Question

You are currently working at a mid-sized certified public accounting firm. Your client is Bob Jones. Bob, age 60 and single, has recently retired from IBM. He has $690,000 available in his 401(k) fund and he is thinking of using that money to open a used car business that will be located at 210 Ocean View Drive in Pensacola, Florida. Bob has estimated that the business might make $300,000 in taxable income. Bob’s personal wealth including investments in land, stocks, and bonds is about $14,000,000. He reported an interest income of $20,000 and dividend income of $6,000 last year. The $14,000,000 includes land worth $9,000,000 that Bob bought in 1966 for $450,000. Bob has hired your firm for professional advice regarding whether he should operate as a sole proprietor, a partnership, an S corporation, or a C corporation. He is also considering transferring a possible 40% interest in his new business to his daughter Mandy, age 23 and single.  

Required:

A. Prepare a memorandum to the client, recommending a type of business entity, including an appendix of supporting IRS tax schedules and forms.

B. Identify the tax consequences on the sale or exchange of the land consistent with capital gain rules. Consider the selling expense, broker’s fees, closing costs, appraisals, and surveys and the correct schedule form to complete

C. Describe the after tax effects on the client’s cash flow based on the sale of the land that is needed to provide the funds necessary to start the business. Consider including capital gains tax rules

D. Explain whether or not the client and his child should take a salary or cash distribution according to tax purposes and Internal Revenue Code and Treasury regulations. Consider the type of business and the tax effect whether it is salary, dividends, or cash withdrawal.

Answer 1

To:

From:

Subject: Tax Benefits and Liability for S Corporations.

Date

Based on the nature and type of the business of providing services, forming S Corporation is recommendable for BOB. S Corporation comprises a number of appealing benefits of tax and still provides corporation' liability protection to the business owners. The obtained losses and incomes are transferred to the shareholders along with the reporting on the individual tax returns in the case of S corporation. Therefore, it would be not required for bob would be bear the losses encountered and entire burden of tax in the business. Though in the overall return, a 10% growth is projected by the business.

It is recommended for bob to use S Corporation, because the nature of his business does not require inventory due to which , it is suitable and easy for him to use cash accounting to system rather than using accrual accounting system. Income is taxable once it has been received and expenditures deductible paid under the cash accounting system. Certain recent changes in the tax regulation and law result in the formation of small business Job Protection Act 1996 that has made the S Corporation eye-catching for the entrepreneurs and business owners. S corporation restricted to 35 shareholders previously , though the shareholders increased to 75 by the tax law 1996. This increment in the number of shareholders enables more investors to join business; thus, it result in more capital in the business.

Regardless of the limited liability protection and tax benefits, S corporation have certain drawbacks. For example, S Corporation have a number of requirements that need to be fulfilled and therefore, it implies higher tax service and legal cost. S corporations are required to file the articles of the incorporation along with the holding regular meetings of the shareholders. Regardless of all, the cost of accounting and legal services are equal to the standard corporation's costs. Moreover, the of the returns preparation is lower as compared to cost of the C Corporation. S corporations are required for filing tax once in year. While, the C corporation is required ti file tax quarterly. The company shareholders and employees enjoy protection of full limited liability. Their individual asset cannot be utilized for paying for the corporation's losses.

The limited liability and the tax effect of S corporations comprises that the corporations passes all the losses, deductions and corporate incomes to the shareholders for federal taxation. Therefore, S corporations shareholders would report the income and losses to their personal tax returns. Taxes are assessed on the income of the S corporations. S corporations are accountable for the income and certain gains within the entity level. One more key advantage of S corporation is that it regard the drawback of double taxation associated with the corporate income along with dividends from the shareholders. Once the S corporation has been selected. It would be essential for Bob to file numerous forms and tax schedules comprising IRS form 2553 and form 1120SU.S. income tax return for an S corporation.