To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER 13 COMPARATIVE FORMS OF DOING BUSINESS SOLUTIONS TO PROBLEM MATERIALS Question/ Problem Learning Objective LO LO 1, 3 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Topic Legal and tax forms Taxation of C corporation versus S corporation LO Limited liability company LO Tax rates: corporation versus individual LO 2, Limited liability partnership LO Limited liability: corporate general partner LO Nontax factors and tax factors in choosing a business entity LO 1, 2, Limited liability and loss pass-throughs LO 3, 4, S corporation versus C corporation status LO Distribution policy: C corporation and S corporation LO Alternative minimum tax: ACE adjustment LO Alternative minimum tax: shifting income and deductions LO S corporation and limited liability company: state income tax treatment LO Fringe benefits and tax treatment LO Double taxation and reasonable compensation LO Avoiding double taxation: techniques LO Avoiding double taxation: interest payments LO Avoiding double taxation: no distributions LO Accumulated earnings tax LO 4, S corporation versus C corporation status LO S corporation: qualification LO Contribution of personal use assets to a corporation or a sole proprietorship LO Recognition under § 351 and § 721 LO Special allocations Status: Present Edition Q/P in Prior Edition Unchanged New New Updated Unchanged Unchanged Modified Unchanged Unchanged Modified 10 Unchanged New 11 Unchanged 13 New New New New Unchanged Unchanged Unchanged Modified Unchanged 18 19 20 21 22 Modified Unchanged 23 24 Instructor: For difficulty, timing, and assessment information about each item, see p 13-4 13-1 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-2 Question/ Problem 2012 Corporations Volume/Solutions Manual Learning Objective 25 LO 26 27 28 29 LO LO LO LO 30 LO 31 32 33 34 35 36 37 LO LO 2, 3, 4, 5, 6, LO LO 5, LO LO LO 1, 2, 38 LO 2, 39 *40 *41 *42 43 44 *45 46 *47 *48 *49 50 LO LO LO LO LO LO LO LO LO LO 3, LO LO 51 LO *52 LO *53 LO *54 55 *56 57 58 *59 LO LO LO LO LO LO Topic Basis for ownership interest: effect of entity liabilities Basis for ownership interest S corporation as a taxpayer Partnership and C corporation: distributions Partnership: § 465 at-risk and § 469 passive activity loss Sale of an ownership interest: sole proprietorship Sale of an ownership interest: C corporation Entity attributes Entity attributes Special allocations: § 754 election Liability exposure Corporate tax rates: marginal and effective Choice of business entity: tax and nontax factors Choice of business entity: tax and nontax factors Choice of business entity Single versus double taxation Alternative minimum tax Alternative minimum tax: installment sale Fringe benefits Fringe benefits Reasonable compensation Shareholder loans to corporation Shareholder leasing property to corporation Accumulated earnings tax Stock redemption versus sale to outsiders S corporation: maintaining or revoking status Recognition under § 351, basis, and allocation of gain Recognition at time of contribution and basis Effects of contributions, profits, and distributions on basis: different types of entity Transactions affecting different entity types Distributions to owners Passive activity losses Basis and at-risk rules: partnership Special allocations Asset sale versus stock sale Status: Present Edition Q/P in Prior Edition New Unchanged Unchanged New Modified 26 27 29 Modified 30 Modified Unchanged 31 32 Unchanged Unchanged Modified New Unchanged 33 34 35 Modified 38 Unchanged Modified New New Modified Unchanged Unchanged New Unchanged Modified Modified Unchanged 39 40 37 43 44 45 47 48 49 50 New Unchanged 52 New Unchanged Modified New Modified Unchanged Unchanged 54 55 57 58 59 Instructor: For difficulty, timing, and assessment information about each item, see p 13-4 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Comparative Forms of Doing Business Question/ Problem Learning Objective *60 LO 61 62 LO LO Topic Sale of partnership interests: tax consequences Sale of a business: partnership Purchase of a business: C corporation 13-3 Status: Present Edition Q/P in Prior Edition Modified 60 Unchanged New 61 *The solution to this problem is available on a transparency master Instructor: For difficulty, timing, and assessment information about each item, see p 13-4 Research Problem Topic Stock redemption versus dividend S corporation shareholder and payroll taxes S corporation debt basis Partnership: share of profits Internet activity Internet activity Internet activity Internet activity Status Present Edition Q/P in Prior Edition Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged Unchanged © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-4 2012 Corporations Volume/Solutions Manual Question/ Problem Est’d completion time Difficulty Assessment Information AICPA* AACSB* Core Comp Core Comp Easy Easy Easy Easy Easy Easy Easy Medium 5 10 10 5 10 FN-Reporting FN-Reporting FN-Reporting FN-Measurement FN-Reporting FN-Reporting FN-Reporting FN-Reporting Medium 10 FN-Reporting 10 Medium 10 FN-Reporting 11 12 Easy Easy 13 Medium 14 Easy 15 Medium 16 Easy 17 Medium 18 Easy 19 20 Easy Medium 10 10 21 22 Medium Easy 10 23 24 25 Easy Medium Easy 10 26 27 Easy Easy 10 28 Easy 10 29 Easy 5 10 10 10 FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Comparative Forms of Doing Business Question/ Problem Difficulty Est’d completion time 30 Easy 10 31 Medium 10 32 33 Medium Easy 10 10 34 Medium 10 35 36 Medium Medium 10 10 37 38 Medium Medium 15 15 39 Medium 10 40 Medium 15 41 Hard 15 42 Hard 15 43 Easy 10 44 Medium 15 45 Medium 10 46 Easy 10 47 Medium 10 48 49 Medium Hard 10 15 50 Medium 10 51 Hard 20 52 Medium 15 53 Medium 20 54 Medium 15 13-5 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Reporting FN-Measurement | FNReporting FN-Reporting FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Communication | Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic | Reflective Thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic | Reflective Thinking Analytic | Reflective Thinking Analytic Analytic Analytic Analytic | Reflective Thinking *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-6 2012 Corporations Volume/Solutions Manual Question/ Problem Est’d completion time Difficulty 55 Medium 15 56 Easy 10 57 58 59 Medium Easy Hard 10 10 20 60 Hard 10 61 Hard 15 62 Hard 20 Assessment Information AICPA* AACSB* Core Comp Core Comp FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement FN-Reporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting FN-Measurement | FNReporting Analytic