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Problem 2-34 (LO. 1, 2)

Ellie and Linda are equal owners in Otter Enterprises, a calendar year business. During the current year, Otter Enterprises has $320,000 of gross income and $210,000 of operating expenses. In addition, Otter has a long-term capital gain of $15,000 and makes distributions to Ellie and Linda of $25,000 each. What is the impact of this information on the taxable income of Otter, Ellie, and Linda?

If an amount is zero, enter "0".

a. If Otter is a partnership, it will report net ordinary business income (loss) of $ on its Form 1065. Ellie and Linda will receive a Schedule K-1 and each will report net profit of $ and separately stated long-term capital gain of $. The 20/15/0% preferential tax rate applies to only the long-term capital gain for Ellie and Linda. The partner's distributions do not affect Otter's taxable income and are not reported as income by Ellie and Linda. The partners' basis in the partnership is decreased by the distributions.

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Business operations can be conducted in a number of different forms. Among the various possibilities are the following: Sole proprietorships; Partnerships; Trusts and estates; S corporations; Regular corporations and Limited liability companies. For Federal income tax purposes, the distinctions among these forms of business organization are very important.

b. If Otter is an S corporation, it will report net ordinary business income (loss) of $ on its Form 1120S. Ellie and Linda will receive a Schedule K-1 and each will report net profit of $ and separately stated long-term capital gain of $. The 20/15/0% preferential tax rate applies to only the long-term capital gain for Ellie and Linda. The corporation's distributions do not affect Otter's taxable income and are not reported as income by Ellie and Linda. The shareholder's basis in the corporation is decreased by the distributions.

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Partially correct

c. If Otter is a C corporation, it will report net ordinary business income (loss) of $ on its Form 1120. Ellie and Linda will receive a Schedule M-3 and each will report net profit of $ and separately stated long-term capital gain of $ as well as dividend income of $. The corporation's distributions do not affect Otter's taxable income and are reported as income by Ellie and Linda.

Answer 1