Central Colorado Leasing, Inc. (Central), a
calendar year, accrual basis C corporation, is in the business of leasing heavy
construction equipment and subcontracting certain types of heavy construction
services.
CENTRAL COLORADO LEASING, INC.
Colorado Leasing, Inc. (Central), a calendar year, accrual basis C corporation,
is in the business of leasing heavy construction equipment and subcontracting
certain types of heavy construction services.
The average rental period for the equipment is two weeks, and the rental
contracts provide that Central will perform all required maintenance and repair
for the equipment during the rental period.
Brothers Jonathan and James Black each own 50 percent of the outstanding
stock of Central. Jonathan is the
president of the corporation and James is the vice-president. Currently, the Black brothers have no
interest in making an S election for their corporation. Attached are Central’s financial statements
for the current year.
I
Jonathan Black is involved in a number of successful business ventures,
and he estimates that his adjusted gross income for Federal tax purposes will
fall in the $375,000 – $425,000 range for the next several years. Jonathan brings a $200,000 capital loss
carryover and a $175,000 passive activity loss (PAL) carryover into the current
year.
Jonathan owns Bishops Woods, a commercial office building and complex. His acquisition cost for Bishops was $2,750,000;
$500,000 of this cost was allocated to the land. Through the beginning of this year, Jonathan
has deducted $377,438 of depreciation on the property. Because of a low occupancy rate, the
operation of Bishops has been generating net tax losses for several years ($50,000
of Jonathan’s PAL carryover is allocable to the office building).
To generate a sizeable §1231/capital gain and use the loss carryforward,
Jonathan is considering selling Bishops Woods to Central. Central then will move its administrative
operations into the vacant office space upon expiration of its present lease in
June.
Although Jonathan has not obtained an independent appraisal of Bishops
Woods, he and James have agreed informally to a total purchase price of $3.25
million. Central will borrow this amount
from an unrelated commercial lender, at market interest rates. The property forms
the collateral on the debt.
II
Jonathan Black, James Black, James’ three adult children, and two adult
grandchildren are considering the creation of CC Asphalt, a new corporate
venture through which to operate an asphalt paving business. The seven individuals anticipate capitalizing
the corporation so as to become equal shareholders. The Black brothers have projected that the
business will generate net income before taxes of approximately $80,000 per
year. The family members have agreed
upon a strategy to reinvest the after-tax corporate income in the business,
with the expectation of selling their corporate stock at a substantial profit
at a future date.
To finance his capital contribution to CC Asphalt, James plans to
borrow $250,000 in cash from Central.
The note will be a properly drafted 1.0 percent demand note, when the
market rate of interest for such loans is 2.5 percent. Jonathan Black has agreed to these terms for
the proposed loan to his brother.
Jonathan and James have requested that you identify any potential tax
problems or planning ideas suggested by the facts presented. In responding to the Black brothers’ request,
be as specific as possible in describing the issues involved, and provide
suggestions and/or alternatives you recommend to minimize risks and maximize
opportunities.
Central Colorado Leasing, Inc
Book Balance
Sheet
December 31
Notes
1. Company policy requires that customers
make weekly payment on equipment rentals; therefore receivable balances
generally are low.
2. Accrued expenses include a $25,000
year-end bonus payable to President Jonathan Black.
3. Jonathan and James Black both drive cars
furnished to them by Central. The two
brothers use the cars both for commuting and business reasons.
Central Colorado Leasing, Inc
Book Income Statement
Year Ending December 31
Notes
1. Officers’ salaries: Jonathan Black
$150,000 (includes $25,000 accrued bonus); James Black $100,000.
2. Because of the small corporation exemption
[§ 55(e)], Central is not liable for the alternative minimum tax.
brokers high-quality fresh fruits and vegetables to restaurants and specialty
grocery stores
BEARDEN’S SPECIALTY
PRODUCE, INC.
brokers high-quality fresh fruits and vegetables to restaurants and specialty
grocery stores. Frank’s business does
not carry any inventories. Frank’s
attorney has urged Frank to incorporate the business, primarily because of the
limited shareholder liability associated with corporate status, and to
facilitate a business succession plan in the future. Frank has operated the business as a cash
basis sole proprietorship for two decades, and anticipates incorporating the
business on July 1 of the current year.
Projected balance sheet and income statements for the business as of
June 30 are attached.
I
Frank plans
to transfer all existing business assets and liabilities to a newly
incorporated entity, Bearden’s Specialty Produce, Inc. (Produce), in exchange
for 1,000 shares of voting common stock.
He will serve as President of the corporation, and he will be a member
of the Board of Directors. Frank wants
to adopt an August 31 fiscal year end for Produce because August tends to be
the slowest month of the year for the business, and accounts receivable
typically are at their lowest level.
Frank also intends for Produce to continue to use the cash method of
accounting.
Frank’s close friend, Maria Garcia, has for
some time been interested in buying into Frank’s business. Maria will not have access to the cash necessary
for this acquisition until October, so Frank has agreed to proceed with the
incorporation, and then sell 400 of his new Produce shares for $75,000 to Maria
sometime before the end of the current year.
In discussing the proposed incorporation with
you, Frank specifically asks about the amount of any gain he must recognize,
both upon the incorporation itself, and upon the subsequent stock sale. Naturally, he is eager to minimize any
recognized gain to the extent possible.
Frank also wants to structure the transaction to achieve the best tax
outcome for Garcia, as Frank is eager to have her as a business associate.
In addition to addressing these specific
concerns, identify any potential tax problems or planning ideas suggested by
the facts. Be specific in describing the
issues involved, give full citations to controlling law, and provide
suggestions and/or alternatives to minimize risks and maximize opportunities.
II
Elsewhere in his portfolio, Frank is a
limited partner in Build Arkansas, a real estate development partnership. Build has generated losses during the past
two years. Frank holds a $35,000 suspended
passive loss. Frank earns no passive
activity income, and he anticipates that the partnership will continue to
generate losses for several years into the future. He has asked you to explain the §469 tax
consequences of transferring his interest in Build to Produce as part of the
incorporation. The value of the partnership interest exceeds Frank’s basis in
the interest by approximately $50,000.
Bearden’s
Specialty Produce
Projected
Balance Sheet
June
30
Bearden’s
Specialty Produce
Projected
Income Statement
For
January 1 – June 30
* Legal costs for drafting the
corporate charter and by-laws and for filing the necessary legal papers with
Arkansas will total $7,000. Frank
estimates that Produce will incur accounting fees attributable to the incorporation
of $5,200.
