Questions and Problems for Discussion
A sole proprietorship is not a legal entity but merely a business activity carried on by an individual.
The proprietor is personally liable to the business creditors. The net profit or loss from the activity is part of the proprietor’s taxable income. Because a sole proprietorship has no separate identity from its proprietor, it can’t be described as a passthrough entity.
Mrs. Liu should use the marginal rate applying to the next dollar of taxable income on Form 1040.
If the $17,000 business loss exceeds the total of Mr. Pitt’s other income items for the year (salary, dividends, interest, etc.), the excess qualifies as a net operating loss, which he can carryback as a deduction to his two prior taxable years.
Firm Q remitted $13,400 employer payroll tax (which it deducted as a business expense) and
$13,400 employee payroll tax withheld from the compensation paid to its employees during the year.
The employee payroll tax is extremely convenient because the responsibility for computing and paying the tax is on the employer, not the employee. However, the payroll tax rate structure is regressive: 7.65 percent on a base amount of annual compensation + 1.45 percent on compensation in excess of the base. In 2007, the employee payroll tax on $50,000 compensation is $3,825 for an average rate of 7.65 percent. The employee payroll tax on $200,000 compensation is $8,945 for an average rate of 4.47 percent. Thus, the employee payroll tax is often criticized as vertically inequitable. 6.
The selfemployment tax is based on net earnings from selfemployment, which is essentially the profit that sole proprietors earn from their business. Individuals pay their selfemployment tax at the same time and in the same manner as they pay income tax.
The income tax deduction for onehalf of selfemployment tax corresponds to the employer’s deduction for employer payroll tax. The nondeductible onehalf of selfemployment tax corresponds to the nondeductible employee payroll tax.
a. General partners have unlimited personal liability for all recourse debts of their partnership.
b. Limited partners have no personal liability for the debts of their partnership. However, Tom,
Angela, and Peter all cannot be limited partners because a limited partnership must have at least one general partner.
The members of an LLC have no personal liability for the debts of their company.
d. The shareholders of an S corporation have no personal liability for the debts of their corporation.
Any item recognized by a passthrough entity that is subject to a special rule, limitation, or treatment in the computation of individual or corporate taxable income or tax liability must be separately stated.
This separate accounting allows each owner to apply the special rule, limitation, or treatment to that owner’s share of the item.
Chapter 10 - Sole Proprietorships, Partnerships, LLCs, and S
10. Each partner in Soya Partnership must combine its share of Soya’s Section 1231 loss with all other
Section 1231 gains and losses realized during the year to determine that partner’s net Section 1231 gain or loss. The rule that a net Section 1231 loss is deductible as an ordinary loss and a net Section
1231 gain is treated as a capital gain can be applied only at the partner (rather than the partnership) level. 11. The different uses of cash have no effect on the federal income tax liabilities of Mr. A and Mr. Z.
Both will pay tax on the income generated by their sole proprietorships, regardless of the amount of cash flow generated or the use to which the owners put such cash flow.
12. a. As a shareholder, Mr. Bates has limited liability for creditor claims against UPF. In other words, the creditor cannot demand repayment of the corporate debt from Mr. Bates.