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Chapter 15: Entities Overview

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Question;Discussion Questions1.(LO1)What are the more common legal entities used for operating a business? How are these entities treated similarly and differently for state law purposes?2.(LO1)How do business owners create legal entities? Is the process the same for all entities? If not, what are the differences?3.(LO1)What is an operating agreement for an LLC? Are operating agreements required for limited liability companies? If not, why might it be important to have one?4.(LO1)Explain how legal entities differ in terms of the liability protection they afford their owners.5.(LO1)Why are taxable corporations still popular despite the double tax on their income?6.(LO1)Why is it a nontax advantage for corporations to be able to trade their stock on the stock market?7.(LO1)How do corporations protect shareholders from liabilities? If you formed a small corporation, would you be able to avoid repaying a bank loan from your community bank if the corporation went bankrupt? Explain.8.(LO1, LO2)Other than corporations, are there other legal entities that offer liability protection? Are any of them taxed as flow-through entities? Explain.9.(LO2)In general, how are unincorporated entities classified for tax purposes?10.(LO2)Can unincorporated legal entities ever be treated as corporations for tax purposes? Can corporations ever be treated as flow-through entities for tax purposes? Explain.11.(LO2)What are the differences, if any, between the legal and tax classification of business entities?12.(LO2)What types of business entities does our tax system recognize?13.(LO3)Who pays the first level of tax on a taxable corporation?s income? What is the tax rate applicable to the first level of tax?14.(LO3)Who pays the second level of tax on a taxable corporation?s income? What is the tax rate applicable to the second level of tax and when is it levied?15.(LO3)Is it possible for shareholders to defer or avoid the second level of tax on corporate income? Briefly explain.16.(LO3)How does a corporation?s decision to pay dividends affect its double-tax rate?17.(LO3)Is it possible for the overall or double-tax rate on corporate income for corporations to be lower than the tax rate on flow-through entity taxable income? If so, under what conditions would you expect the overall corporate tax rate to be lower?18.(LO3)Assume Congress increases individual tax rates on ordinary income while leaving all other tax rates constant. How would this change affect corporate overall or double-tax rates? How would this change affect overall tax rates for owners of flow-through entities?19.(LO3)Assume Congress increases individual capital gains rates while leaving all other tax rates constant. How would this change affect the overall corporate or double-tax rate?20.(LO3)Evaluate the following statements: ?Dividends and long-term capital gains are generally taxed at the same rate. Therefore, the overall tax rate on corporate income is the same whether the corporation distributes its after-tax earnings as a dividend or whether it reinvests the after-tax earnings to increase the value of the corporation.?21.(LO3)If the reduced 15 percent dividend tax rate is repealed and increased to the ordinary rate, would the overall tax rate of corporate income tend to increase or decrease? Explain.22.(LO3)If XYZ corporation is a shareholder of BCD corporation, how many levels of tax is BCD?s before-tax income potentially subject to? Has Congress provided any tax relief for this result? Explain.23.(LO3)How many times is income from a C corporation taxed if a retirement fund is the owner of the corporation?s stock? Explain.24.(LO3)List four basic tax planning strategies that corporations and shareholders can use to mitigate double taxation of a taxable corporation?s taxable income.25.(LO3)Explain why paying a salary to an employee-shareholder is an effective way to mitigate the double taxation of corporate income.26.(LO3)What limits apply to the amount of deductible salary a corporation may pay to an employee-shareholder?27.(LO3)Explain why the IRS would be concerned that a closely held taxable corporation only pay its shareholders reasonable compensation.28.(LO3)When a corporation pays salary to a shareholder-employee beyond what is considered to be reasonable compensation, how is the salary in excess of what is reasonable treated for tax purposes? Is it subject to double taxation?[Hint: See Reg. ?1.162-7(b)(1).]29.(LO3)How can fringe benefits be used to mitigate the double taxation of corporate income?30.