Could you please help me with this question? I promise to transfer more money if you can.

PwC Case Studies in Taxation, 2013, PwC, LLP NEELEY SERVICES GROUP The Neeley Services Group is owned equally by Norma, Irene, and Carole. The entity is a calendar-year, cash-basis partnership that was organized in Indiana about ten years ago. Neeley Services operates a same-day trucking service out of the Indianapolis airport, taking small packages of hazardous materials to customers when national delivery companies will not handle the shipped goods. Neeley Services has been highly profitable since its inception, as profit margins are high - Neeley is one of the few local businesses that can charge \"what the traffic will bear.\" In fact, delivery fees are raised as needed to cover increases in NEELEY Since 2005 insurance, maintenance, licenses, and fuel costs. Neeley's drivers are not unionized, but the Group provides adequate salaries and generous fringe benefits to its employees. Neeley operates essentially as a cash-only business - no services are delivered until the customer remits the invoice in full, almost always by electronic funds transfer. Rumors circulated that DHL was about to move into the market and present some aggressive competition, but that company no longer operates in the US, so those rumors have died down, and none of the other potential competitors seem interested. Carole wants to move permanently back to Fort Wayne so as to care for her aging parents. The time required to meet these needs means that Carole will retire from the entity at the end of the current year, Year One. No additional capital is needed by Neeley to carry on at its existing service levels, and Norma and Irene have no current expansion plans. They are open to bringing in a new partner in the future, say when they themselves decide to retire, or when new market opportunities, perhaps in Dayton OH and Evansville IN, pop up. The projected end-of-Year-One balance sheet and capital accounts for Neeley Services and its owners is presented below. All parties agree that Carole's one-third interest then will be worth $700,000, taking into account any potential goodwill. The retirement agreement calls for cash payments to Carole of $300,000 per year at the end of each of Years One, Two, and Three. Norma and Irene will assume all of Neeley's entity liabilities. Myrna, Neeley's long-time accountant, has prepared the Group's financial statements and Forms 1065 for seven years running, but she feels that a third-party like you should analyze the retirement agreement and its tax effects on Carole. According to Myrna, each partner's interest basis for federal income tax purposes is the same as the total in her capital account. Page 1 of 3 PwC Case Studies in Taxation, 2013, PwC, LLP NEELEY SERVICES GROUP Required: Prepare a spreadsheet in good form, to compute and characterize Carole's gain realized and recognized from the retirement payments that Neeley Services makes to her. Neeley Services Group Projected Balance Sheet End of Year One Tax B asis Fair Market Value AS E S TS C ash 1231 Land and buildings 1231 Trucks Land held for investment $ 900,000 200,000 100,000 540,000 $ 900,000 500,000 100,000 1,080,000 Totals $ 1,740,000 $ 2,580,000 Mortgage payable, investment land Norma, capital Irene, capital C arole, capital $ 480,000 420,000 420,000 420,000 $ Totals $ 1,740,000 $ 2,580,000 L IL SAND C IAB ITIE APITAL 480,000 700,000 700,000 700,000 Neeley Services Group. Keep these in mind as you work this case. Start by determining the Amount Realized for each of the three payments. How is the debt relief treated for this purpose? Now compute the Gain Realized with each payment received. What is Carole's interest basis at the end of Year One? For the total of the cash payments to Carole, how much is designated a 736(b) payment? A 736(a) payment? Page 2 of 3 PwC Case Studies in Taxation, 2013, PwC, LLP NEELEY SERVICES GROUP Remember that Neeley is classified as a service partnership - its asset holdings are not so capitalintensive as to find otherwise. Its greatest financial asset is its guaranteed cash flow from the service contracts. Now find the amounts of capital and ordinary income that Carole recognizes with each payment. A Attach your Word or Excel compatible document here. Page 3 of 3 PwC Case Studies in Taxation, 2013, PwC, LLP HAWAIIAN MEMORIES, INC. Hawaiian Memories, Inc. (HMI) is a C corporation that was formed in 2007 in Maui. The company markets specialty tourism products of the islands of Hawaii. The initial incorporators were Angie Lee and Bob Lin, who now own 1,000 shares of voting common stock and 100 shares of preferred stock each. The company has eight employees who collectively own 500 shares of nonvoting stock. Most of the employees have worked for the company for several years. They purchased the stock when the company offered it at the end of each year. Two own 100 shares each; the other six own 50 shares each. None of the shareholders are related to each other by blood or marriage, except for Angie and Bob. All individual shareholders are native Hawaiians except for Inge; she is Swedish and has lived on Maui and worked for HMI for three years. Inge plans to move back to Sweden in one year and try to develop markets for HMI products there. Another stockholder is the Plantation Sugar Partnership (PSP). PSP owns 500 nonvoting common shares; it supplies raw sugar in bulk to HMI. Bob Lin and his sister Katie each own 50% of PSP. The corporation uses a June 30 year end. The year was chosen arbitrarily. All of the HMI shareholders use calendar years. Financial statements for the year ended June 30, 