Case 3

Background & Facts

Gene Wilder and Charlie Bucket each own a chocolate factory in the State of Rhode Island. Gene has owned and managed various businesses in the chocolate industry for over 30 years. Gene started his current chocolate factory roughly 20 years ago, and his factory is the predominant chocolate factory in the southern part of the state

Charlie earned an M.B.A. from Fordham University and has 15 years of experience in chocolate factory management. He began his chocolate factory only five years ago and in that short time has captured 35 percent of the chocolate market in the northern part of the state. Charlie has also developed a software program tailored to meet the accounting, billing, and reporting requirements of chocolate factories. Because of the unique and complex billing requirements of chocolate factories, the software is expected to be a substantial revenue producer once it is marketed to its full potential.

Confident of the success of his software program, Charlie borrowed $400,000 from Nestle National Bank to cover the cost of developing the program. Charlie began marketing the software only 18 months ago and it has been very well received by the industry. Charlie is concerned that without additional capital for the software venture that he will not be able to provide the training and technical support that the licensees of the software will demand. Therefore, he has limited the number of licenses that he has issued for the software to 75 customers until he is able to expand his support capabilities. Charlie realizes the software will soon lose its competitive advantage in the market unless he is able to move quickly to market the product to its full potential.

Gene and Charlie, both Fordham graduates, met several years ago at an alumni event and became fast friends. They have discussed their vision of a national chocolate factory for the past couple of years. A few months ago, they decided that with Gene's years of experience and access to capital, and Charlie's management capabilities and contacts in the chocolate industry, they would be perfect business partners. After months of negotiation, Gene and Charlie agreed to combine their chocolate factories to form Gobstopper Chocolate, Inc. (GCI).

Willy Wonka, who has been one of Gene's most valuable employees in his various business ventures for nearly 30 years, would like to have an ownership interest in GCI. Given Willy's dedication and loyal service to Gene, and Willy's extensive knowledge of the chocolate industry, Gene and Charlie have agreed to allow him to participate in the business venture. In addition to contributing the assets described below, Willy has agreed to oversee the integration of the accounting and information systems of Charlie and Gene's chocolate factories in partial consideration of his stock in GCI. The parties agree that the value of these services is $133,000.

The following are the relevant facts regarding GCI:

GCI is formed on October 1, 2019. It will have an October 1 to September 30 fiscal year.

$25,000 of organizational costs are incurred by GCI before September 30, 2020.

GCI will be taxed as a C corporation.

Additional information regarding GCI:

o Employer Identification Number: 48-15162842

o Address: 111 Everlasting Lane, Providence, R.I. 02901

Assignment #3

Given the success and growth of GCI after only one year of operations, Gene, Charlie, and Willy receive an offer from National Chocolate, Inc., the largest chocolate factory in the United States, to purchase GCI's assets. From a strategic standpoint, National is seeking to establish a presence in the state and sees this acquisition as achieving that goal. In addition, National has been much impressed by the accounting, billing, and reporting software program owned by GCI. After prolonged negotiations, a deal is reached, whereby GCI will sell certain assets to National for $10,700,000. The purchase price will be allocated to the assets purchased by National as set forth in Exhibit 1

GCI will retain ownership of its cash, accounts receivable, and marketable securities. National has agreed to provide the administrative services necessary to bill and collect GCI's receivables for a 2 percent fee. National will not assume any of the debts or liabilities of GCI. Instead, GCI will remain liable for its debts and liabilities.

GCI will retain ownership of its cash, accounts receivable, and marketable securities. National has agreed to provide the administrative services necessary to bill and collect GCI's receivables for a 2 percent fee. National will not assume any of the debts or liabilities of GCI. Instead, GCI will remain liable for its debts and liabilities.

GCI will collect 97 percent of the outstanding receivables reported in Exhibit 1. The remaining will be written-off on the final tax return as "bad debt expense." Therefore, the amount of accounts receivable collected (net of the 2% collection fee) is $1,708,323.

GCI will incur legal and accounting fees of $125,000 in connection with the sale of its assets and its liquidation.

GCI will write-off its remaining organizational costs.

GCI will pay federal and state income taxes incurred as a result of the sale of its assets; and then distribute the remaining cash balance and the marketable securities to Gene, Charlie, and Willy in a pro rata liquidating distribution.

The fair market value of the marketable securities on the date of distribution is $1,400,000.

Assume, for the purposes of your computations, Rhode Island has a flat corporate income tax rate of 7 percent that applies upon the sale of all, or substantially all, of the assets of a corporation.

Total deductions on the final return will amount to $568,635. This amount includes the deduction for bad debts, the deduction for legal and accounting fees and the deduction for the collection fees.

The federal corporate tax rate is 21%.

Task

You must complete the following and show all work using the sample spreadsheet.

1. Compute the gain or loss on the sale of assets to National and the liquidation of the marketable securities to the three shareholders. You must identify whether the gain or loss is ordinary or capital in character. Hint: the depreciable assets and intangibles are subject to recapture under Section 1245.