(LO3)How many levels of taxation apply to corporate earnings paid out as qualified fringe benefits? Explain.31.(LO3)How many levels of taxation apply to corporate earnings paid out as nonqualified fringe benefits? Explain.32.(LO3)How can leasing property to a corporation be an effective method of mitigating the double tax on corporate income?33.(LO3)When a corporation leases property from a shareholder and pays the shareholder at a higher than market rate, how is the excess likely to be classified by the IRS?34.(LO3)How do shareholder loans to corporations mitigate the double tax of corporate income?35.(LO3)Conceptually, what is the overall tax rate imposed on interest paid on loans from shareholders to corporations?36.(LO3)If a corporation borrows money from a shareholder and pays the shareholder interest at a greater than market rate, how do you believe the interest in excess of the market rate will be treated by the IRS?37.(LO3)Rank taxable corporations, S corporations, and LLCs in terms of their usefulness in allowing owners to defer gain or income when contributing property or services to the entity. Why is one type of entity preferred over another?38.(LO3)Are taxable corporations or flow-through entities (S corporations and LLCs) more flexible in terms of selecting a tax year-end? Why are the tax rules in this area different for taxable corporations and flow-through entities?39.(LO3)Rank taxable corporations, LLCs, and S corporations in terms of their flexibility to use the cash method of accounting. In general, do the tax rules in this area favor taxable corporations or flow-through entities?40.(LO3)According to the tax rules, how are profits and losses allocated to LLC members? How are they allocated to S corporation shareholders? Which entity permits greater flexibility in allocating profits and losses?41.(LO3)What does it mean to do a special allocation of profits and losses? Why would business owners want to be able to do a special allocation? What types of entities are allowed to specially allocate profits and losses?42.(LO3)Compare and contrast the FICA tax burden of S corporation shareholder-employees and LLC members receiving guaranteed payments, assuming LLC members are treated as general partners for FICA tax purposes. How does your analysis change if LLC members are treated as limited partners for FICA tax purposes?43.(LO3)A tax advisor recently recommended that her client form an LLC because distributions of appreciated property always trigger gain recognition when made from taxable corporations or S corporations, but less often when made from LLCs. Was her analysis correct? Why or why not?44.(LO3)When a C corporation reports a loss for the year, can shareholders use the loss to offset their personal income? Why or why not?45.(LO3)Is a current-year loss of a taxable corporation (a net operating loss) available to offset income from the corporation in other years?46.(LO3)A taxable corporation has a current year loss of $100,000. The corporation had paid estimated taxes for the year of $10,000 and expects to have this amount refunded when it files its tax return. Is it possible that the corporation may receive a refund larger than $10,000? If so, how is it possible? If not, why not?47.(LO3)What happens to a taxable corporation?s net operating loss carryforward after 20 years?48.(LO3)Does a taxable corporation gain more tax benefit by using a net operating loss to offset other taxable income (1) two years after the NOL arises or (2) ten years after the loss arises? Explain.49.(LO3)In its first year of existence, KES, a taxable corporation, reported a taxable loss of $10,000. Kim, KES?s sole shareholder, reports $50,000 of taxable income from sources other than KES. How much of the $10,000 loss can be applied to offset her taxable income from other sources? Explain.50.(LO3)Explain how liabilities of an LLC or an S corporation affect the amount of tax losses from the entity that limited liability company members and S corporation shareholders may deduct. Do the tax rules favor LLCs or S corporations?51.(LO3)When shareholders of taxable corporations or S corporations sell their shares at a gain, how much of the gain is treated as capital gain and how much is treated as ordinary gain? Does this approach also apply to partners that sell their partnership interests?52.(LO3)To what extent are gains and losses on distributed assets recognized when taxable corporations, S corporations, or partnerships liquidate? Do the tax rules in this area always favor certain entities over others? Why or why not?53.(LO3)If limited liability companies and S corporations are both taxed as flow-through entities for tax purposes, why might an owner prefer one form over the other for tax purposes? List separately the tax factors supporting the decision to operate as either an LLC or S corporation.54.