Posted: March 3rd, 2014

Tax problems

Harry had the following property exchanges in 2012:

• Harry exchanged a machine used in his business, with an adjusted basis of $37,484 and a fair market value of $59,000, for a machine owned by Jack. Jack’s machine had an adjusted basis of $49,500 and a fair market value of $55,000. As part of the exchange, Jack also gave Harry $4,000 in cash.

• Harry exchanged a machine used in his business, with an adjusted basis of $9,371 and a fair market value of $14,750, for office furniture owned by Jill. Jill’s furniture had an adjusted basis of $11,250 and a fair market value of $13,750. As part of the exchange, Jill also gave Harry $1,000 in cash.

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• Harry exchanged a refrigeration system used in his business, with an adjusted basis of $112,000 and a fair market value of $110,000, for a small warehouse owned by Peter. Peter’s warehouse had a $60,000 liability that Harry agreed to assume. Peter’s warehouse had an adjusted basis of $185,600 and a fair market value of $170,000.

• Harry exchanged a tract of land that he was holding for investment for a tract of land owned by Mina Co. Harry had acquired the land 13 years ago for $6,000. Its fair value is $13,000. The land owned by Mina Co. was acquired 9 months ago for $17,000 and had a fair market value of $20,000 at the date of exchange. Harry agreed to assume the $7,000 debt on Mina’s land.

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Required:

For each of the above situations, respond to the following:

a) Calculate the realized gain for Harry and the other party in the exchange.

b) Calculate the recognized gain for Harry and the other party in the exchange.

c) What is each party’s basis in the property received?

Question 2 (20 marks)

Erica, a scientist, had worked for PBJ Labs, Ltd. for 15 years. On June 30, 2012, she lost her job due to corporate downsizing. Her husband, Morris, an assembly line worker, lost his job on July 31, 2012 when his employer closed down due to bankruptcy. From January 1 to July 31, 2012, Morris earned $25,000. He felt fortunate that he received all his pay when his employer closed down. For 2012, Erica received $50,000 in salary and benefits from PBJ. In addition, PBJ gave Erica a severance package of $5,000 and agreed to continue paying her medical insurance premiums of $500 per month until June 30, 2013. Her medical plan provided coverage for her and her family.

Late in 2011, Morris learned that his employer was having financial difficulties. He suspected that he might lose his job, so he signed up for a training course that would qualify him to drive city buses. He took the course on a part-time basis from January through February and passed his examination in May, 2012. He paid $3,500 for the course.

Erica found a job in September, 2012. However, it was located in Maryland. With Morris losing his job as well, they decided that it was time to relocate from California to Maryland. Erica started her new job in November and Morris found a job driving buses. He started in December. Erica’s new monthly salary was $7,000. She usually receives her pay at the end of the month but because of the Christmas break, she did not pick up her December paycheck until January 5, 2012, even though it was available for pick-up on December 30. In contrast, Morris’s employer paid everyone in advance because of the Christmas break. Morris receives a semi-monthly salary of $2,000. Erica needed some lab supplies for her new job and paid $1,000 for them. The company said that it would reimburse her but never did.

In relocating to Maryland, Erica and Morris sold their house for $390,000 on September 30, 2012. They paid a $9,000 commission to their realtor and had closing costs of $7,000. They had paid $525,000 cash for the house four years ago. Property taxes for 2012 for the house were $2,800. These taxes were apportioned at closing as the 2012 taxes were not due until February 2013. Erica had a home equity loan of $150,000 secured by the house. She had paid interest of $12,000 on the loan in 2012.

Erica flew to Maryland on a house-hunting trip in October and Morris stayed behind to take care of their three young children. Erica purchased a new house for $300,000, taking out a $175,000 mortgage. She paid points of $2,200 to take out the mortgage. She took possession of the house on November 1. For 2012, Erica paid interest of $1,350 on this mortgage. In order for Erica to get an early possession date, she had to agree to pay for all the property taxes in 2012. These taxes total $3,900 and are due and payable in January 2013. The cost of Erica’s trip was $3,000 including air fare, accommodations, and meals. To save money, Morris decided to rent a trailer and drive his family and possessions to Maryland. The trailer rental was $750 and the trip covered 3,200 miles. Motel rooms during the trip cost a total of $400 and meals totaled $550.

