Accounting homework help. Entity Formation and Taxation Case
Pirates Properties was formed on June 1st by Peedee and Tuffy to operate as a calendar-year, accrual basis company that develops and markets land to customers. Peedee contributed land with a fair market value of $2,000,000, an adjusted tax basis of $1,300,000 and a $800,000 nonrecourse bank loan incurred to purchase the land, for an interest in the company. The land was purchased by Peedee four years ago and has been held as an investment. Tuffy contributed shares of stock in Explorer Corporation with a fair market value of $415,000 and an adjusted tax basis of $340,000, and shares of stock in Seahawk Corporation with a fair market value of $385,000 and an adjusted tax basis of $420,000, for an interest in the company. Tuffy purchased both blocks of stock 18 months ago as an investment.
If Pirates Properties was organized as a corporation, then Peedee receives 60 percent of the shares of stock for his interest and Tuffy receives 40 percent of the shares of stock for his interest. Alternatively, if organized as a limited liability company taxed as a partnership, then Peedee receives a 60 percent interest and Tuffy a 40 percent interest in Pirates Properties.
Pirates Properties (Pirates) then proceeded to sell 15 percent of the land for $400,000 on September 15th, all of the shares of stock in Explorer Company for $430,000 on November 30th, and incurred selling and administrative expenses of $100,000 (all related to land sale), which was paid in cash before the end of the year. Pirates Properties also distributed a total of $90,000 in cash to Peedee and Tuffy based on their proportional ownership on December 25th. Both Peedee and Tuffy are in their 40s, using Single filing status with no dependents. They each earn salaries of $115,000 from other employers and they do not claim itemized deductions. Assume the 2019 corporate and individual tax rates and refer to Schedule SE (F1040), Qualified Dividends and Capital Tax Worksheet, Form 8960 (Net Investment Income Tax) and Form 8959 (Additional Medicare Tax) for the calculation of individual taxes.
CASE REQUIREMENTS (all of your work should be done in the provided Excel template)
- Corporate
(C1) Prepare a schedule calculating the initial tax basis (stock basis) for Peedee and Tuffy for the ownership interest in Pirates Properties assuming that it was formed as a corporation. What is the holding period for Peedee and Tuffy?
Tip: Check IRC §1223(1).
(C2) Will Peedee or Tuffy be required to recognize any gain on the exchange of their property for stock in the corporation? If so, how much?
Tip: Check IRC §351.
(C3) Assuming that Pirates Properties was formed as a corporation, prepare 1) the year-end U.S. GAAP balance sheet (initial balance sheet is provided in the Excel template, ignore Deferred Tax Assets or Liabilities); 2) the initial and year-end tax balance sheets; and 3) the U.S. GAAP and tax income statements for the corporation. Note: Assume all tax liabilities are paid with cash by the year end. The stock ownership is 60 percent for Peedee and 40 percent for Tuffy. (Show all your work.)
Tips:
- Under ASC 805, the FMV is used to establish the initial U.S. GAAP balance sheet (Ignore the deferred tax liability attributable to the difference in the fair market value and the tax basis on the date of the contribution under ASC 805-740-25-3 & 740-10-25).
- For U.S. GAAP purposes, any distributions in excess of Retained Earnings should not be treated as dividends.
- If the distribution for tax purposes is distributed out of current earnings and profits (see IRC §312 & Revenue Ruling 79-69, 1979-1 CB 134), then check IRC §316 and §301(c)(1) to find out how the distribution is treated for the shareholder.
(C4) If Pirates Properties was organized as a corporation, then identify the different types of taxes that apply and analyze the tax implications for the entity and stockholders (Peedee and Tuffy). More specifically, calculate the federal tax liability that would apply at the entity level (ignore accumulated earnings tax and personal holding company tax) and individual level. Is there any change in the shareholder’s stock basis? (Show all your work.)
- Partnership
(P1) Prepare a schedule calculating the initial tax basis for Peedee and Tuffy for the ownership interest in Pirates Properties assuming that it was formed as a limited liability company (hereafter, LLC) taxed as a partnership What is the holding period for Peedee and Tuffy?
Tips:
- Check IRC § 722 for basis, IRC § 752 (a-c) for treatment of liabilities, and IRC § § 733 for distribution.
- Use the partner’s interest percentage to allocate the nonrecourse debt.
(P2) Will Peedee or Tuffy be required to recognize any gain on the exchange of their property for their partnership interest? If so, how much?
Tip: Check IRC § 721.
(P3) Assuming that Pirates Properties was formed as an LLC, prepare 1) the year-end U.S. GAAP balance sheet (initial balance sheet is provided in the Excel template); 2) the initial and year-end tax balance sheets; and 3) the U.S. GAAP and tax income statements (pay attention to the character of income variable) for the partnership. Note: It would be helpful to prepare a reconciliation of the partners’ capital accounts to arrive at the year-end U.S. GAAP and tax balance sheets. (Show all your work.)
Tips:
- Under ASC 805, the FMV is used to establish the initial U.S. GAAP balance sheet (a partner’s capital account is not the same as his tax basis of partnership interest in this case, the initial GAAP balance sheet should be helpful to figure out what goes into a partner’s capital account).
- For the partners’ capital account for tax purposes, check IRS Regs 1.704-1(b)(2)(iv)(d)(1) for the general rule and Regs § 1.704-1(b)(2)(iv)(d)(3) for the special rule concerning contributed property.
- Neither partner assumes the nonrecourse debt (not personally liable for). Only liabilities being assumed by a partner can be included in the partner’s capital account based on IRS Regs 1.704-1(b)(2)(iv)(c).
(P4) Assuming that Pirates Properties was organized as an LLC, identify the different types of taxes that apply and analyze the tax implications for the entity and partners (Peedee and Tuffy. More specifically, calculate the federal tax liability that would apply at the entity level and individual level. Include a schedule updating the partners’ tax basis for their partnership interests. (Show all your work.)
Tips:
- Check IRC §704(c) and § 1.704-3 (b) (1) & (2) to find out if the entire tax gain on the disposition of a property is a pre-contribution gain, then how it should be allocated between the two partners.
- Check IRC §1221 to determine what assets qualify for the capital gain treatment.
III. Entity Choice
(1) Please tabulate which organizational form, corporation or LLC (taxed as partnership), will result in: the lowest overall tax liability; the lowest entity tax liability; and the lowest shareholder/partner tax liability.
(2) What advice would you provide to Peedee and Tuffy, from a tax perspective, regarding the most advantageous organizational form? What factors are responsible for the overall tax difference between the two alternatives? What other non-tax factors should also be considered in organizational formation? (between 100 and 500 words)
Additional instructions:
- This is an open-ended research case that requires a comprehensive solution. Each student should submit his/her own Excel file to Bb (in the Exams/Final Project folder) by the due day. This is not a group project.
- Use the Excel template to answer all questions, make sure that you use cell reference and formulas for all calculations. Directly keyed-in answers will not be graded.
- Show all steps in your calculation. More is better in this case.
- When you work on a financial statement, pay special attention to whether it is for GAAP or for TAX.
- Due day: 5/5/20 (no exceptions, no makeups)
Resources:
- Textbook
- IRS website for publications, tax forms, instructions, etc.
- Research tools: GAAP – the FASB Codification database; TAX – RIA/CCH
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