(LO3)What are the tax advantages and disadvantages of converting a taxable corporation into an LLC?Problems55.(LO1)Visit your state?s official Web site and review the information there related to forming and operating business entities in your state. Write a short report explaining the steps for organizing a business in your state and summarizing any tax-related information you found.56.(LO3)Evon would like to organize SHO as either an LLC or as a corporation generating an 11 percent annual before-tax return on a $200,000 investment. Individual and corporate tax rates are both 35 percent and individual capital gains and dividend tax rates are 15 percent. SHO will pay out its after-tax earnings every year to either its members or its shareholders.How much would Evon keep after taxes if SHO is organized as either an LLC or a corporation?What are the overall tax rates if SHO is organized as either an LLC or a corporation?57.(LO3)Evon would like to organize SHO as either an LLC or as a corporation generating a 9 percent annual before-tax return on a $200,000 investment. Individual and corporate tax rates are both 30 percent and individual capital gains and dividends tax rates are 20 percent. SHO will distribute its earnings annually to either its members or shareholders.How much would Evon keep after taxes if SHO is organized as either a corporation or an LLC?What are the overall tax rates if SHO is organized as either an LLC or a corporation?58.(LO3)Jack would like to organize PPS as either an LLC or as a corporation generating an 11 percent annual before-tax return on a $100,000 investment. Individual ordinary rates are 35 percent, corporate rates are 15 percent, and individual capital gains and dividends tax rates are 20 percent. PPS will distribute its earnings annually to either its members or shareholders.How much would Jack keep after taxes if PPS is organized as either a corporation or an LLC?What are the overall tax rates if PPS is organized as either an LLC or a corporation?59.(LO3)Gaby would like to organize CBC as either an LLC or as a corporation generating a 7 percent annual before-tax return on a $300,000 investment. Individual and corporate tax rates are both 35 percent and individual capital gains and dividends tax rates are 10 percent. CBC will pay out its after-tax earnings every year to either its members or its shareholders. How much would Gaby keep after taxes if CBC is organized as either a corporation or an LLC?60.(LO3)Gaby would like to organize CBC as either an LLC or as a corporation generating a 9 percent annual before-tax return on a $300,000 investment. Individual and corporate tax rates are both 35 percent and individual capital gains and dividends tax rates are 5 percent. CBC will distribute its earnings annually to either its members or shareholders.How much would Gaby keep after taxes if CBC is organized as either a corporation or an LLC?What are the overall tax rates if CBC is organized as either an LLC or a corporation?61.(LO3)Anna would like to organize RLI as either an LLC or as a corporation generating a 7 percent annual before-tax return on a $250,000 investment. Individual ordinary rates are 30 percent, corporate rates are 15 percent, and individual capital gains and dividends tax rates are 15 percent. RLI will distribute its earnings annually to either its members or shareholders.How much would Anna keep after taxes if RLI is organized as either a corporation or an LLC?What are the overall tax rates if RLI is organized as either an LLC or a corporation?62.(LO3)Using the Web as a research tool, determine which countries levy a double tax on corporate income. Based on your research, what seem to be the pros and cons of the double tax?63.(LO3)LNS corporation, a taxable corporation, reports $300,000 of taxable income in the current year. LNS?s tax rate is 30 percent. Answer the following questions, assuming Natalie, LNS?s sole shareholder, has a marginal tax rate of 35 percent on ordinary income and 15 percent on dividend income.Compute the first level of tax on LNS?s taxable income for the year.Compute the second level of tax on LNS?s income assuming that LNS currently distributes all of its after-tax earnings to Natalie. What is the overall corporate (double) tax rate on LNS?s taxable income for the year?64.(LO3)In the current year, BCS had taxable income of $500,000 and distributed all of its after-tax earnings to Braxton, its sole shareholder. BCS?s tax rate is 35 percent. Assuming Braxton?s marginal tax rate on ordinary income is 35 percent and his dividend rate is 20 percent, what is the amount of the double tax that the corporation and Braxton must pay on BCS?s $500,000 of taxable income?65.