Question

In: Accounting

Barry Potter and Winnie Weasley are considering making an S election on March 1, 2019, for...

Barry Potter and Winnie Weasley are considering making an S election on March 1, 2019, for their C corporation, Omniocular. However, first they want to consider the implications of the following information:

  • Winnie is a U.S. citizen and resident.
  • Barry is a citizen of the United Kingdom, but a resident of the United States.
  • Barry and Winnie each own 50 percent of the voting power in Omniocular. However, Barry’s stock provides him with a claim on 60 percent of the Omniocular assets in liquidation.
  • Omniocular was formed under Arizona state law, but it plans on eventually conducting some business in Mexico.

a. Is Omniocular eligible to elect S corporation status?

For the remainder of the problem, assume Omniocular made a valid S election effective January 1, 2019. Barry and Winnie each own 50 percent of the voting power and have equal claim on Omniocular’s assets in liquidation. In addition, consider the following information:

  • Omniocular reports on a calendar tax year.
  • Omniocular’s earnings and profits as of December 31, 2018, were $55,000.
  • Omniocular’s 2018 taxable income was $15,000.
  • Omniocular’s assets at the end of 2018 are as follows:

Omniocular Assets

December 31, 2018

Asset

Adjusted Basis

FMV

Cash

$

50,000

$

50,000

Accounts receivable

20,000

20,000

Investments in stocks and bonds

700,000

700,000

Investment in land

90,000

100,000

Inventory (LIFO)

80,000

*

125,000

Equipment

40,000

35,000

Totals

$

980,000

$

1,030,000

*$110,000 under FIFO accounting.

  • On March 31, 2019, Omniocular sold the land for $42,000.
  • In 2019, Omniocular sold all the inventory it had on hand at the beginning of the year. This was the only inventory it sold during the year.

Other Income/Expense Items for 2019

Sales revenue

$

155,000

Salary to owners

(50,000

)

Employee wages

(10,000

)

Depreciation expense

(5,000

)

Miscellaneous expenses

(1,000

)

Interest income

40,000

Qualified dividend income

65,000

  • Assume that if Omniocular were a C corporation for 2019, its taxable income would have been $88,500.
  1. How much LIFO recapture tax (in total) is Omniocular required to pay and when is the first installment due?
  2. How much built-in gains tax, if any, is Omniocular required to pay?
  3. How much excess net passive income tax, if any, is Omniocular required to pay?
  4. Assume Barry's basis in his Omniocular stock was $40,000 on January 1, 2019. What is his stock basis on December 31, 2019?

For the following questions, assume that after electing S corporation status Barry and Winnie had a change of heart and filed an election to terminate Omniocular’s S election, effective August 1, 2020.

  • In 2020, Omniocular reported the following income/expense items:

January 1—July 31, 2020 (213 days)

August 1—December 31, 2020 (153 days)

January 1—December 31, 2020

Sales revenue

$

80,000

$

185,000

$

265,000

Cost of goods sold

(40,000

)

(20,000

)

(60,000

)

Salaries to Barry and Winnie

(60,000

)

(40,000

)

(100,000

)

Depreciation expense

(7,000

)

(2,000

)

(9,000

)

Miscellaneous expenses

(4,000

)

(3,000

)

(7,000

)

Interest income

6,000

5,250

11,250

Overall net income (loss)

$

(25,000

)

$

125,250

$

100,250

  1. For tax purposes, how would you recommend Barry and Winnie allocate income between the short S corporation year and the short C corporation year if they would like to minimize double taxation of Omniocular’s income?
  2. Assume in part (f) that Omniocular allocates income between the short S and C corporation years in a way that minimizes the double taxation of its income. If Barry’s stock basis in his Omniocular stock on January 1, 2020, is $50,000, what is his stock basis on December 31, 2020?
  3. When is the earliest tax year in which Omniocular can be taxed as an S corporation again?

Question:

How much LIFO recapture tax (in total) is Omniocular required to pay and when is the first installment due? As per new tax rule, the corporate tax rate is 21% .

Due Date

Total LIFO recapture tax -----------------?             April 15,2019

--------------------------------------------------------------------------------------------------------------------------------------

e. Assume Barry's basis in his Omniocular stock was $40,000 on January 1, 2019. What is his stock basis on December 31, 2019? (Do not round intermediate calculations. Round your final answers to the nearest whole dollar amount.)
g. Assume in part (f) that Omniocular allocates income between the short S and C corporation years in a way that minimizes the double taxation of its income. If Barry’s stock basis in his Omniocular stock on January 1, 2020, is $50,000, what is his stock basis on December 31, 2020? (Do not round intermediate calculations. Round your final answers to the nearest whole dollar amount.)

e.Stock basis   -------------------------?

g. Stock basis ------------------------?

