Question

1. Review of Ace’s financial reports and information revealed the following:

Sales 2.4 million

Opening inventory                 650,000

Purchase                                    1.1million

Closing inventory                    585,000

Heat, light utilities                   300,000

Employee payroll                    245,000

Executive salary and pension 350,000

EPA fines                                    85,000

Life insurance premiums paid               47,000

Life insurance collected on death of vice-president   500,000

Depreciation expense: GAAP Double declining balance   total for year 85,000

                                          MACRS, including section 179 and special first year, 692,000

Income tax paid    Federal Regular 62,000, AMT 16,000, New York State/City 27,000

Compute income reported for GAAP purposes and taxable income, if different.

Categorize as favorable/unfavorable a differences. Are they timing or permanent differences?

2. Betta Inc. has 100 shares outstanding. As of January 1, 2016 Betta had 200,000 earnings and profits from prior years. On June 30, 2016 Betta paid a dividend of 35 per share to all shareholders. Bob and his three brothers each owned 25 shares of Betta. Each invested $10,000 to start the company and made no further investment in Betta. In November 2016 Bob and his wife got divorced and he needed money to pay her settlement. To raise the cash needed bob sold 10 shares of Betta back to Betta as treasury stock. Betta gave Bob $65,000 in cash and the car he was driving, cost 62,000, fair market value, 38,000, basis $20,000.

On December 31, 2016 when Betta closed its books for the year there was a profit of $10,000.

Compute Bob’s treatment of the money he received and his basis in the remaining shares he owned.

3. Carl and Dan agree to form a partnership on January 2, 2016. Each will get a 50% share of profit. Carl will invest $50,000 ($25,000 in cash and a parcel of land, value today $75,000, cost in 2002 25,000) and Dan will do the necessary accounting and legal work to form the partnership. If Dan did that amount of work for a regular client he would have charged $50,000.

The partnership sold the land for $80,000[JF1] on December 10, 2016.

Profit for 2016 was $10,000. What will each report on their federal tax return?

4. Sales Inc. was a regular C corporation with only 100 shares issued for many years. In 2015 they filed the necessary forms to become an S corporation as of January 1, 2016. At the time they had $500,000 of retained earnings. They had no cash because they had been using all the profit to pay down the mortgages. All shareholders meet the at-risk and active tests for all transactions. Tom bought his 50 shares for 50,000 when Sales was formed in 1996. Vic bought his 25 shares in 2011 for $200,000. Wes bought his 25 shares in 2014 for $350,000. In 2016 Sales made a profit of $900,000. They used the profit to purchase real estate. There were no distributions to shareholders.

What will Tom, Vic and Wes report on their income tax returns for 2016?

[JF1]

Answer 1

1. Income as per GAAP and Taxable income

Particulars	Income as per GAAP ($)	Particulars	Computation of Taxable Income ($)
Sales	24,00,000	Profit before Tax	6,23,000
Less : Material costs	11,65,000	Add : EPA Fines	85,000
Less : Heat, Light and Utilities	3,00,000	Add : GAAP double declining depreciation	85,000
Less : Employee Payroll	2,45,000	Less : MACRS depreciation.	6,92,000
Less : Executive Salary and Pension	3,50,000	Taxable Income	1,01,100
Less : EPA fines	85,000
Less : Life insurance premium	47,000
Less :GAAP double declining depreciation	85,000
Operating Profit	1,23,000
Add : Non Operating Income	5,00,000
Profit Before Tax	6,23,000
Tax	1,05,000
Profit after Tax	5,18,000

EPA fines is unfavourable difference and is of a permanent nature.

Difference between GAAP double declining depreciation method and MACRS depreciation is due to timing difference of favorable nature.

2. (a) Computation of Profits on sale of shares by Bob.

Sale proceeds on sale of 10 shares $ 65,000

Less : Cost of 10 shares $ 4,000

Profit on sale of shares $ 61,000

(b) Dividend income recieved by Bob $ 875.

(c) Profit of Bob on reciept of Car at free of cost is the Fair Market Value of the car i.e.$ 38,000.

(d) Computation of the basis of valuation of the remaining stock by Bob on 31.12.16.

Cost of 15 shares of Bob $ 6,000

Add : 15 % share of profits for the year 2016 $ 1,500

Add : Share of Profits as on 01.01.16

Adjusted Retained Earnings of earlier years $ 2,00,000

Less : Purchase of Treasury shares $ 65,000

Less : W.D.V. of car given to Bob $ 20,000

Less : Dividend $ 3,500

Adjusted Retained earning of earlier years. $ 1,11,500

15 % Bob's share of the above $ 16,725

Therefore total book value of remaining shares of Bob is $ 24,225.

3. Carl's taxable income.

(a) Difference between the taxable Market value of land when transferred to the partnership and actual cost of acquisition. $ 50,000.

(b) Share of profit of the firm in the year 2016 $ 5,000

(c) Share of profit on sale of land 50 % of ($ 80,000 - $ 75,000) = $ 2,500.

Dan's taxable income.

Share of profits on sale of land and profits for the year 7,500.

4. Tom will report $ 4,50,000 as his taxable income, Vic and West will report 2,25,000 each as their taxable income.