(LO3)After several years of profitable operations, Javell, the sole shareholder of JBD Inc., a taxable corporation, sold 18 percent of her JBD stock to ZNO Inc., a taxable corporation in a similar industry. During the current year JBD reports $1,000,000 of taxable income. JBD distributes all of its after-tax earnings to its two shareholders in proportion to their shareholdings. How much tax will ZNO pay on the distribution it receives from JBD assuming ZNO?s marginal tax rate is 35 percent?[Hint: See IRC ?243(a).]66.(LO3)In its first year of existence SCC corporation (a taxable corporation) reported a loss for tax purposes of $30,000. How much tax will SCC pay in year 2 if it reports taxable income from operations of $20,000 in year 2 before any loss carryovers?67.(LO3)In its first year of existence, Willow Corp. reported a loss for tax purposes of $30,000. In year 2, it reports a $40,000 loss. For year 3, it reports taxable income from operations of $100,000. How much tax will Willow Corp. pay for year 3?68.(LO3)For the current year, Custom Craft Services Inc., a taxable corporation, reports taxable income of $200,000 before paying salary to Jaron the sole shareholder of Custom Craft Services Inc. (CCS). Jaron?s marginal tax rate on ordinary income is 35 percent and 15 percent on dividend income. Assume CCS?s tax rate is 35 percent.How much total income tax will Custom Craft Services and Jaron pay on the $200,000 taxable income for the year if CCS doesn?t pay any salary to Jaron and instead distributes all of its after-tax income to Jaron as a dividend?How much total income tax will Custom Craft Services and Jaron pay on the $200,000 of income if CCS pays Jaron a salary of $150,000 and distributes its remaining after-tax earnings to Jaron as a dividend?Why is the answer to part b lower than the answer to part a?69.(LO3)For the current year, Maple Corporation, a taxable corporation, reports taxable income of $200,000 before paying salary to its sole shareholder, Diane. Diane?s marginal tax rate on ordinary income is 35 percent and 15 percent on dividend income. If Maple pays Diane a salary of $150,000 but the IRS determines that Diane?s salary in excess of $80,000 is unreasonable compensation, what is the amount of the double income tax on Maple?s $200,000 presalary income? Assume Maple?s tax rate is 35 percent and it always distributes all after-tax earnings to Diane.70.(LO3)Sandy Corp. projects that it will have taxable income of $150,000 for the year before paying any fringe benefits. Karen, Sandy?s sole shareholder, has a marginal tax rate of 35 percent on ordinary income and 15 percent on dividend income. Assume Sandy?s tax rate is 35 percent.What is the amount of the double income tax on Sandy?s $150,000 of pre-benefit income if Sandy Corp. does not pay out any fringe benefits and distributes all of its after-tax earnings to Karen?What is the amount of the double income tax on Sandy?s $150,000 of pre-benefit income if Sandy Corp. pays Karen?s adoption expenses of $10,000 and the payment is considered to be a qualified fringe benefit? Sandy Corp. distributes all of its after-tax earnings to Karen.What is the amount of the double income tax on Sandy?s $150,000 of pre-benefit income if Sandy Corp. pays Karen?s adoption expenses of $10,000 and the payment is considered to be a nonqualified fringe benefit? Sandy Corp. distributes all of its after-tax earnings to Karen.71.(LO3)Jabar Corporation, a taxable corporation, projects that it will have taxable income of $300,000 before incurring any lease expenses. Jabar?s tax rate is 35 percent. Abdul, Jabar?s sole shareholder, has a marginal tax rate of 35 percent on ordinary income and 15 percent on dividend income. Jabar always distributes all of its after-tax earnings to Abdul.What is the amount of the double tax on Jabar Corp.?s $300,000 prelease expense income if Jabar Corp. distributes all of its after-tax earnings to its sole shareholder, Abdul?What is the amount of the double tax on Jabar Corp.?s $300,000 prelease expense income if Jabar leases equipment from Abdul at a cost of $30,000 for the year?What is the amount of double tax on Jabar Corp.?s $300,000 prelease expense income if Jabar Corp. leases equipment from Abdul at a cost of $30,000 for the year but the IRS determines that the fair market value of the lease payments is $25,000?72.