Entity Tax Compliance and Planning
The TCP discipline on the CPA exam tests your knowledge of how different business entities are taxed and the planning opportunities available. CPAs must understand entity selection, filing requirements, and the tax implications of business operations for each entity type.
Entity Tax Treatment Comparison
| Feature | C Corporation | S Corporation | Partnership |
|---|---|---|---|
| Tax form | Form 1120 | Form 1120-S | Form 1065 |
| Entity-level tax | Yes, flat 21% | Generally no | Generally no |
| Pass-through | No | Yes (Schedule K-1) | Yes (Schedule K-1) |
| Double taxation | Yes | No | No |
| Loss limitations | NOL stays at entity level | Basis, at-risk, passive activity | Basis, at-risk, passive activity |
| Owner limit | Unlimited | 100 shareholders | Unlimited partners |
| Entity debt in basis | N/A | Only direct loans | Yes, share of all debt |
Entity Selection Factors
CPAs advise clients on entity selection based on multiple factors:
- Tax efficiency: Flow-through entities avoid double taxation; C corporations benefit from the flat 21% rate for high-income businesses that retain earnings
- Self-employment tax: S corporation distributions (reasonable salary required) avoid SE tax; general partners pay SE tax on all earnings
- Section 199A deduction: Available only to pass-through entity owners; potentially reduces effective rate to below corporate rate
- Fringe benefits: C corporations can deduct benefits for all employees including owner-employees; S corporation 2%+ shareholders are treated as partners
- Future plans: C corporations can go public; S corporations face ownership restrictions; partnerships offer maximum flexibility in profit/loss allocation
C Corporation Tax Planning
- Accumulated earnings tax (IRC Section 531): 20% penalty tax on earnings retained beyond reasonable business needs (applies to closely held corporations)
- Personal holding company tax (IRC Section 541): 20% penalty tax on undistributed personal holding company income; applies when 60%+ of income is passive and 50%+ of stock owned by 5 or fewer individuals
- Dividends received deduction: 50% DRD for less than 20% ownership; 65% for 20-79% ownership; 100% for 80%+ ownership of distributing corporation
- Net operating losses: Can offset up to 80% of taxable income; carried forward indefinitely (no carryback for post-2017 NOLs)
S Corporation and Partnership Planning
- Reasonable compensation (S corps): The IRS scrutinizes shareholder-employee compensation; too low triggers recharacterization of distributions as wages
- Guaranteed payments (partnerships): Deductible by partnership, ordinary income to partner, subject to SE tax when paid for services
- Special allocations (partnerships): Partnership agreement can allocate items disproportionately if allocations have substantial economic effect under Section 704(b)
- Built-in gains tax (S corps): Former C corporations pay 21% tax on net recognized built-in gain for 5 years after conversion
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