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problem: Your client, a physician, recently purchased a yacht on which he flies a pennant with the medical emblem on it. He recently informed you that he purchased the yacht and flies the pennant to advertise his occupation and therefore attract new patients. He has asked you if he might deduct as ordinary and essential business expenses the costs of insuring and maintaining the yacht. In search of an answer, consult RIA’s CHECKPOINT TAX accessible on-line via the SNHU Shapiro Library. Describe the steps taken to find out your answer.

problem: Stacey Small has a small salon which she has run for a few years as a sole proprietorship. The proprietorship employs the cash technique of accounting and the calendar year as its tax year. Stacey requires additional capital for expansion and knows two people who might be fascinated in investing. One would like to practice hairdressing in the salon. The other would only invest.

Stacey wants to know the tax consequences of incorporating the business. Her business assets comprise a building, equipment, accounts receivable and cash. Liabilities comprise a mortgage on the building and a few accounts payable that are deductible when paid.

prepare a memo to Stacey describeing the tax consequences of the incorporation. As part of your memo look at the possibility of having the corporation issue common and preferred stock and debt for shareholders’ property and money.

problem: 5 years ago, Lacey, Kaylee and Doug organized a software corporation, DLK that develops and sells Online Meetings software for the businesses. DLK is a C corporation. Each and every individual contributed $10,000 to the company in exchange for 1,000 shares of DLK stock (for a total of 3,000 shares). The corporation as well borrowed $250,000 from ACME Venture Capital to finance operating costs and capital expenditures.

Since of intense competition, DLK struggled for the first few years of operation and the corporation sustained chronic losses. This year, Lacey, DLK’s president, decided to seek extra funds to finance DLK’s working capital.

CME declined to extend extra funds since of the money already invested in DLK. High Tech Venture Capital Inc. proposed to lend DLK $100,000, however at a 10% premium over the prime rate. (Other software manufacturers in similar market can borrow at a 3% premium.) First Round Capital proposed to invest $50,000 of equity capital into DLK, however on the condition that the investment firm be granted the right to elect 5 members to DLK’s board of directors. Discouraged by the “high cost” of external borrowing, Lacey decides to approach Doug and Kaylee.

Lacey proposes to Kaylee and Doug that each of the three original investors contributes an additional $25,000 to DLK in exchange for five 20-year debentures. The debentures will be unsecured and subordinate to the ACME’s debt. Annual interest on the debentures will accrue at a floating 5% premium over the prime rate. The right to receive interest payments will be cumulative; that is each and every debenture holder is entitled to past and current interest payments before DLK’s board can declare a common stock dividend. The debentures would be both non-transferable and non-callable. Lacey, Kaylee and Doug have asked you, their tax accountant, to advise them on the tax implications of the proposed financing agreement. After researching the issue, issue your advice in the tax research memo. At a minimum, you must consult the given authorities:

• IRC. Sec 385
• Rudolph A. Hardman, 60 AFTR 2d 87-5651, 82-7 USTC ¶9523 (9th Cir., 1987)
• Tomlinson v. The 1661 Corporation, 19 AFTR 2d 1413, 67-1 USTC ¶9438 (5th Cir., 1967)

problem: Which of the given groups constitute a controlled group? (Any stock not listed below is held by unrelated individuals each owning less than 1% of the outstanding stock.) For brother-sister corporations, which definition applies?

a) Mark owns 90% of the single classes of the stock of Hot and Ice Corporations.
b) Johnson and Carey Corporations each contain just a single class of stock outstanding. The two controlling individual shareholders own the stock as shown:

                        Stock Ownership Percentages
Shareholder   Johnson Corp.    Carey Corp
David             60%                    80%
Kelly              30%                     0%

c) Red, Blue and ABC Corporations each contain a single class of stock outstanding. The stock is owned as shown:

                     Stock Ownership Percentages
Shareholder   Blue Corp.     ABC Corp
Red                 80%             50%
Blue                40%

Red Corporation’s stock is broadly held by over 1,000 shareholders, none of whom owns directly or indirectly more than 1% of Red’s stock.

d) Helm, Oak, Walnut and Zinnia Corporations each contain a single class of stock outstanding. The stock is owned as shown:

                                     Stock Ownership Percentages
Shareholder    Helm Corp.  Oak Corp  Walnut Corp      Zinnia Corp
James             100%           90%               
Helm                                                    80%                   30%
Walnut                                                                           60%

problem: Eric and Denise are partners in the ED Partnership. Eric owns a 60% capital, profits and loss interest. Denise owns the remaining interest. Both materially contribute in the partnership activities. At the starting of the current year, ED’s only liabilities are $50,000 in accounts payable that remain outstanding at year-end. In August, ED borrowed $120,000 on a nonrecourse basis from the Delta Bank. The loan is secured by property with a $230,000 FMV. Such are ED’s only liabilities at year-end. Basis for the partnership interest at the starting of the year is $40,000 for Denise and $60,000 for Eric before considering the impact of liabilities and operations. ED has a $200,000 ordinary loss throughout the current year. How much loss can Eric and Denise recognize?

problem: Linda pays $100,000 cash for Jerry’s 1/4 interest in JILL Partnership. The partnership has a Sec. 754 election effect. Just prior to the sale of Jerry’s interest, JILL’s balance sheet appears as shown:

                  Partnership’s Basis   FMV
Assets:               
Cash          $75,000                    $75,000
Land          $225,000                  $325,000
Total          $300,000                  $400,000

Partners' capital

Jerry                           $75,000        $100,000
Instrument Corp        $75,000        $100,000
Logo Corp                  $75,000        $100,000
Lighthouse Corp        $75,000        $100,000
Total                          $300,000       $400,000

a) What is Linda’s total optional basis adjustment?

b) When JILL Partnership sells the land for its $325,000 FMV instantly after Linda purchases her interest, how much gain or loss will the partnership recognize?

c) How much gain will Linda report as an outcome of the sale?

problem: Monte and Allie each own 50% of Raider Corporation, an S corporation. Both individuals actively participate in the Raider’s business. On January 1, Monte and Allie have adjusted bases for their Raider stock of $80,000 and $90,000 correspondingly. Throughout the current year, Raider reports the given results:

Ordinary loss                          $175,000
Tax-exempt interest income   20,000
Long-term capital loss            32,000

Raider’s balance sheet at year-end exhibits the given liabilities: accounts payable, $90,000; mortgage payable, $30,000; and note payable to the Allie, $10,000.

a) Determine income and deductions will Monte and Allie report from Raider’s current year activities?

b) Determine the Monte’s stock basis on December 31?

c) What are Allie’s stock basis and debt basis on December 31?

d) Find out loss carryovers is available for Monte and Allie?

e) Describe how the use of the losses in Part a would change if instead Raider were a partnership and Monte and Allie were partners who shared profits, losses and liabilities equally.

problem: Tom Hughes died in 2009 with a gross estate of $3.9 million and debt of $30,000. He made post-1976 taxable gifts of $100,000, valued at $80,000 when he died. His estate paid state death taxes of $110,200. Determine his estate tax base?

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