(LO3)Nutt Corporation projects that it will have taxable income for the year of $400,000 before incurring any interest expense. Assume Nutt?s tax rate is 35 percent.What is the amount of the double tax on the $400,000 of preinterest expense earnings if Hazel, Nutt?s sole shareholder, lends Nutt Corporation $30,000 at the beginning of the year, Nutt pays Hazel $8,000 of interest on the loan (interest is considered to be reasonable), and Nutt distributes all of its after-tax earnings to Hazel? Assume her ordinary marginal rate is 35 percent and dividend tax rate is 15 percent.Assume the same facts as in part a except that the IRS determines that the fair market value of the interest should be $6,000. What is the amount of the double tax on Nutt Corporation?s preinterest expense earnings?73.(LO3)Ultimate Comfort Blankets, Inc., has had a great couple of years and wants to distribute its earnings while avoiding the double tax. It decides to give its sole shareholder, Laura, a salary of $1,500,000 in the current year. What factors would the courts examine to determine if Laura?s salary is reasonable?[Hint: See Elliotts, Inc. v. Commissioner, 716 F.2d 1241 (9th Cir. 1983)].74.(LO3)Alice decided that she would purchase a building and then lease the building to QLP. She leased the building to QLP for $1,850 per month. However, the IRS determined that the fair market value of the lease payment should only be $1,600 per month. How would the lease payment be treated with respect to both Alice and QLP?75.(LO3)Larry and his friend Cade formed FitQuest with each taxpayer receiving a 50 percent ownership interest in the entity. For his interest valued at $120,000, Larry contributed land valued at $120,000 with an adjusted basis of $30,000 and Cade agreed to contribute services valued at $120,000 for his interest valued at $120,000. For each interest received, $60,000 of the value is derived from the value of the property in the entity and the remaining $60,000 reflects expectations of future profits. What amount of income does Larry and Cade recognize in these transactions if CCS is a corporation (taxable or S) or an LLC (an entity taxed as a partnership)?76.(LO3)Dave and his friend Stewart each own 50 percent of KBS. During the year, Dave receives $75,000 compensation for services he performs for KBS during the year. He worked about 1,000 hours and was involved in significant management decisions of the entity. After deducting Dave?s compensation, KBS reports taxable income of $85,000. How much FICA and/or self-employment tax is Dave required to pay on his compensation and his share of the KBS income if KBS is formed as a taxable corporation, S corporation, or a limited liability company?77.(LO3)Aaron and his sister Jessica each own 50 percent of PLR. During the year, Aaron receives $40,000 compensation for services he performs for PLR during the year. He worked about 100 hours, but was not involved in significant management decisions of the entity nor was he personally responsible for any of PLR?s debts. After deducting Aaron?s compensation, PLR reports taxable income of $90,000. How much FICA and/or self-employment tax is Aaron required to pay on his compensation and his share of the PLR income if PLR is formed as a taxable corporation, S corporation, or a limited liability company?78.(LO3)Daniel invites his associate, Matt, to join him in forming MDW, with each party contributing $40,000 in cash to become equal owners in all respects. MDW plans to obtain additional cash through a $200,000 small business loan from the local bank, which will be allocated equally to Daniel and Matt. For its first year of business, MDW reported a net loss of $50,000, but did not make any distributions during the year.What is Daniel?s tax basis in his ownership interest at the end of MDW?s first year if it was organized as a C corporation, an S corporation, or an LLC?Assuming instead that MDW reported $50,000 of profit and distributed $20,000 to each owner, what is Daniel?s tax basis in his ownership interest at the end of MDW?s first year if it was organized as a C corporation, an S corporation, or an LLC?79.(LO3)Lazy Acres, after operating for several years, distributes to Peter (a 50 percent owner) land with a fair market value of $250,000. Lazy Acres purchased the land several years ago for $75,000. If Peter?s tax basis in Lazy Acres is $600,000 at the time of the distribution, and Lazy Acres has accumulated $2.3 million in undistributed profits, how much gain or loss will Lazy Acres report from the distribution and how much income will Peter report from the distribution if Lazy Acres was originally organized as a C corporation, an S corporation, or an LLC?80.