During the move to Maryland, someone broke into the trailer while they were staying at a motel. The cost of the stolen goods totaled $9,800. However, Morris did not properly complete the insurance paperwork when he rented the trailer and the claim was denied.
Morris sold 500 shares of Krane Ltd. stock on September 25, 2012 for $10 per share. He had purchased the stock 10 years ago for $13 per share. His intention was to use the money to make charitable contributions to his college and Erica’s university before they left. After talking to Erica, they decided that it was too generous, given their situation. He purchased 250 shares of Krane on October 5, 2012 for $9 per share. The remainder of the cash was donated, split equally between Morris and Erica’s alma maters.

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A total of $11,500 in federal income taxes and $1,000 in state income taxes has been withheld by Erica’s employers on her paychecks. A total of $6,000 in federal income taxes and $1,500 in state income taxes has been withheld by Morris’s employers on his paychecks. During 2012, the couple received a federal income tax refund of $3,800 and a state income tax refund of $900. These refunds relate to their 2011 returns. They chose to itemize their deductions on their 2012 Form 1040.

Required:

a) Erica and Morris will file a joint return. Calculate their AGI.

b) Calculate the amount of their itemized deductions.

c) Calculate their taxable income.

d) What is the basis of their new house in Maryland?

Question 3 (10 marks)

Wow Events Co. was incorporated and began operations on February 1, 2011. It is an accrual basis taxpayer and has a December 31 year-end. During its 2011 fiscal year, Wow incurred the following organizational costs:

Costs for organization meetings and temporary directors $ 15,000
State incorporation fees 1,500
Accounting fees 15,500
Legal services for drafting corporate charter and bylaws 33,000
Costs related to printing and sale of stock certificates 49,000

For 2011, Wow maximized its organizational expenditures deduction.

For the 2012 fiscal year, Wow reported the following:

Sales $949,000
Dividends received from 12%-owned domestic corporation 175,000
Long-term capital gain 32,000
Short-term capital loss 49,800
Operating expenses, excluding depreciation and amortization 709,500
Charitable contributions 25,000
MACRS 223,400

Required:

a) Calculate Wow’s taxable income and regular tax liability.

b) Assume that the $175,000 in dividends received by Wow were comprised of the following:

From a 33%-owned domestic corporation $131,250
From a 10%-owned domestic corporation 43,750

Recalculate Wow’s taxable income.

c) What carryovers, if any, are available and to what years can they be applied?

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Question 4 (20 marks)

Sarah has been designing women’s wear for many years. She received a large inheritance from her grandmother a few years ago and opened a store to sell her designs. The store has not been profitable since it opened, mainly because Sarah is more interested in creating than selling. Two of her friends, Ellen and Tina, have recently agreed to invest in her business.

With her friends coming on board as investors, Sarah decided to change her business entity from a sole proprietorship to a C corporation. To form the corporation, Sarah contributed the following in exchange for 60 common shares:

Adjusted
Basis Fair Market
Value
Inventory $ 10,000 $ 15,000
Building 100,000 175,000
Land 75,000 130,000
$185,000 $320,000

In addition to the stock issued, the newly-formed corporation, Edgewear Co., assumed Sarah’s $215,000 mortgage on the land and building. Ellen contributed $75,000 cash for 25 shares and Tina contributed marketable securities with a basis of $29,000 and a fair value of $45,000 for 15 shares.