Analytic Analytic Analytic Analytic Analytic Analytic Communication | Analytic *Instructor: See the Introduction to this supplement for a discussion of using AICPA and AACSB core competencies in assessment © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Comparative Forms of Doing Business 13-7 CHECK FIGURES 35.a 35.b 35.c 35.d 36.a 36.b 39.a 39.b 40.a 40.b 40.c 41.a 42 43.a 43.b 44.a 46.a 46.b 48.a 48.b 48.c 49.a 49.b 50 52.a $4 million $4 million $975,000 Same as c Red 34%, 19.67%; White 39%, 33.51%; Blue 34%, 34%; Magenta 35%, 35% Phaseout benefits of lower brackets C corporation results in tax savings of $10,850 C corporation results in tax savings of $177 $0 for Mabel and Alan $78,750 each $275,500; $280,000 $2,125,000 Select the cash option $78,000 excludible $78,000 gross income Partnership $165,000; C Corporation $95,000; S Corporation $165,000 Parrott deducts interest expense $54,000; Abner reports interest income $32,400; Freda reports interest income of $21,600 each year Parrott not allowed deduction; Abner reports dividend income $32,400 each year; Freda reports dividend income of $21,600 each year $79,200 accumulated earnings tax and $272,000 regular tax liability for Flower $272,000 regular tax liability for Flower $0 regular tax liability for Flower Grace yes; Frank no Grace yes; Frank yes S election should be maintained $0 recognized gain for Agnes and Becky, $50,000 recognized gain for Carol; outside basis: Agnes $108,000, Becky $48,000, Carol $54,000 52.b 52.c 53.a 53.b 53.c 55.a 55.b 56.a 56.b 56.c 57.a 57.b 58.a 58.b 58.c 59.a 59.b 59.c 60.a 60.b 61.a 61.b 62 $0 recognized gain for Agnes and Becky, $50,000 recognized gain for Carol; stock basis: Agnes $100,000, Becky $40,000, Carol $50,000 Same as b $88,000 partnership basis $103,500 stock basis $114,750 stock basis Sam $95,000 gain; Allison $240,000 dividend income; Swift $65,000 gain Sam $95,000 gain; Allison $240,000 basis reduction; Swift $65,000 gain passthrough $374,000 $49,000 $54,000 Abby $500,000; Velma $275,000 Abby $450,000; Velma $225,000 Megan $10,000; Vern $90,000 $100,000 loss to corporation Megan $60,000; Vern $40,000 Emily and Freda stock basis $908,000; George recognized capital gain $348,000 Emily and Freda have basis for listed assets $750,000 and goodwill $158,000; George recognized capital gain on liquidation $229,680 Emily and Freda stock basis $550,000; George recognized capital loss $10,000 Tom’s outside basis $325,000; Walt’s outside basis $325,000 Copper Partnership terminates; basis for partnership assets $650,000 Gail $207,000 LTCG; Harry $157,000 LTCG Acquire the assets Acquire the assets © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-8 2012 Corporations Volume/Solutions Manual DISCUSSION QUESTIONS The principal legal forms for conducting a business entity are the sole proprietorship, partnership, limited liability company, and corporation The principal Federal income tax forms are the same, except that the corporation is divided into the C corporation and the S corporation p 13-3 A corporation is a separate legal entity, apart from its owners If it is a C (regular) corporation for Federal income tax purposes, the corporation is taxed on its earnings If the corporate earnings are distributed to the shareholders as dividends, the earnings are subject to a second layer of taxation A corporation that elects S corporation status receives tax treatment similar to that of a partnership with the corporate earnings being taxed only at the shareholder level The tax law provides for S status to allow entities to choose the corporate form and avoid double taxation pp 13-3 and 13-6 to 13-8 The business advantage of a limited liability company is limited liability The tax advantage is that the entity can be taxed under the conduit concept available to partnerships Thus, only single taxation rather than double taxation applies Also, losses can be passed through from the entity to the owners pp 13-3, 13-5, and 13-7 The maximum statutory rate for a C corporation and for an individual is 35% However, at certain levels of income the individual rates are lower than the corporate rates For example, in 2011 income between $137,300 and $250,000 is taxed at 28% or 33% for a married taxpayer filing a joint return, whereas for a corporation the rate is 39% In addition, at certain levels of income, the individual rates are higher than the corporate rates For example, in 2011 income between $500,000 and $10,000,000 is taxed to a corporation at 34%, whereas for a married taxpayer filing a joint return, the rate is 35% So what is relevant is the actual rates that apply in a particular situation and not the maximum statutory rates Also double taxation may apply with corporations if dividend distributions are made to shareholders pp 13-7 and 13-18 The motivation for the change in legal form is to limit liability Under the general partnership form, there is unlimited liability with the personal assets of each of the firm partners being subject to the claims of the partnership creditors Under the limited liability partnership form, the personal assets of a particular partner are subject to the claims of the partnership creditors for his or her actions (Note in some states that even this amount is limited.) However, the personal assets of a particular partner are not subject to the claims of partnership creditors for the actions of other partners The income tax consequences associated with the general partnership form and the limited liability form are the same That is, the entity is not subject to taxation (i.e., the partnership is a tax reporter and the partners are the taxpayers) Both profits and losses are passed through to the partners p 13-5 and Tax in the News on p 13-4 The limited liability objective can be achieved by forming a limited partnership whose general partner is a corporation The liability of the limited partners is limited by statute The owners of the corporation have effectively limited their liability by having the corporation be the general partner Prior to the issuance of the check-the-box Regulations, it was necessary to structure the entity carefully in order to avoid the limited partnership being classified as an association and taxed as a corporation Under the check-the-box Regulations, the limited partnership cannot be reclassified as an association and taxed as a corporation So this prior pitfall no longer exists pp 13-5, 13-6, and Figure 13.1 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Comparative Forms of Doing Business 13-9 a Nontax factors are important to Samuel in selecting the business entity form for his