105+ Free EA Part 2 Practice Questions

Explanation: Form 8832 (Entity Classification Election) is used by eligible entities to choose how they are classified for federal tax purposes. For example, an LLC can use Form 8832 to elect to be taxed as a corporation rather than as a disregarded entity or partnership. Form 2553 is specifically for electing S corporation status, not general entity classification.

Explanation: By default, a single-member LLC is classified as a disregarded entity for federal tax purposes. This means the LLC is not recognized as separate from its owner, and all income and expenses are reported on the owner's individual tax return (typically on Schedule C). The LLC must file Form 8832 if it wants to elect a different classification.

Explanation: A multi-member LLC that has not filed Form 8832 to elect a different classification is treated by default as a partnership for federal tax purposes. It must file Form 1065 and issue Schedule K-1s to each member. A disregarded entity classification only applies to single-member LLCs.

Explanation: Pass-through taxation is a characteristic of partnerships, S corporations, and sole proprietorships, NOT C corporations. C corporations are subject to double taxation: the corporation pays tax on its income at the corporate level, and shareholders pay tax again on dividends received. Limited liability, double taxation, and perpetual existence are all characteristics of C corporations.

Explanation: Under the IRS rules for Form 8832, once an entity makes a classification election, it generally cannot change that election for 60 months (5 years) unless the IRS consents to an earlier change or more than 50% of the ownership interests change. This rule prevents entities from frequently switching classifications to gain tax advantages.

Explanation: An LLC provides limited liability protection to all of its members while also offering pass-through taxation by default (as either a disregarded entity for single-member LLCs or as a partnership for multi-member LLCs). General partnerships do not provide limited liability to general partners. Sole proprietorships offer no liability protection. C corporations provide limited liability but are subject to double taxation, not pass-through taxation.

Explanation: Under IRC Section 183, an activity is presumed to be engaged in for profit if it produces a profit in at least 3 out of the last 5 consecutive tax years (2 out of 7 years for activities involving horses). If the activity does not meet this test, the IRS may classify it as a hobby, and deductions are limited to the amount of hobby income.

Explanation: The IRS considers nine factors when determining hobby vs. business status under Section 183. Modifying methods and seeking professional advice to improve profitability demonstrates a genuine profit motive, which is one of the strongest indicators of business intent. Personal enjoyment and other income sources actually weigh against business classification.

Explanation: A sole proprietorship with no employees that does not file excise tax, pension plan, or alcohol/tobacco/firearms returns is not required to obtain an EIN. The owner can use their Social Security Number instead. All partnerships, S corporations, and C corporations must obtain an EIN regardless of whether they have employees.

Explanation: A newly formed C corporation may adopt any fiscal year ending on the last day of any month simply by filing its first tax return for that period. It does not need IRS approval for its initial tax year choice. However, S corporations, partnerships, and personal service corporations generally must use a calendar year unless they can establish a business purpose for a different year-end or make a Section 444 election.