Question

Adam, Linda, and Mike are considering starting a bakery together in Burlington, VT called Vermont Bakes. They have come to you looking for advice on the advantages and disadvantages of each business entity. Adam and Linda will each own 40% of the business and Mike will own 20%. Adam would like to contribute cash of $40,000, Linda will contribute land with an FMV of $60,000 and an adjusted basis of $25,000. Mike will contribute services of $20,000. In addition, Linda receives $20,000 of cash. Adam, Linda & Mike have indicated that they would like to take distributions of profits from Vermont Bakes each year in addition to compensation. They plan to pay themselves compensation of $45,000 each and they project that Vermont Bakes will have $10,000 in profits each year that they would like to distribute based on their ownership percentages. The distributions are as follows:

Adjusted Basis FMV

Adam - Equipment $2,000 $4,000

Linda - Cash $4,000 $4,000

Mike - Cash $2,000 $2,000

1. Calculate Adam, Linda & Mike's basis in their ownership interest if they were part of a prearranged plan to incorporate Vermont Bakes as a C corporation. Calculate the basis the C corporation would take in the property contributed by Adam, Linda & Mike. Calculate the realized and recognized gain to Adam, Linda & Mike on their contribution to the C corporation (if any).

2. Calculate Adam, Linda & Mike's basis in their ownership interest if they decided to form Vermont Bakes as a partnership. Calculate the basis the partnership would take in the property contributed by Adam, Linda & Mike. Calculate the realized and recognized gain to Adam, Linda & Mike on their contribution to the partnership (if any).

Answer 1

1. Incomplete Information

2.

Basis refers to an owner’s investment in a particular business, and basis must be tracked accurately for annual tax reporting. When an owner sells his or her business interest, the profit on the sale is calculated as (sales proceeds received) less (basis). Adam and Linda own 40% share of the business.

Adam’s basis in ownership interest:

Adam contributed $40000 as cash to the business, $45000 he received as compensation, and $4000 as share of profit in the form of FMV value of equipment.

Therefore, his total basis is $(40000+45000+4000) = $89000

Linda’s basis in ownership interest:

Linda contributed $60000 value of land (inclusive of adjusted basis of $25000) that means cost of $(60000-25000=$35000) of land. She also received $20000 as cash, $45000 she received as compensation, and $4000 as share of profit in the form of FMV value of equipment.

Therefore, his total basis is $(35000+45000+20000+4000) = $104000

Mike’s basis in ownership interest:

Mike contributed $20000 as services to the business, $45000 he received as compensation, and $2000 as share of profit in the form of FMV value of equipment.

Therefore, his total basis is $(20000+45000+2000) = $67000

Calculation of realized and recognized gain:

Adam’s gain:

Realized gain =$45000-$40000= $5000.

Recognized gain=$(45000+4000)-$40000= $9000.

Linda’s gain:

Realized gain =$45000+4000-$35000= $14000.

Recognized gain=$45000+4000-$35000= $14000.

Mike’s gain:

Realized gain =$45000+2000-$20000= $27000.

Recognized gain=$$45000+2000-$20000= $27000.