Solutions

Expert Solution

Answer:

a)

All shareholders are eligible S corporation shareholders. However, it appears as though Omniocular has more than one class of stock because even though Barry and Winnie each have 50 percent of the voting power, Barry’s stock provides him with 60 percent of the assets in liquidation. Consequently, Omniocular is not eligible to make an S election.

b)

$6,300 LIFO recapture tax ($30,000 x 21%). The LIFO recapture amount is $30,000 ($110,000 FIFO inventory basis minus $80,000 LIFO inventory basis). This additional $30,000 is taxed at Omniocular’s marginal tax rate of 21%. The LIFO recapture tax is paid in four installments of $1,575 each ($6,300/4). The first installment is due on April 15, year 2019 (the unextended due date for the 2018 C corporation tax return). The remaining three installments are due on March 15 of years 2020, 2021, and 2022 (the unextended due date for the S corporation tax returns). Note that the LIFO recapture tax increases Omniocular’s tax basis in the inventory to $110,000.

c)

$3,150. Omniocular’s net unrealized built-in gain at the time it converted to an S corporation is $20,000 [$10,000 built-in gain on the land plus $15,000 built-in gain on inventory (after increasing basis to $110,000 due to LIFO recapture tax) minus $5,000 built-in loss on equipment]. Its built-in gains tax is 21% multiplied by the least of (a) $15,000 which is its recognized built-in gain on the inventory (b) $20,000 which is its net unrealized built-in gain when it converted to an S corporation (it had not recognized any of this amount previously), and (c) $88,500 which is what its taxable income would have been if it were still a C corporation.

So, its built-in gains tax is 21% x $15,000 = $3,150. This tax passes through as an ordinary loss (the tax arose from the sale of inventory so the loss is ordinary to Omniocular’s shareholders).

d)

$8,400. Omniocular’s passive and net passive investment income is $105,000 ($40,000 interest income + $65,000 qualified dividend income). Its gross receipts are $260,000 ($155,000 sales revenue + $40,000 interest income + $65,000 dividend income). Because Omniocular’s passive investment income exceeds 25% of its gross receipts it is subject to the excess net passive income tax. The amount of the tax is $8,400, computed as follows:

The excess net passive income tax is 21% multiplied by the lesser of:

(1)$40,000 [$105,000 net passive investment income x (105,000 – 25% x $260,000)/$105,000] or (2) $88,500 (Omniocular’s taxable income if it had been a C corporation). Thus its excess net passive income tax is $8,400 (21% x 40,000). Each item of passive income that flows through to the shareholders is reduced by a pro-rata portion of the excess net passive income tax. In this situation, Omniocular’s passive income is $40,000 of interest and $65,000 of qualified dividend income. Thus, the amount of interest that flows through to Omniocular’s shareholders is $34,667 [$40,000 – (40,000/105,000 x 14,000) and the amount of qualified dividend income that flows through to the shareholders is $56,333 [$65,000 – (65,000/105,000 x 14,000)]

e)

Barry is a 50 percent shareholder in Omniocular. His basis on December 31, 2019 is $48,375, computed as follows:

Description

Amount

Description

Basis on 1/1/2019

$40,000

Interest income

17,334

$34,667 (interest income reduced by portion of excess net passive income tax) x 50% (Barry is a 50 percent owner).

Qualified dividend income

28,166

$56,333 (dividend income reduced by portion of excess net passive income tax) x 50%

Business (loss) (see below)

(13,125)

($26,250) x 50%

Capital loss (on land sale)

(24,000)

($48,000) x 50%

Basis at year end

$48,375

Business income (loss):

Description

Amount

Sales revenue

$155,000

COGS (adjusted to FIFO basis due to LIFO recapture tax)

(110,000)

Loss from built-in gains tax

(5,250)

Salaries to owners

(50,000)

Employee wages

(10,000)

Depreciation expense

(5,000)

Miscellaneous expenses

(1,000)

Business income (loss)

($26,250)

f.

They should allocate the income based on the number of days in the short year compared to the entire year (i.e., the daily method). This will allow them to shift income out of the short C corporation year and into the short S corporation year and thus subject less income to double taxation.

g.

$79,171. If Omniocular allocates its income based on the number of days in the S corporation period and the C corporation period it will allocate $29,171 of income to Barry ($100,250 x 213/366 x 50% ownership). Thus, his stock basis will be $79,171 ($50,000 plus 29,171).

h.

January 1, 2025. This is the beginning of the fifth year after the year in which the S election was terminated.