Required:

a) What is Sarah’s realized gain or loss?

b) What is Sarah’s recognized gain or loss?

c) What is Sarah’s basis in the Edgewear stock?

d) What is Edgewear’s basis in the property transferred in by Sarah?

e) What is Tina’s recognized gain or loss?

f) What is Tina’s basis in her Edgewear stock?

g) What is Edgewear’s basis in the marketable securities transferred by Tina?

h) When do Sarah’s, Ellen’s, and Tina’s holding periods for their stock begin?

i) Assume that Ellen, an attorney, contributed $70,000 in legal services and $5,000 cash for her 25 shares. In what way, if any, would your answers to questions (a) to (h) change under this assumption?

Question 5 (10 marks)

Black Corporation is a calendar year taxpayer. Bob is the sole shareholder. His basis in the stock is $20,000.

Required:

Determine the tax consequences of the distribution to Bob and Bob’s basis in the stock after the distribution, in each of the following independent situations. Question (d) asks an addition question.

a) Black had current E & P of $40,000 and accumulated E & P of $(15,000). Black distributed $60,000 to Bob on August 31, 2012.

b) Black had current E & P of $(26,500) and accumulated E & P of $75,000. Black distributed $80,000 to Bob on March 1, 2012.

c) Black had current E & P of $(10,000) and accumulated E & P of $(45,000). Black distributed $50,000 to Bob on June 30, 2012.

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d) Black had current E & P of $60,000 and accumulated E & P of $29,000. Black distributed a tract of land to Bob on September 15, 2012. The land had a fair market value of $80,000 and an adjusted basis of $40,000. Bob assumed the $26,000 mortgage on the land. What are the tax consequences of the distribution to Bob? What is Bob’s basis in the stock after the distribution and what is his basis in the land?

Question 6 (25 marks)

Spa Products, a business entity, has provided the following information for 2012:

Sales $1,054,000
Cost of goods sold 403,800
Operating expenses 315,300
Rental income 100,000
Rental expenses (excluding depreciation) 31,000
Interest from City of Portland bonds 50,200
Interest from Courtland Ltd. bonds 10,000
Dividend income from an 18%-owned domestic corporation 35,600
Dividend income from a 35%-owned domestic corporation 47,200
Accounting gain on sale of land 153,000
Long-term capital gain on sale of stocks 30,300
Long-term capital loss on sale of stocks 35,800
Short-term capital gain on sale of stocks 17,500
Section 1231 gain on sale of equipment 26,300
Section 1245 gain on sale of machinery 33,300
Unrecaptured Section 1250 gain on sale of building 85,000
Accounting depreciation on machinery and equipment 203,900
Accounting depreciation on rental property 9,900
Charitable contributions 50,000
Interest expense on business loan 43,700
Interest expense on loan used to acquire City of Portland bonds 12,300
Interest expense on loan used to acquire Courtland bonds 2,500

Additional information:

• The land sold by the entity that yielded the $153,000 gain was contributed by Sophia years ago when its basis was $29,000 and its FMV was $57,000. For financial accounting purposes, the land was recorded at its fair market value.

• A total of $200,000 in rent was received in 2012: $100,000 for 2012 and $100,000 for $2013. For accounting purposes, the $100,000 for 2013 was recorded as deferred revenue.

• MACRS depreciation – rental property $ 6,300
– machinery and equipment 198,500

• Included in operating expenses are life insurance premiums of $6,000 paid on a policy for Sophia, the CEO. Spa Products is the beneficiary of the policy.

Required:

a) Assume that the entity is a C corporation and that Sophia had contributed the land in exchange for 100% of the shares of the corporation.

i. Calculate the taxable income for the entity.
ii. Can Sophia convert this C corporation into an S corporation? Fully explain your answer. If it is possible, describe the process to do so.

b) Assume that the entity is a limited liability limited partnership (LLLP) and that Sophia had contributed the land in exchange for a 60% partnership share. Sophia is a general partner and manages the LLLP. The other partners are limited partners. Identify which of the above items should be treated

i. as part of ordinary income for tax purposes.
ii. as separately-stated items for tax purposes.

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