2012 are attached. HMI does not expect that it will generate any significant increases in investment or passive activity income in the coming years. This was the first year of corporate operating losses in some time. The corporation elected not to carry back the losses because the tax rate paid in those years was lower than they expect to pay in the future. Bob and Angie expect one or two more years of losses and then steady increases in net income. Bob lives in Hawaii and manages operations there. Angie moved to San Francisco in 2008 to develop mainland markets for their products. Both earn annual salaries of $150,000. The shareholders and all employees are provided accident and health insurance. The company contributes 10% of each employee's salary to a defined contribution pension plan each year. PART I On October 1, 2012, Bob and Angie came to your office for the first time. They have just filed the corporate return for the fiscal year ended June 30, 2012 and are interested in having you take over all the future tax work for the corporation. They inform you that they have just read an article in Tourism Retailing about the tax and cash-flow benefits of pass-through losses. They have filed an election to be an S corporation, effective on July 1, 2012. Bob and Angie signed the consent for the S election because they were the only shareholders with voting stock. Their reasoning for making the S election is that they expect losses for a year or two as they try to expand, and they would like to use the losses already incurred as well as the prospective losses against their other income. Review all relevant information and identify any issues related to conversion to S status. Advise Bob and Angie about the conversion to S status. Page 1 of 4 PwC Case Studies in Taxation, 2013, PwC, LLP HAWAIIAN MEMORIES, INC. PART II Now instead assume the following: Memories' conversion to S status was made, effective for the taxable year beginning July 1, 2013. HMI had wanted to keep its fiscal year, but it could not document significant seasonality. So the first S tax return will be for six months, reflecting the new calendar tax year. A C corporation return was filed for the fiscal year ending June 30, 2013. That return showed a zero taxable income for current year operations. The balance sheet for June 30, 2013 only differs from the June 30, 2012 statement as presented by $40,000 additional depreciation deductions claimed. HMI plans to sell the investment land in 2014 to raise some cash, because Bob and Angie feel that the appreciation potential in the land will have flattened by then. They expect the property to be worth about $1,000,000 in 2014. Angie and Bob anticipate that there will be net tax losses from operations of $200,000 during the six-month period ending December 31, 2013 and $150,000 in calendar year 2014, without consideration of the land sale. Convey to HMI the tax effects of such a 2013 conversion to S status. Provide a restated HMI balance sheet as of June 30, 2013, and compute the passthrough to the shareholders for the 2014 HMI calendar year. Page 2 of 4 PwC Case Studies in Taxation, 2013, PwC, LLP HAWAIIAN MEMORIES, INC. Hawaiian Memories, Inc. Book/Tax Balance Sheet June 30, 2012 Notes The difference between FIFO and LIFO is expected to be approximately the same for the next year. The entire layer of inventory on hand at conversion will be sold by December 31, 2013. Memories' balance in Earnings and Profits is $300,000. Current E&P for the year ended June 30, 2013 was $0. Page 3 of 4 PwC Case Studies in Taxation, 2013, PwC, LLP HAWAIIAN MEMORIES, INC. Hawaiian Memories, Inc. Book and Tax Income Statement for the 12 months ending June 30, 2012 Neeley Services Group. Keep these in mind as you work this case. Start by determining the Amount Realized for each of the three payments. How is the debt relief treated for this purpose? Now compute the Gain Realized with each payment received. What is Carole's interest basis at the end of Year One? For the total of the cash payments to Carole, how much is designated a 736(b) payment? A 736(a) payment? Remember that Neeley is classified as a service partnership - its asset holdings are not so capitalintensive as to find otherwise. Its greatest financial asset is its guaranteed cash flow from the service contracts. Now find the amounts of capital and ordinary income that Carole recognizes with each payment. A Attach your Word or Excel compatible document here. Page 4 of 4 PwC Case Studies in Taxation, 2013, PwC, LLP BEARDEN'S SPECIALTY PRODUCE, INC. Your client, Frank Bearden, owns an Arkansas business that 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 since 1985, 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. PART 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 necessary cash 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. REQUIRED: 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. PART 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 $27,000 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. REQUIRED: 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. PART III Page 1 of 3 PwC Case Studies in Taxation, 2013, PwC, LLP BEARDEN'S SPECIALTY PRODUCE, INC. Assume for this section that the transfers involving Maria and Build Arkansas did not take place. One of Frank's reasons for incorporating Produce is to put the business into a form to facilitate certain of his family tax planning goals. Frank is 60 years old, and he has an adult son (Frankie, now age 31) and daughter (Phyllis, now age 34) who are interested in participating in the family business. Frank anticipates that Produce will hire