(LO3)Rondo and his business associate, Larry, are considering forming a business but they are unsure about whether to form it as an S corporation or as an LLC. Each will invest $50,000 and the business will borrow $100,000. They project Rondo?s share of business income and loss for the first five years of the business as follows:YearIncome (Loss)1($25,000)2($25,000)3($8,000)4$60,0005$40,000If they form their new business as an LLC, they plan to allocate the debt 50 percent to each of them.What is Rondo?s tax basis at the end of year 3 if he and Larry organize their business as an LLC?What is Rondo?s tax basis at the end of year 3 if he and Larry organize their business as an S corporation?Will Rondo?s losses be limited in year 3 if he and Larry organize their business as an S corporation? Explain.81.(LO3)Tim and Manuel recently obtained a patent for a technology they invented to significantly increase the storage capacity of cell phones and other handheld electronic devices. They want to form a business to bring their idea to market but haven?t decided whether to form their business as an LLC or as an S corporation. In addition to the patent, they will each contribute some cash to the new business, but most of the required funds will come from bank loans they must personally guarantee. Tim and Manuel will work full-time in the business, but they expect that the business will incur significant losses for at least three years before becoming profitable. Until then, Tim and Manuel would like to utilize their losses currently to reduce their current tax liabilities as much as possible.Assuming that Tim and Manuel are not required to guarantee their firm?s debt, will they prefer to organize as an LLC or as an S corporation?Given that Tim and Manuel are required to guarantee their firm?s debt, will they prefer to organize as an LLC or as an S corporation?[Hint: See Reg. ?1.1367-2, Rev. Rul. 70-50, 1970-1 CB 178.]82.(LO3)Kevin and Bob have owned and operated SOA for a number of years. When they formed the entity, Kevin and Bob each contributed $100,000 to SOA. Information on SOA?s assets at the end of year 5 is as follows (SOA does not have any liabilities):AssetsFMVAdjusted BasisRealizable GainCash$200,000$200,000$ 0Inventory80,00040,00040,000Land and building360,000300,00060,000Total$640,000At the end of year 5, Kevin sold his 50 percent ownership interest to another investor for $320,000 when the basis in his ownership interest was $270,000.What is the amount and character of gain or loss Kevin will recognize on the sale if SOA is organized as a taxable corporation or as an S corporation?What is the amount and character of gain or loss Kevin will recognize on the sale if SOA is organized as an LLC?Comprehensive Problems83.Dawn Taylor is currently employed by the state Chamber of Commerce. While she enjoys the relatively short workweeks, she eventually would like to work for herself rather than for an employer. In her current position, she deals with a lot of successful entrepreneurs who have become role models for her. Dawn has also developed an extensive list of contacts that should serve her well when she starts her own business.It has taken a while but Dawn believes she has finally developed a viable new business idea. Her idea is to design and manufacture bed sheets that have various colored patterns and are made of unique fabric blends. The sheets look great and are extremely comfortable whether the bedroom is warm or cool. She has had several friends try out her prototype sheets and they have consistently given the sheets rave reviews. With this encouragement, Dawn started giving serious thoughts to making ?Color Comfort Sheets? a moneymaking enterprise.Dawn had enough business background to realize that she is embarking on a risky path, but one, she hopes, with significant potential rewards down the road. After creating some initial income projections, Dawn realized that it will take a few years for the business to become profitable. After that, she hopes the sky?s the limit. She would like to grow her business and perhaps at some point ?go public? or sell the business to a large retailer. This could be her ticket to the rich and famous.Dawn, who is single, decided to quit her job with the state Chamber of Commerce so that she could focus all of her efforts on the new business. Dawn had some savings to support her for a while but she did not have any other source of income. Dawn was able to recruit Linda and Mike to join her as initial equity investors in CCS. Linda has an MBA and a law degree. She was employed as a business consultant when she decided to leave that job and work with Dawn and Mike. Linda?s husband earns around $300,000 a year as an engineer (employee). Mike owns averyprofitable used car business. Because buying and selling used cars takes all his time, he is interested in becoming only a passive investor in CCS. He wanted to get in on the ground floor because he really likes the product and believes CCS will be wildly successful. While CCS originally has three investors, Dawn and Linda have plans to grow the business and seek more owners and capital in the future.The three owners agreed that Dawn would contribute land and cash for a 30 percent interest in CCS, Linda would contribute services (legal and business advisory) for the first two years for a 30 percent interest, and Mike would contribute cash for a 40 percent interest. The plan called for Dawn and Linda to be actively involved in managing the business while Mike would not be. The three equity owners? contributions are summarized as follows:Dawn ContributedFMVAdjusted BasisOwnership InterestLand (held as investment)$120,000$70,00030%Cash$ 30,000Linda ContributedServices$150,00030%Mike ContributedCash$200,00040%Working together, Dawn and Linda made the following five-year income and loss projections for CCS. They anticipate the business will be profitable and that it will continue to grow after the first five years.Color Comfort Sheets 5-Year Income and Loss ProjectionsYearIncome (Loss)1($200,000)2($80,000)3($20,000)4$60,0005$180,000With plans for Dawn and Linda to spend a considerable amount of their time working for and managing CCS, the owners would like to develop a compensation plan that works for all parties. Down the road, they plan to have two business locations (in different cities). Dawn would take responsibility for the activities of one location and Linda would take responsibility for the other. Finally, they would like to arrange for some performance-based financial incentives for each location.To get the business activities started, Dawn and Linda determined CCS would need to borrow $800,000 to purchase a building to house its manufacturing facilities and its administrative offices (at least for now). Also, in need of additional cash, Dawn and Linda arranged to have CCS borrow $300,000 from a local bank and to borrow $200,000 cash from Mike. CCS would pay Mike a market rate of interest on the loan but there was no fixed date for principal repayment.Required:Identify significant tax and nontax issues or concerns that may differ across entity types.Provide your recommendation for forming CCS as a C corporation, S corporation, LLC, or partnership. Explain your reasoning for your choice of entity, identify any issues that you may still be concerned about, and suggest recommendations for dealing with the concerns.84.Color Comfort Sheets (CCS) has been in business for about 10 years now. Dawn and Linda are each 50 percent owners of the business. They initially established the business with cash contributions. CCS manufactures unique bed sheets that look great and are very comfortable. CCS has been fairly profitable over the years. Dawn and Linda have both been actively involved in managing the business. They have developed very good personal relationships with many customers (both wholesale and retail) that, Dawn and Linda believe, keep the customers coming back.On September 30 of the current year, CCS had all of its assets appraised. Below is CCS?s balance sheet, as of September 30, with the corresponding appraisals of the fair market value of all of its assets. Note that CCS has several depreciated assets. CCS uses the hybrid method of accounting. It accounts for its gross margin-related items under the accrual method and it accounts for everything else using the cash method of accounting.AssetsAdjusted Tax BasisFMVCash$150,000$150,000Accounts receivable20,00015,000Inventory*90,000300,000Equipment120,000100,000Investment in XYZ stock40,000120,000Land (used in the business)80,00070,000Building200,000180,000Total Assets$700,000$935,000**LiabilitiesAccounts payable$ 40,000Bank loan60,000Mortgage on building100,000Equity500,000Total liabilities and equity$700,000*CCS uses the LIFO method for determining the adjusted basis of its inventory. Its basis in the inventory under the FIFO method would have been $110,000.**In addition, Dawn and Linda had the entire business appraised at $1,135,000, which is $200,000 more than the value of the identifiable assets.From January 1 of the current year through September 30, CCS reported the following income:Ordinary business income:$530,000Dividends from XYZ stock:$ 12,000Long-term capital losses:$ 15,000Interest income:$ 3,000Dawn and Linda are considering changing the business form of CCS.Required:Assume CCS is organized as a C corporation. Identify significant tax and nontax issues associated with converting CCS from a C corporatio

 

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