Required for text below

a. Summarize relevant tax facts

b. List and refine issues to research

c. Search for authority

d. Evaluate authority

e. Formulate recommendation

Jeb Golden was employed by Foxtown Industries as a mechanical engineer at the time he decided to start his own business. Jeb and Pete, both engineers at Foxtown, developed and implemented an internal use mechanical mechanism called BRC, which saved Foxtown approximately $100,000 per year in wasted raw materials. Jeb and Pete spent numerous hours perfecting the details prior to starting to develop BRC. After working together a few years Jeb and Pete realized a profitable market existed for Project BRC. Several plant managers had contacted Jeb about designing a Project BRC for their company. Jeb discussed purchasing the rights to Project BRC with the president of Foxtown, James C Lyon. James agreed to sell the rights to Project BRC for $80,000. Jeb and Pete decided to create a company called Mechanical Engineering Services (MES) to implement products similar to Project BRC for other companies. In addition, MES would design, develop, and sell new cost saving products to these companies. But Jeb and Peter had one major problem: they did not have the required investment capital. MES would need approximately $400,000 to purchase the rights to Project BRC, acquire essential equipment, and pay initial operating expenses. Furthermore, Jeb and Pete want to control MES by holding common stock from the date of incorporation.

Jeb discussed his ideas and problem with his accountant, Numbers (Num for short). After considering various alternatives, Jeb, Pete, and Num worked out a plan of action. They incorporated MES in 2020 and entered into the following transactions during 2021: 1. MES sold $400,000 of cumulative preferred stock to six independent investors. This stock was sold for $20 per share, which was its par value.

2. Jeb was issued 30 shares of common stock in exchange for his knowledge of Project BRC’s design.

3. Pete was issued 10 share of common stock in exchange for his knowledge of how to implement Project BRC.

4. MES paid Foxtown Industries $80,000 for the rights to Project BRC. 5. Num was issued 10 common shares in exchange for accounting and financial services rendered during 2021. These services would have generated $6,000 if performed by a CPA.

6. Jeb was issued an additional 65 shares of common stock in exchange for services rendered during 2021. The value of these services was $54,000.

7. Pete was also issued stock in exchange for services. He received 25 shares for services valued at $27,000.

For tax purposes, Num capitalized Jeb and Pete’s know-how as an intangible asset ($40,000) and amortized it over five years. He considered the contribution of know-how as nontaxable contribution to a corporation in exchange for stock. Therefore, Jeb and Pete did not recognize gain or loss on the incorporation of MES. Also, Num capitalized the $80,000 paid Foxtown for the rights to Project BRC and amortized it over a five-year period.

MES had a net operating loss (excluding the value of Jeb, Pete, and Num’s services) of $242,000 for 2021 and has projected losses for the next two years. In the fourth year, MES is expected to make a slight profit and in the fifth year it should make a substantial profit. At the end of year five, the book value per common share is expected to be $60.00 per share. However, in year one through year three MES will have a negative book value per common share. Since this is a closely held corporation, MES does not have an established market value for its stock.

Num decided that the services performed by Jeb, Pete, and himself should only be taxed at $1.00 per share since the common stock received in exchange of the services had relatively no value at the time of issue and no guarantee of any future value. Num reasoned that if the stock did increase in value, income would be recognized upon subsequent disposition.

In an attempt to comply with generally accepted accounting principles, Num decided to record an estimate for book purposes for the value of services rendered by Jeb, Pete, and Num even though the stock received had negligible value. This approach was consistent with the account-ing conservatism doctrine because it lowered financial accounting income.