lawn-servicing business The ability of the entity to raise capital as well as the advantages of limited liability should be considered when selecting the form of business entity Additional factors which should be taken into account include: (1) the estimated life of the business, (2) the number of owners and their roles in the management of the business, (3) the ease of transfer of ownership interests, and (4) the organizational formality required to establish the entity b Tax factors are also important to Samuel However, one cannot conclude which are more significant to Samuel Above all, business decisions should make economic sense pp 13-4 to 13-8 Abe can benefit by passing the losses through and offsetting them against his other income Since he is the sole owner, the three business forms available that will permit this are the sole proprietorship, limited liability company (LLC), and the S corporation A benefit of the S corporation and the limited liability company when compared with the sole proprietorship is limited liability Once Abe’s business starts producing a profit, each of these three business forms will result in single taxation (i.e., the entity is not subject to taxation and Abe is subject to taxation) pp 13-6 to 13-8 The S corporation and its owners are subject to single taxation and the C corporation and its owners are subject to double taxation As Sue suggests, one way to avoid double taxation is to reduce the corporate taxable income to zero However, one must be aware of the possibility of the IRS raising the unreasonable compensation issue To the extent that the IRS is successful, the salary is reclassified as a dividend and double taxation is produced Sam is correct that being an S corporation does provide certain constraints in that the requirements that must be satisfied in order to elect S status (e.g., number and types of shareholders, only one class of stock) become maintenance requirements For example, issuing preferred stock would result in termination of the S election One approach would be for Sam to elect S corporation status presently If at some time in the future he cannot continue to satisfy the maintenance requirements, he would then become a C corporation During the period that the S corporation election is in effect, he would not have to be concerned about double taxation Note that a tax advisor should not limit his or her analysis to the options provided by the client Sam should also consider the limited liability company (LLC) pp 13-6, 13-11, and Concept Summary 13.2 10 a A C corporation is taxed on its earnings A dividend is a distribution of some or all of the after-tax earnings of the C corporation Therefore, the shareholder is taxed on the full amount of the dividend distribution If a distribution is entirely a return of capital, then the shareholder is not taxed on the distribution If the distribution is partially a return of capital (e.g., a stock redemption), the shareholder is taxed only on the portion that does not qualify for return of capital treatment (i.e., the excess of the amount realized over the basis) b Return of capital treatment applies for an S corporation which has never been a C corporation A distribution that does not exceed a shareholder’s basis for stock © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-10 2012 Corporations Volume/Solutions Manual merely reduces the basis If a distribution exceeds a shareholder’s basis for stock, the excess is classified as a capital gain pp 13-6 to 13-8 and 13-13 11 The adjusted current earnings (ACE) modification applies only to C corporations The amount of the adjustment is 75% of the excess of ACE over unadjusted alternative minimum taxable income If unadjusted alternative minimum taxable income exceeds ACE for the tax year, the adjustment is negative pp 13-8 and 13-9 12 Violet’s acceleration of income and deferral of deductions for a tax year in which it is subject to the AMT can be beneficial Since Violet is subject to the AMT for the current year, any increase in net income is taxed at the 20% AMT rate If such income were taxed next year, it would be subject to a 34% regular corporate tax rate p 13-9 13 Both the S corporation and the limited liability company forms will permit Mary and Richert to pass the entity losses through to their Federal individual income tax returns For state income tax purposes, the limited liability company form also will accomplish this result However, not all states permit S corporation treatment Thus, Mary and Richert need to ascertain if such treatment is available in the southeastern state If S corporation treatment is not available, then they should select the limited liability company form If S corporation treatment is available, they probably still should select the limited liability company form because of the statutory restrictions that exist with S corporations (e.g., number and types of owners and the capital structure) p 13-9 14 For a taxpayer to receive favorable tax treatment for certain fringe benefits, the taxpayer must be an employee The IRS defines the term employee restrictively For the owner of a business entity to be treated as an employee, the entity must be a corporation For this purpose, an S corporation is treated as a partnership, and a greater-than-2 percent shareholder is treated as a partner pp 13-10 and 13-11 15 a b Since David and Tan, Inc.’s objective is to avoid double taxation, the following need to be addressed: • Tan’s taxable income can be reduced through reasonable compensation payments Is the $400,000 annual salary for David reasonable? It might be possible to increase this amount and still be reasonable! • Based on the data, it appears that Tan is not distributing dividends to David While such a technique can be used to avoid or defer double taxation, is the retention defensible in terms of the accumulated earnings tax? • Would an S corporation election be advisable? Yes, avoiding double taxation associated with Tan should be a goal of David and Tan This is consistent with the general goal of minimizing taxation pp 13-11 to 13-14 16 The following payments to shareholders are deductible in calculating corporate taxable income • Salary payments to shareholder-employees • Lease rental payments to shareholder-lessors © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-20 2012 Corporations Volume/Solutions Manual The combined entity/owner tax liability in b will be as follows: S corporation Shareholders taxed on S corporation earnings ($450,000 × 35%) Shareholders on salaries ($350,000 × 35%) Combined tax liability $ –0– 157,500 122,500 $280,000 p 13-6 and Example 