A number of tax and nontax factors should be considered in choosing the type of

Question

A number of tax and nontax factors should be considered in choosing the type of passthrough entity through which to operate a new business. For each of the following considerations, indicate whether the item favors the partnership form or the S corporation form of passthrough entity and why.

a. State taxes, including franchise tax and potential entity-level income taxes.

b. Flexibility of income and loss sharing arrangements.

c. Complexity in the application of the relevant tax statutes.

d. Liability for self-employment tax on allocable shares of the entity’s ordinary business income.

Explanation / Answer

CORRECT ANSWER a. State taxes, including franchise tax and potential entity-level income taxes

REASON

Most individual U.S. states collect a state income tax in addition to federal income tax. The two are separate entities. Some local governments also impose an income tax, often based on state income tax calculations. Forty-three states and many localities in the United States may impose an income tax on individuals. Forty-seven states and many localities impose a tax on the income of corporations.[1]

State income tax is imposed at a fixed or graduated rate on taxable income of individuals, corporations, and certain estates and trusts. The rates vary by state. Taxable income conforms closely to federal taxable income in most states, with limited modifications.[2] The states are prohibited from taxing income from federal bonds or other obligations. Most do not tax Social Security benefits or interest income from obligations of that state. Several states require different useful lives and methods be used by businesses in computing the deduction for depreciation. Many states allow a standard deduction or some form of itemized deductions. States allow a variety of tax credits in computing tax.

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