is made to minority shareholders holding less than 20% of the subsidiary
4. The subsidiary elects to be taxed as a partnership before liquidating

Answer: A — The parent owns at least 80% of the subsidiary's stock (by vote and value) and the liquidation qualifies under §332

A) Correct — §337 provides nonrecognition to the liquidating subsidiary on distributions to an 80%-or-more parent when the liquidation qualifies for §332 parent nonrecognition treatment. B) Insolvency is not the trigger for §337 nonrecognition; the required 80% ownership relationship and §332 qualification are. C) §337 nonrecognition applies to distributions to the qualifying 80% parent, not to minority shareholders. D) A subsidiary's entity classification election is unrelated to whether §337 nonrecognition applies to a liquidating distribution.

Which event, standing alone, does NOT cause a partnership to terminate for tax purposes?

1. Sale of 100% of partnership interests to a single unrelated buyer who continues the business as a sole proprietor
2. Distribution of all partnership assets in complete liquidation with no continuing business
3. The death of one partner, where the remaining partners continue operating the business
4. A merger where the partnership's business ceases entirely and is absorbed into an unrelated corporation

Answer: C — The death of one partner, where the remaining partners continue operating the business

A) Selling all interests to a single buyer ends the partnership form because only one owner remains (no partnership can exist with one owner). B) A complete liquidation with no continuing business is a classic terminating event. C) Correct — the death of one partner does not terminate the partnership as long as the remaining partners continue the business; the deceased partner's interest simply passes to a successor. D) A merger that ends the partnership's business and absorbs it into an unrelated entity ends the partnership's separate existence.

When a partnership terminates under §708(b), which of the following occurs?

1. All partners are treated as having sold their interests to unrelated third parties
2. The partnership's tax year closes, and the partnership is deemed to contribute its assets and liabilities to a new partnership, which then liquidates by distributing interests to the remaining partners
3. The partnership automatically converts to a sole proprietorship
4. All prior elections, such as depreciation methods, carry over unchanged with no new elections required

Answer: B — The partnership's tax year closes, and the partnership is deemed to contribute its assets and liabilities to a new partnership, which then liquidates by distributing interests to the remaining partners

A) Termination does not treat the partners as selling to outside third parties. B) Correct — the deemed transaction is a contribution of assets/liabilities to a new partnership followed by an immediate liquidating distribution of interests in that new partnership. C) A multi-member entity terminating under §708(b) does not automatically become a sole proprietorship unless only one partner remains. D) The new partnership may need to make fresh elections; prior elections do not automatically carry over unchanged.

Under current §708(b), a partnership is considered terminated for tax purposes when:

1. No part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners
2. More than 50% of total partnership interests are sold or exchanged within a 12-month period
3. A single partner withdraws from the partnership
4. The partnership admits a new partner during the year

Answer: A — No part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners

A) Correct — under current law, termination occurs only when no partner continues to carry on any part of the partnership's business, financial operation, or venture. B) This describes the former §708(b)(1)(B) technical termination rule, which was repealed by the Tax Cuts and Jobs Act and no longer causes termination. C) A single partner's withdrawal does not terminate the partnership if the remaining partners continue the business. D) Admitting a new partner is a routine event that does not, by itself, terminate the partnership.

§336 — corporate-level gain on liquidating distributions?

A liquidating corporation generally recognizes gain or loss on distributed property as if the property were sold to the distributee shareholder at fair market value, subject to related-party and built-in-loss limitations.

§331 — shareholder-level treatment in a taxable liquidation?

Amounts received by a shareholder in complete liquidation are treated as full payment in exchange for the stock, generally producing capital gain or loss equal to the difference between the value received and the shareholder's stock basis.

General vs limited partnership?

GP: all partners liable. LP: limited partners liable only to investment, can't manage.

S corporation — passive investment income termination rule?

If the S corporation has accumulated C corporation earnings and profits and passive investment income exceeds 25% of gross receipts for 3 consecutive years, the S election terminates automatically.