41 a Owl’s regular income tax liability on taxable income of $6,250,000 is calculated as follows: 15% 25% 34% 39% 34% × × × × × $ 50,000 25,000 25,000 235,000 5,915,000 = = = = = $ 7,500 6,250 8,500 91,650 2,011,100 $2,125,000 Since the tax benefits of the 15% and 25% brackets have been phased out, the tax liability could be calculated as follows: $6.25 million × 34% = $2,125,000 The AMT of the corporation is calculated as follows: Taxable income + Positive AMT adjustments including ACE adjustment ($600,000 + $750,000) – Negative AMT adjustments + Tax preferences = Alternative minimum taxable income (AMTI) – Exemption [$40,000 – 25%($12,570,000 – $150,000)] = AMT base × Rate = Tentative AMT – Regular income tax liability = AMT $ 6,250,000 1,350,000 (30,000) 5,000,000 $12,570,000 (–0–) $12,570,000 20% $ 2,514,000 (2,125,000) $ 389,000 Thus, if Owl is a C corporation, its tax liability is $2,514,000 ($2,125,000 regular income tax + $389,000 AMT) b An S corporation is a tax reporter rather than a taxpayer Thus, Owl will pass the regular taxable income, the separately stated items, and AMT attributes through to its shareholders who will make the regular tax liability calculation and the AMT calculation on their individual income tax returns c The results in a will be the same Whether the C corporation is closely held is not relevant An S corporation, however, cannot have 5,000 shareholders It would be taxed as a C corporation The answer to b then would be the same as the result in a pp 13-8 and 13-9 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Comparative Forms of Doing Business 42 13-21 Falcon’s tax liability for 2011 and 2012 is as follows if the cash option is selected Regular Income Tax Liability Taxable income before sale Gain from sale ($500,000 – $400,000) Taxable income 2011 $400,000 100,000 $500,000 2012 $400,000 –0– $400,000 Tax liability (34% rate) $170,000 $136,000 Taxable income before sale AMT gain from sale ($500,000 – $425,000) Other AMT adjustments and tax preferences AMTI Exemption amount AMT base Rate Tentative AMT 2011 $400,000 75,000 425,000 $900,000 (–0–) $900,000 × 20% $180,000 2012 $400,000 –0– –0– $400,000 (–0–) $400,000 × 20% $ 80,000 AMT $ 10,000 $ AMT –0– Falcon’s tax liability for 2011 and 2012 is as follows if the installment option is selected Regular Income Tax Liability Taxable income before sale Gain from sale ($500,000 – $400,000) Taxable income 2011 $400,000 –0– $400,000 2012 $400,000 100,000 $500,000 Tax liability (34% rate) $136,000 $170,000 Taxable income before sale AMT gain from sale ($500,000 – $425,000) Other AMT adjustments and tax preferences AMTI Exemption amount AMT base Rate Tentative AMT 2011 $400,000 –0– 425,000 $825,000 (–0–) $825,000 × 20% $165,000 2012 $400,000 75,000 –0– $475,000 (–0–) $475,000 × 20% $ 95,000 AMT $ 29,000 $ AMT –0– If the cash option is selected, the combined tax liability for the two years is $316,000 ($180,000 in 2011 and $136,000 in 2012) If the installment option is selected, the combined tax liability for the two years is $335,000 ($165,000 in 2011 and $170,000 in 2012) Thus, Falcon saves $19,000 ($335,000 – $316,000) by selecting the cash option pp 13-8, 13-9, and Chapter © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-22 43 2012 Corporations Volume/Solutions Manual a If the farm is incorporated as a C (regular) corporation, then the sisters and the brother as shareholder-employees can qualify as employees Thus, the $78,000 ($50,000 for lodging and $28,000 for meals) is excludible to the sisters and the brother under the § 119 meals and lodging exclusion If the farm is an S corporation, the sisters and the brother are treated as partners (see part b.) b If the farm is not incorporated (i.e., a partnership), the IRS position is that the sisters and the brother not satisfy the definition of an employee Therefore, they are not eligible for the §119 exclusion and the $78,000 must be included in their gross income pp 13-10, 13-11, and Example 10 44 a Taxable income before cost of certain fringe benefits – Deductible fringe benefits Taxable income Partnership $400,000 (235,000) $165,000 C Corporation $400,000 (305,000) $ 95,000 S Corporation $400,000 (235,000) $165,000 Assuming that the fringe benefit plans are not discriminatory, the potential exists for the employer business entity to deduct the amounts paid for fringe benefits Thus, regardless of the entity form, the amounts paid to a qualified pension plan (H.R 10 plan for owner/employees of a partnership or an S corporation) are deductible by the business entity For the partners and S corporation shareholders, the pension amount is included in their gross income and then is eligible for deduction as a contribution to an H.R 10 plan Group-term life insurance and meals and lodging are only deductible by the C corporation (see part b.) For beneficial fringe benefit treatment for group-term life insurance and meals and lodging to be received, the individual must be an employee Partners not qualify as employees, and greater than 2% shareholders of an S corporation are treated the same as partners in a partnership for fringe benefit purposes b For beneficial fringe benefit treatment for group-term life insurance and meals and lodging to be received, the individual must be an employee Partners not qualify as employees, and greater than 2% shareholders of an S corporation are treated the same as partners in a partnership for fringe benefit purposes Since partners and greater than 2% S corporation shareholders not qualify as employees, they not qualify for either § 79 exclusion treatment for group-term life insurance or § 119 exclusion treatment for meals and lodging Therefore, the amounts paid by the business entity for these fringe benefits are included in the gross income of the partners and S corporation shareholders For the corporate shareholders, the amounts paid are deductible by the corporation and excludible by the employee-shareholders The pension plan contributions made for employees are excludible by the covered employees Income will not be recognized by the employees until they receive payments from the pension plan For the owner/employees of a partnership or an S corporation who have contributions made to their H.R 10 plans by the business entity, the amounts paid must be included in their gross income However, this inclusion can be offset by a corresponding deduction for adjusted gross income on the individual’s tax return When benefits are paid from the H.R 10 plan, the recipient includes the amount in his or her gross income pp 13-10 and 13-11 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Comparative