Related Solutions

Barry Potter and Winnie Weasley are considering making an S election on March 1, 2019, for...
Barry Potter and Winnie Weasley are considering making an S election on March 1, 2019, for their C corporation, Omniocular. However, first they want to consider the implications of the following information: Winnie is a U.S. citizen and resident. Barry is a citizen of the United Kingdom, but a resident of the United States. Barry and Winnie each own 50 percent of the voting power in Omniocular. However, Barry's stock provides him with a claim on 60 percent of the...
Barry Potter and Winnie Weasley are considering making an S election on March 1, 2019, for...
Barry Potter and Winnie Weasley are considering making an S election on March 1, 2019, for their C corporation, Omniocular. However, first they want to consider the implications of the following information: Winnie is a U.S. citizen and resident. Barry is a citizen of the United Kingdom, but a resident of the United States. Barry and Winnie each own 50 percent of the voting power in Omniocular. However, Barry's stock provides him with a claim on 60 percent of the...
List five disadvantages of making an S election. ​(Select all that​ apply.) A. An S corporation...
List five disadvantages of making an S election. ​(Select all that​ apply.) A. An S corporation is subject to the personal holding company tax or the accumulated earnings tax if they elect to have a​ year-end that is not a calendar year end. B. Allocation of ordinary income or loss and the separately stated items is based on the stock owned on each day of the tax year. Special allocations of particular items are not​ permitted, as they are in...
1. List five advantages and five disadvantages of making an S election. Explain each item. 2....
1. List five advantages and five disadvantages of making an S election. Explain each item. 2. Which of the following events cause an S election to terminate? The S corporation earning 100 percent of its gross receipts in its first tax year from passive sources The S corporation issuing nonvoting stock that has a dividend preference The S corporation purchasing 100 percent of the single class of stock of a second domestic corporation that has conducted business activities for four...
Last year Drone Corporation was formed on January 1st. An S election was filed by March...
Last year Drone Corporation was formed on January 1st. An S election was filed by March 15th of the same year. When the S election was filed it was missing a consent from one of the shareholders. The missing consent was filed on August 5th. Which of he following statements is correct? A- The S election is valid for last year, if the shareholder was out of the country until August 1st. B- The S election will be vaild beginning...
1. Complete the following statements regarding the election of S corporation status. A qualifying election requires...
1. Complete the following statements regarding the election of S corporation status. A qualifying election requires the consent of (the majority/at least 80%/all) of the corporation's shareholders. The election is made on (Form 1120S/Form 1065/Form 2553). For S corporation status to apply in the current tax year, the election must be filed either (on the date of incorporation/in the previous year) or on or before the fifteenth day of the (first/third/fourth/sixth) month of the current year. 2. Complete the following...
List five advantages of making an S election. Briefly explain each item. List five advantages of...
List five advantages of making an S election. Briefly explain each item. List five advantages of making an S election. (Select all that apply.) A. Deductions, losses, and tax credits are separately stated and retain their character when passed through to the shareholders. These amounts may be subject to the various limitations at the shareholder level. This treatment can permit the shareholder to claim a tax benefit when it otherwise would be denied to the corporation (e.g., a shareholder can...
Harry Potter Inc.,informationfor 2019:1. Depreciation reported on the tax return exceeded depreciationreported on...
Harry Potter Inc.,informationfor 2019:1. Depreciation reported on the tax return exceeded depreciation reported on the income statement by $75,000.This difference will reverse in equal amounts of $25,000 over the years 2020–2021 .2. Interest received on municipal bonds was $24,000.3. Rent collected in advance on January 1, 2019, totaled $45,000 for a 3-year period. Of this amount, $30,000 was reported as unearned at December 31, 2019, for book purposes.4. The tax rates are 0% for 2019 and % for 2020 and...
Harry Potter Inc., information for 2019: 1. Depreciation reported on the tax return exceeded depreciation reported...
Harry Potter Inc., information for 2019: 1. Depreciation reported on the tax return exceeded depreciation reported on the income statement by $75,000. This difference will reverse in equal amounts of $25,000 over the years 2020–2021 . 2. Interest received on municipal bonds was $24,000. 3. Rent collected in advance on January 1, 2019, totaled $45,000 for a 3-year period. Of this amount, $30,000 was reported as unearned at December 31, 2019, for book purposes. 4. The tax rates are 20%...
SUBJECT ACCOUNTING On March 1, 2019 a new refridgerator was purchased for $2,400. The equipment will...
SUBJECT ACCOUNTING On March 1, 2019 a new refridgerator was purchased for $2,400. The equipment will be used for 5 years and then donated to the food bank. Financial Statements are prepared on a monthly basis. At March 31, 2020 what amount of depreciation will be recognized?
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT