Entity Tax Compliance and Planning
Entity tax compliance and planning is a major topic on the TCP section of the CPA exam. CPAs must understand how different entity structures affect tax outcomes and be able to advise clients on the optimal entity selection for their business and personal circumstances.
Choice of Entity Analysis
Selecting the right entity structure requires evaluating multiple factors:
| Factor | C Corp | S Corp | Partnership/LLC | Sole Proprietorship |
|---|---|---|---|---|
| Entity-level tax | Yes (21%) | Generally no | No | No |
| Self-employment tax | No on dividends | No on distributions | General partners: yes | Yes |
| Loss flow-through | No | Yes (basis limited) | Yes (basis limited) | Yes |
| Liability protection | Yes | Yes | LLC: yes; GP: no | No |
| Section 199A QBI | No | Yes | Yes | Yes |
| Number of owners | Unlimited | Max 100 | Unlimited | One |
C Corporation Tax Compliance
- Flat 21% corporate tax rate on taxable income (Section 11).
- Accumulated earnings tax (Section 531): 20% penalty tax on earnings retained beyond reasonable business needs to avoid shareholder-level dividend tax.
- Personal holding company tax (Section 541): 20% penalty tax on closely held corporations with predominantly passive income.
- Net operating losses: Can be carried forward indefinitely but limited to 80% of taxable income in the carryforward year.
- Dividends received deduction: 50% (less than 20% ownership), 65% (20-80% ownership), or 100% (80%+ ownership of another corporation).
Multi-Entity Planning
Advanced entity planning strategies tested on TCP include:
- Consolidated returns: Affiliated groups (80%+ ownership chain of C corporations) may elect to file a consolidated return, offsetting profits and losses across entities.
- Transfer pricing: Transactions between related entities must be at arm's length under Section 482. The IRS can reallocate income to reflect economic reality.
- Entity conversion: Tax implications of converting between entity types. C to S conversion triggers the built-in gains tax for 5 years. Partnership to corporation can be accomplished tax-free under Section 351.
- Qualified business income deduction (Section 199A): Pass-through entity owners may deduct up to 20% of QBI, subject to W-2 wage and qualified property limitations for higher-income taxpayers. Specified service businesses face additional phase-out rules.
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