Forms of Doing Business 45 a 13-23 Under option 1, Turtle can deduct salaries of $600,000 Thus, Turtle’s taxable income will be $0 ($600,000 – $600,000) No dividends will be distributed since there are no after-tax earnings Britney will include $270,000 of salary in her gross income, Shania will include $180,000 of salary in her gross income, and Alan will include $150,000 of salary in his gross income Under option 2, Turtle can deduct salaries of $300,000 Thus, Turtle’s taxable income will be $300,000 ($600,000 – $300,000) and Turtle’s tax liability will be $100,250 15% 25% 34% 5% × × × × $ 50,000 25,000 225,000 200,000 = = = = $ 7,500 6,250 76,500 10,000 $100,250 Britney will include $135,000 of salary and $66,583 [($300,000 – $100,250) × 1/3] of dividend income in her gross income Shania will include $90,000 of salary and $66,583 ($199,750 × 1/3) of dividend income in her gross income Alan will include $75,000 of salary and $66,583 ($199,750 × 1/3) of dividend income in his gross income b Under option 1, the salary payments reduce Turtle taxable income to $0 Thus, Turtle should be aware of the possibility of the unreasonable compensation issue being raised by the IRS pp 13-11 and 13-12 46 a Parrott will deduct interest expense each year of $54,000 ($900,000 × 6%) Abner will report interest income of $32,400 ($540,000 × 6%) each year and Freda will report interest income of $21,600 ($360,000 × 6%) each year b Parrott will not be allowed a deduction each year for the interest payments of $54,000 Instead, the payments will be labeled as dividends Abner will report dividend income of $32,400 each year and Freda will report dividend income of $21,600 each year When the loan is repaid in years, assuming adequate earnings and profits, Abner will report dividend income of $540,000 and Freda will report dividend income of $360,000 p 13-12 and Example 12 47 If Lavender acquires the shopping mall, its tax liability would increase as follows: Additional liability ($500,000 net rental income × 34%) $170,000 The individual tax liabilities of Marci and Jennifer would not be affected by the shopping mall acquisition by the corporation If Marci and Jennifer acquire the shopping mall and lease it to the corporation, their combined tax liabilities would increase as follows: Net rental income – Depreciation = Increase in their taxable incomes $300,000 (37,000) $263,000 Additional tax liability ($263,000 ì 35%) $ 92,050 â 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-24 2012 Corporations Volume/Solutions Manual At the corporate level, the corporate taxable income would increase as follows: Net rental income – Rental payments to Marci and Jennifer = Additional taxable income $500,000 (300,000) $200,000 Additional tax liability ($200,000 × 34%) $ 68,000 Thus, under the option recommended by the CPA, the combined tax liability of $160,050 ($92,050 + $68,000) is slightly less than the $170,000 tax liability under the corporate acquisition option (34% × $500,000) In addition, Lavender has been able to channel $300,000 to Marci and Jennifer with the amount being deductible in calculating Lavender’s taxable income p 13-11 48 a Flower, Inc.’s corporate tax liability is calculated as follows: 15% 25% 34% 5% × × × × $ 50,000 25,000 725,000 235,000 = = = = $ 7,500 6,250 246,500 11,750 $272,000 In addition, Flower may be subject to the accumulated earnings tax This tax liability could be as high as $79,200 ($528,000 × 15%) The $528,000 represents the after-tax earnings of the corporation ($800,000 – $272,000) b In this case, Flower would not be subject to the accumulated earnings tax Thus, the total corporate tax liability would be $272,000 The shareholders of Flower would be taxed on their dividend income of $528,000 ($800,000 – $272,000) c Flower’s regular income tax liability is $0 because the S election results in the corporation not being subject to Federal income tax The taxable income of $800,000 is passed through to the shareholders’ tax returns The accumulated earnings tax does not apply to S corporations pp 13-6, 13-7, and 13-13 49 a Grace’s redemption qualifies as substantially disproportionate under $ 302(b)(2) Before the redemption, Grace owned 25% of the stock and after the redemption, she owns only 11.1% Therefore, she has had a greater than 20% reduction in her proportionate stock ownership As a result, she qualifies for return of capital treatment Amount realized Basis [$150,000 × (125 shares ÷ 175 shares)] Recognized long-term capital gain $175,000 (107,143) $ 67,857 Frank’s redemption does not qualify as substantially disproportionate—after the redemption, he does not own less than 50% of the stock Therefore, he has dividend income of $175,000 which is eligible for the beneficial 15% tax rate His total stock basis will not change (i.e., $350,000), but his basis per share will increase from $667 ($350,000 ÷ 525 shares) to $875 ($350,000 ữ 400 shares) â 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Comparative Forms of Doing Business b The tax consequences to Grace of selling 125 shares to Chuck would be the same as in a above However, Frank would now receive return of capital treatment rather than dividend treatment His recognized gain on selling 125 shares to Chuck is calculated as follows: Amount realized Basis [($350,000 × (125 shares ÷ 525 shares)] Recognized long-term capital gain c 13-25 $175,000 (83,333) $ 91,667 Factors that would influence the form of the transaction (i.e., stock redemption versus sale of stock to an outsider) include the following: • External market for the stock • Willingness of Frank and Grace to permit an outsider to purchase stock in the corporation • Frank’s preference for capital gain treatment (e.g., other capital losses available) rather than dividend results • Frank’s preference for increasing gross income by only $91,667 instead of $175,000 p 13-13 and Example 14 50 If the S election is voluntarily terminated, another election for Eagle Corporation cannot be made for a five-year period Therefore, the decision regarding revoking the S election should be considered a long-run, rather than a short-run, one The revocation of the election can be made only if a majority of the shareholders consent Thus, Nell will need one of the other shareholders to agree with her in order to voluntarily revoke the election Assuming that the S election is maintained and the earnings of $150,000 are distributed to the shareholders, the tax liability associated with the distribution for all the shareholders is $49,500 ($150,000 × 33%) If the S election is revoked effective for 2011, the