Question

You will advise Quark, Inc. about its potential tax problems and about any solutions you may have to reduce tax liability.  

Corporate Background - Quark, Inc. is a calendar-year accrual-based C corporation.

• Marvin Marshon owns 100% of the Quark stock.
• Quark manufactures aluminum casing for the lighting industry.
• At the beginning of 2019, Quark had $2 million of accumulated earnings and profits.

Situation - Quark's management has come to you and indicated that it has excess cash that Marvin wants to use personally.

• Quark intends to loan $500,000 to Marvin by the end of 2019.
• Quark gave you interim 9/30/19 financial statements. You have been able to determine that Quark will have $300,000 in working capital needs at the end of 2019.
• You are also aware that Quark needs equipment that will cost in the range of $150,000 to $250,000 but it has no current purchase orders or other arrangements.

Additional Information

• Its interim balance sheet shows $800,000 in current assets (other than inventories) of cash and marketable securities held for investment.
• Quark has not paid dividends yet this year or last year.
• Quark projects its taxable income to be $1,000,000 (not counting deductions for any equipment purchases).
• The taxable income amount includes a deduction for Marvin's salary of $200,000.

Special Considerations

• Assume that there are no charitable contribution, capital gain/loss or net operating losses (or any carrybacks or carryovers).
• Also, ignore the dividends received deduction.

What are Quark's potential tax problems and what solutions are there to reduce tax liability?

Answer 1

ANSWER

• Quark Corporation has projected taxable income of $ 1,000,000 for year 2019-20.
• It has around $ 800,000 held in cash and cash equivalent securities for purpose of investment.
• Quark is in need of some equipment purchase which would cost around $150,000 to $250,000
• Taxable income includes a deduction for Marvin's salary of $200,000.
• Assumption that there are no charitable contribution, capital gain/loss or net operating losses or any carrybacks or carryovers.

In above mentioned scenario, in normal circumstances, entire projected taxable income of $1,000,000 will subjected to tax and would result into higher tax liability for Calendar year 2017-18. Quark may adopt some of following strategies to lower the tax liability.

1. Provide for Marvin Salary of $ 200,000 from taxable income which will bring down the income by equivalent amount.
2. Utilize portion of Cash equivalents to provide for loan to Mr Marvin. This would lower the interest income from investment and inturn tax liability.
3. Use portion of retained earnings to pay for dividend.
4. Quark may apply for a Bank Loan for financing purchase of Equipment. This will provide additional deduction on account of interest payable on Bank Loan to reduce tax liability.
5. Further if the equipment is put to use during current Calendar year, the depreciation amount will also qualify for deduction from taxable income.

Above mentioned strategies would facilitate in terms of lowering the tax burden.

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