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In: Accounting

Dumbledore Corporation was formed on January 1, 2018. Mr. Smith owns 25% of the corporation's stock....

Dumbledore Corporation was formed on January 1, 2018. Mr. Smith owns 25% of the corporation's stock. The corporation made an S election immediately, and it is a calendar-year corporation. Mr. Smith contributed $15,000 cash to Dumbledore in exchange for his stock. On August 8, 2018, Dumbledore Corporation borrowed $22,000 from Mr. Smith, and $10,000 from First National Bank under a recourse financing arrangement. Dumbledore had losses from its operations of $104,000 in 2018 and $82,000 in 2019. At the end of 2019, Dumbledore Corporation had not repaid any of the loans from Mr. Smith or the bank. What part of Dumbledore Corporation's 2019 loss may Mr. Smith report on his 2019 individual tax return?

Solutions

Expert Solution

Answer: Mr. Smith will file a tax return with the loss on stocks of $ 20,500 ($ 82,000*25%), being his share in Dumbledore Corporation.

Explanation: Mr. Smith needs to disclose the gains or losses he makes through equity market trading under capital gains while filing your income tax return (ITR). However, the gains/losses are treated as capital gains only if your money remains in the equity market for at least a day. An assesse can incur the following two kinds of capital gains or losses based on the period of holding:

  • Short-term Gains or Loss: If one owns a stock for a year or less, he/she will have to pay tax on the gain or loss at the same rate as his ordinary income from his job or business. This rate usually runs higher than taxes on long-term stocks. One can deduct up to $3,000 in short-term losses off his regular income as of the 2019 tax year.
  • Long-term Gains or losses: Stocks one hold for more than a year qualify for the capital gains tax rate. This rate runs lower than the tax on regular income or short-term stocks, so one can save a lot of money by holding your stocks for more than a year. Some investors use this strategy by holding short-term stocks one day past a year so that they will qualify as long-term stocks.Mr. Smith can take long-term losses off of his income up to $3,000,
  • Since in the given question, Mr. Smith held the stock for more than a year, it will be considered as a long term capital loss and will be allowed to be reduced from his income.

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