corporate tax liability is $41,750 The tax liability for all of the shareholders on the dividend distribution, assuming the dividends are qualified dividends, is $16,238 [($150,000 – $41,750) × 15%] Therefore, the total corporate and shareholder tax liability would be as follows: Corporate tax liability Shareholder tax liability S Corporation $ –0– 49,500 $49,500 C Corporation $41,750 16,238 $57,988 Revocation of the S election combined with a policy of distributing all the earnings to the three shareholders will result in a greater combined corporation/shareholder tax liability of $8,488 ($57,988 – $49,500) Thus, if all of the earnings are going to be distributed, the S election should be maintained p 13-14 and Example 15 51 a No gain or loss is recognized on the contribution of property to a partnership Therefore, Evans’ realized gain of $275,000 ($400,000 amount realized – $125,000 adjusted basis) is not recognized Basis in the partnership interest is $400,000 for Andrew and $125,000 for Evans The recognized gain on the sale of the land is © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-26 2012 Corporations Volume/Solutions Manual $340,000 ($465,000 amount realized – $125,000 adjusted basis) and is allocated to the partners as follows: Andrew Evans b Pre-contribution gain $ –0– 275,000 Post-contribution gain $32,500 32,500 No gain or loss is recognized on the contribution of property to an S corporation if the contributing shareholders satisfy the 80% control requirement Therefore, Evans’ realized gain of $275,000 ($400,000 amount realized – $125,000 adjusted basis) is not recognized Evans’ stock basis is $125,000 and Andrew’s is $400,000 The recognized gain on the sale of the land is $340,000 ($465,000 amount realized – $125,000 adjusted basis) and is allocated to the shareholders as follows: Andrew Evans $170,000 170,000 c No gain or loss is recognized on the contribution of property to a C corporation if the contributing shareholders satisfy the 80% control requirement Therefore, Evans’ realized gain of $275,000 ($400,000 amount realized – $125,000 adjusted basis) is not recognized Andrew’s stock basis is $400,000 and Evans’ is $125,000 The C corporation has a recognized gain on the sale of the land of $340,000 ($465,000 amount realized – $125,000 adjusted basis) This recognized gain has no effect on either Andrew or Evans d An exchange of the original parcel of land for another parcel of land could qualify for deferral as a § 1031 like-kind exchange However, since the business of the entity is real estate development, it appears that the land is inventory If so, § 1031 deferral treatment does not apply Thus, structuring the disposition and acquisition as an exchange produces the same tax consequences as the sale and purchase option pp 13-15, 13-16, and Example 16 52 a Section 721 provides that no gain or loss is recognized by the partners upon the contribution of property to a partnership Thus, neither Agnes nor Becky has any recognized gain Since Carol is contributing services rather than property, she has a recognized gain of $50,000 Section 722 provides for a carryover basis for the partners The $20,000 mortgage assumed by the partnership results in the adjustments indicated below Thus, the partner’s basis for the partnership interest is as follow: Agnes ($100,000 + $8,000) Becky ($60,000 – $20,000 + $8,000) Carol ($50,000 + $4,000) $108,000 48,000 54,000 Section 723 provides for a carryover basis to the partnership for the assets received Cash Land Organization costs b $100,000 60,000 50,000 Section 351 provides that no gain or loss is recognized upon the contribution of property to a corporation if the shareholders control (i.e., at least 80%) the corporation © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Comparative Forms of Doing Business 13-27 immediately after the transfer Since the combined ownership of Agnes and Becky (40% + 40% = 80%) satisfies this requirement, neither has any recognized gain Since Carol is contributing services rather than property, she has a recognized gain of $50,000 Section 358 provides for a carryover basis for the shareholders Thus, the shareholder’s basis for the stock is as follow: Agnes Becky ($60,000 – $20,000) Carol $100,000 40,000 50,000 Section 362 provides for a carryover basis to the corporation for the assets received Cash Land Organization costs c $100,000 60,000 50,000 Same tax consequences as in part b., above, since S status involves a corporation pp 13-15 and 13-16 53 a Melinda can take her share ($250,000 × 30% = $75,000) of the losses to her individual tax return This reduces her basis for her partnership interest (outside basis) to $105,000 ($180,000 – $75,000) Her share of the distribution in year further reduces her outside basis to $78,000 [$105,000 – ($90,000 × 30%)] She must report her share ($200,000 × 30% = $60,000) of the partnership profits on her individual tax return in year This increases her outside basis to $138,000 ($78,000 + $60,000) Melinda has no recognized gain or loss on the distribution in reduction of her ownership interest in year The distribution reduces her outside basis to $88,000 ($138,000 – $50,000) b Melinda can take her share ($250,000 × 30% = $75,000) of the losses to her individual tax return This reduces her stock basis to $105,000 ($180,000 – $75,000) Her share of the distribution in year further reduces her stock basis to $78,000 [$105,000 – ($90,000 × 30%)] She must report her share ($200,000 × 30% = $60,000) of the S corporation profits on her individual tax return in year This increases her stock basis to $138,000 ($78,000 + $60,000) The redemption distribution qualifies as a stock redemption with Melinda’s recognized gain being $15,500 [$50,000 – ($138,000 × 25%)] Melinda’s remaining stock basis is $103,500 ($138,000 – $34,500) c The corporate losses of $250,000 belong to the C corporation rather than to the stockholders Thus, Melinda’s stock basis of $180,000 is not affected Since the C corporation has no E & P, Melinda’s share of the year distribution of $90,000 reduces her stock basis to $153,000 [$180,000 – ($90,000 × 30%)] The $200,000 of earnings in year are taxed at the corporate level and have no effect on Melinda The redemption distribution qualifies as a stock redemption with Melinda’s recognized gain being $11,750 [$50,000 – ($153,000 × 25%)] Melinda’s remaining stock basis is $114,750 ($153,000 – $38,250) pp 13-16 to 13-18 54 a The conduit concept applies for the partnership The effect of these transactions on partnership taxable income is $0 since each of these transactions is reported separately © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-28 2012 Corporations Volume/Solutions Manual (i.e., “as is”) on the partners’ tax returns Thus, each partner reports his or her distributive share of each of the following with the identity maintained: • LTCG of $10,000 ($30,000 $20,000) Đ 1231 gain of $25,000 ($65,000 – $40,000) • Dividend income of $80,000 The tax-exempt interest of $5,000 is passed through to the partners on their respective Schedule K–1s Since the conduit concept applies, such tax-exempt interest is excludible in calculating each partner’s taxable income b The entity concept applies for the C corporation Thus, each of these transactions, except for the tax-exempt income, affects the calculation of corporate taxable income The dollar amount and classification is as follows: • $10,000 LTCG • $25,000 Đ 1231 gain $80,000 ordinary income The $5,000 of municipal bond interest is excludible in calculating the corporate taxable income The IBM dividend qualifies for a 70% dividends received deduction ($80,000 × 70%= $56,000) c The treatment for the S corporation is similar to that for the partnership The conduit concept applies with these transactions producing no effect on the calculation of corporate taxable income Each of the shareholders reports his or her share of every item based on the per share/per day rule pp 13-17 and 13-18 55 a Since the transaction qualifies as a substantially disproportionate distribution for Sam under § 302(b)(2), he receives return of capital treatment Amount realized – Basis for stock redeemed = Realized gain $120,000 (25,000) $ 95,000 = Recognized gain $ 95,000 The gain is classified as a capital gain As the land distributed is appreciated property, Swift has a recognized gain of $65,000 ($120,000 – $55,000) Because Allison’s redemption does not qualify for stock redemption treatment, she must report the $240,000 received as dividend income The $40,000 basis for the shares surrendered by Allison is reallocated to her remaining shares © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Comparative Forms of Doing Business b 13-29 The tax consequences to Sam of the stock redemption is the same as in part a (i.e., $95,000 capital gain) Swift also has a recognized gain of $65,000 on the distribution of the land to Sam However, since Swift is an S corporation, the $65,000 recognized gain is taxable at the shareholder level Therefore, Sam must include in his gross income his pro rata share of the $65,000, or $9,750 ($65,000 × 15%) The tax consequences to Allison of the nonqualifying stock redemption will be to reduce her stock basis by the $240,000 Allison must also include in her gross income her pro rata share of the $65,000 recognized gain, or $39,000 ($65,000 × 60%) pp 13-17 and 13-18 56 a Indigo’s taxable income is calculated as follows: Active income Portfolio income Passive activity losses Taxable income $325,000 49,000 (–0–)* $374,000 *The assumption is made that Indigo satisfies the three requirements for being labeled a personal service corporation for § 469 purposes Therefore, none of the passive activity losses can be offset against either the active income or the portfolio income The passive activity losses of $333,000 carry over b Indigo’s taxable income is calculated as follows: Active income Portfolio income Passive activity losses Taxable income $ 325,000 49,000 (325,000)* $ 49,000 *The passive activity losses can be offset against the active income of a closely held corporation if the corporation does not meet the stock ownership requirements under the personal holding company provisions If the corporation does meet the PHC provisions requirements, the answer is the same as in part a c Active income Portfolio income Passive activity losses Taxable income $325,000 49,000 (320,000)* $ 54,000 *All of the passive activity losses of $320,000 can be offset against active income Therefore, there is no passive activity loss carryover pp 13-19 and 13-20 57 a The outside basis of each partner is calculated as follows: Contribution Recourse financing Nonrecourse financing Abby $300,000 150,000 50,000 $500,000 Velma $ 75,000 150,000 50,000 $275,000 © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-30 2012 Corporations Volume/Solutions Manual b The at-risk basis of each partner is calculated as follows: Abby $300,000 150,000 $450,000 Contribution Recourse financing Velma $ 75,000 150,000 $225,000 pp 13-15 to 13-17, 13-20, and Examples 19 and 20 58 a Special allocations are permitted for partnerships Thus, under the agreement for sharing losses, the $100,000 loss is allocated, assuming there are substantial economic effects, to the partners as follows: Megan ($100,000 × 10%) $10,000 Vern ($100,000 × 90%) 90,000 b If the entity is a C corporation, the $100,000 loss belongs to the corporation, and there is no direct effect on the shareholders c If the entity is an S corporation, special allocations are not permitted The $100,000 loss is allocated to the shareholders based on the per share/per day rule Megan ($100,000 × 60%) Vern ($100,000 × 40%) $60,000 40,000 p 13-21 59 a The basis for the stock purchased by Emily and Freda would be its cost of $908,000 The basis of the assets to the corporation would not be affected, since the corporation is not involved in the purchase/sale transaction George would have a recognized gain of $348,000 from the stock sale and the gain would be classified as a capital gain Amount realized – Basis for stock Recognized gain b $908,000 (560,000) $348,000 Emily and Freda would have a basis for each of the assets purchased equal to the cost (i.e., FMV) Since the FMV of the listed assets is $750,000, the $158,000 excess of the purchase price over $750,000 will be assigned to goodwill Goodwill is amortized over a period of 15 years for tax purposes If Emily and Freda desire to conduct the business in corporate form, they can contribute the assets to a corporation in a tax-free transaction under § 351 The basis of the contributed assets to the corporation will be a carryover basis (i.e., total basis of $908,000) Pelican will be assigned the following recognized gain from the sale of the assets to Emily and Freda for $908,000: Asset Cash Accounts receivable Recognized Gain $ –0– –0– Classification $ Capital –0– –0– Ordinary $ –0– –0– © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Comparative Forms of Doing Business Inventory Furniture and fixtures Building Land Goodwill 10,000 20,000 50,000 110,000 158,000 $348,000 –0– –0– 50,000** 110,000** 158,000 $318,000 13-31 10,000 20,000* –0– –0– –0– $30,000 *§ 1245 recapture **§ 1231 gain George, as the shareholder, is not involved in the purchase/sale transaction Thus, this transaction will produce no tax consequences for George Logically, however, the corporation would liquidate and distribute the available cash to George Since Pelican is in the 34% tax bracket, the corporate tax liability associated with the asset sale would be $118,320 ($348,000 × 34%) Therefore, when George receives a liquidating distribution of $789,680 ($908,000 – $118,320), he will recognize a capital gain of $229,680 ($789,680 amount realized – $560,000 adjusted basis for stock) c The basis for the stock purchased by Emily and Freda is its cost of $550,000 The basis of the assets to the corporation would not be affected, since the corporation is not involved in the purchase/sale transaction George would receive a recognized loss of $10,000 from the stock sale and the loss would be classified as a capital loss Amount realized Basis for stock Recognized loss $550,000 (560,000) ($ 10,000) p 13-26 and Concept Summary 13.1 60 a Tom’s outside basis is $325,000 ($650,000 × 50%) and Walt’s outside basis is $325,000 ($650,000 × 50%) b Since Tom and Walt have acquired a greater than 50% interest in capital and profits, the original Copper Partnership terminates It is survived by a new Copper Partnership owned by Tom and Walt The basis of the partnership assets is the cost of $650,000 Thus, in this case, a § 754 election that would activate § 743 is not necessary pp 13-24 to 13-26 and Concept Summary 13.1 61 a The sales are treated as the sales of ownership interests Thus, each partner calculates his or her recognized gain as follows: Amount realized – Basis Recognized gain Gail $307,000 (100,000) $207,000 Harry $307,000 (150,000) $157,000 The recognized gain is classified as long-term capital gain under § 741 subject to any ordinary income recognition under § 751 “hot” assets Since GH Partnership has no unrealized receivables or substantially appreciated inventory, all of the gain is classified as long-term capital gain © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-32 2012 Corporations Volume/Solutions Manual The sale of the partnership interests by Gail and Harry results in the termination of GH Partnership Under § 708(b)(1)(B), there is a sale or exchange of at least 50% of the total interest in partnership capital and profits within a 12-month period b If the assets are appreciated, an individual purchasing an interest in a partnership normally would prefer to purchase the assets rather than an ownership interest This preference occurs because the basis of the assets will be equal to the amount paid for them (i.e., FMV) With the purchase of a partnership interest, however, a carryover basis results This negative result associated with the purchase of a partnership interest can be offset if the partnership makes the § 754 election This activates the special basis provisions under § 743 for the acquiring partner However, there are a variety of reasons why the partnership may be unwilling to make this election In the case at hand, the usual choices not apply because the GH Partnership is terminated Regardless of the method of purchase, the assets of the new partnership (i.e., KL Partnership) will have a basis equal to the amount paid by Keith and Liz (i.e., FMV) pp 13-24 to 13-26 and Concept Summary 13.1 62 Hoffman, Raabe, Smith, and Maloney, CPAs 5191 Natorp Boulevard Mason, OH 45040 August 15, 2011 Mr Damon Allred 100 Village Green Chattanooga, TN 37403 Dear Mr Allred: I am responding to the inquiry regarding whether you should negotiate to purchase the stock or the assets of Brass Corporation From a tax perspective, you should acquire the assets of Brass Corporation rather than the stock By purchasing the assets, the basis for the assets will be the purchase price of $825,000 Then contribute the assets to a new corporation under § 351 without any recognition The basis of the assets to the corporation will be $825,000 If the stock of Brass Corporation is purchased instead, the basis for the stock is the purchase price of $825,000 However, the corporation’s basis for its assets would remain at $430,000 A nontax advantage of the asset purchase is the avoidance of legal responsibility for any liabilities of Brass Corporation Although Brass has no recorded liabilities, there is the possibility of unrecorded or contingent liabilities If I can be of further assistance, please let me know Sincerely, Robert Ames, CPA Partner © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Comparative Forms of Doing Business 13-33 TAX FILE MEMORANDUM DATE: August 11, 2011 FROM: Robert Ames SUBJECT: Purchase of Brass Corporation by Damon Allred Damon Allred is going to purchase either the stock of Brass Corporation or its assets Damon has agreed with the seller that Brass has a fair market value of $825,000 Brass’ adjusted basis for its assets is $430,000 Damon has requested our advice on whether he should negotiate to purchase the stock of Brass or its assets If Damon purchases the assets of Brass, his basis for the assets would be the purchase price of $825,000 He then could contribute the assets to a new corporation without any recognition under § 351 The corporation’s adjusted basis for the assets would be $825,000 If Damon purchases the stock of Brass, his basis for the stock would be $825,000 However, since Brass is not involved in the transaction, the corporation’s basis for its assets would remain at $430,000 Thus, from a tax perspective, Damon should purchase the assets rather than the stock of Brass In addition, the asset purchase will avoid any potential unrecorded or contingent liability problem p 13-26 The answers to the Research Problems are incorporated into the Instructor s Guide with Lecture Notes to accompany the 2012 Annual Edition of SOUTH-WESTERN FEDERAL TAXATION: CORPORATIONS, PARTNERSHIPS, ESTATES & TRUSTS © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-34 2012 Corporations Volume/Solutions Manual NOTES © 2012 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ... ebook, solutions and test bank, visit http://downloadslide.blogspot.com 13-16 36 2012 Corporations Volume/Solutions Manual a The tax liability of each of the corporations is as follows: Red Corporation. .. single taxation (i.e., the entity is not subject to taxation and Abe is subject to taxation) pp 13-6 to 13-8 The S corporation and its owners are subject to single taxation and the C corporation. .. liability company, and corporation The principal Federal income tax forms are the same, except that the corporation is divided into the C corporation and the S corporation p 13-3 A corporation is a