Phyllis and Frankie as employees, so that they may familiarize themselves with all aspects of the corporate operation. If after several years his children's interest in the business continues, and if they demonstrate to their father that they are capable of managing Produce, Frank will consider recapitalizing the corporation. The originally issued voting common stock would be exchanged for new issues of (1) voting preferred stock (with a fixed liquidation value and a 9 percent noncumulative annual dividend) and (2) voting common stock. At the date of recapitalization, the preferred stock would represent most of the value of Frank's equity in Produce, while the value of the common stock would be minimal. Frank would then make a gift to Phyllis and Frankie of the common stock, while retaining the preferred stock. Subsequent to the recapitalization, any increase in the value of the corporate business likely will cause a corresponding increase only in the value of the common stock; the value of Frank's preferred stock will be "frozen." Frank anticipates structuring the recapitalization so that the value of the common stock transferred to each child will be no more than the current annual gift tax exclusion. Consequently, he assumes he can transfer the future appreciation in the value of the corporate business without making a taxable gift. REQUIRED: Comment on this part of Frank's business plan. Would any realized gain relative to the recapitalization be deferred for him? Are his assumptions correct about the valuation of the shares and the use of the annual gift tax exclusion? Bearden's Specialty Produce Projected Balance Sheet June 30 Page 2 of 3 PwC Case Studies in Taxation, 2013, PwC, LLP BEARDEN'S SPECIALTY PRODUCE, INC. 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. Neeley Services Group. Keep these in mind as you work this case. Start by determining the Amount Realized for each of the three payments. How is the debt relief treated for this purpose? Now compute the Gain Realized with each payment received. What is Carole's interest basis at the end of Year One? For the total of the cash payments to Carole, how much is designated a 736(b) payment? A 736(a) payment? Remember that Neeley is classified as a service partnership - its asset holdings are not so capitalintensive as to find otherwise. Its greatest financial asset is its guaranteed cash flow from the service contracts. Now find the amounts of capital and ordinary income that Carole recognizes with each payment. A Attach your Word or Excel compatible document here. Page 3 of 3 PwC Case Studies in Taxation, 2013, PwC, LLP FLATIRONS, INC. Flatirons, Inc. (dba Flatirons Flapjacks Caf) specializes in unique breakfast and brunch menus and gourmet coffees. Maria Trujillo and Jason Johnson formed the corporation and opened the first location in Bozeman, Montana in 2008. Flatirons Flapjacks Caf was such an immediate success, Maria and Jason were able to raise money to open three additional Colorado locations in Aspen, Denver, and Boulder by January 2011. Maria and Jason each own 15,000 shares of the corporation's only class of common stock. PART I Since receiving her MBA at the University of New Mexico, Maria had worked in various positions in Santonio's, a large upscale franchise restaurant chain. In 2006, she was promoted to the position of vice-president in charge of development (site expansion). Jason was a regional manager in the same chain. Maria and Jason decided in 2007 to start their own restaurant, the original Flatirons Flapjacks Caf, because they believed they had a unique niche concept and the know-how to make it work. They opened the first Caf on Maria's property, an old service station she inherited from her grandfather, who closed it in 2004. Each new Flatirons location is developed at an older, converted service station. After discussing methods of financing and managing expansion with you, Jason and Maria decided to expand into the Southwest by allowing two new investors who also had expertise in the restaurant business to purchase interests in their corporation. One of these investors, Robert Hopp, was one of the original owners of Santonio's. He plans to take an early retirement offer from Santonio's and devote his full-time efforts to the new endeavor; his Santonio's non-compete clause applies only in New Mexico. He lives in Los Angeles and will maintain his permanent residence there. Robert has purchased three abandoned service stations in San Antonio, and he has begun Flatiron's specified remodeling work. Hopp reports that he will show the following valuations and basis amounts for each of the stations when they are contributed to Flatiron. Robert will contribute the stations to the corporation in exchange for 15,000 shares of stock and a five-year $375,000 note. As a substitute for the $375,000 note, Robert would consider receiving preferred stock that pays a cumulative dividend tied to the prime interest rate, and permitting Robert to require the corporation to redeem the stock for $375,000 at any time five years or more after its issuance. The other new investor, Elizabeth James, currently is the chief financial officer for Santonio's. She will contribute $250,000 cash, as well as $125,000 worth of her professional services required to: set up a new networked accounting and information system, negotiate contracts on additional locations, and negotiate loans necessary to complete the initial expansion plan. Elizabeth will receive 15,000 shares of Flatirons stock. After Elizabeth completes these initial responsibilities, she will be named Flatiron's CFO and receive a salary for that work. Page 1 of 4 PwC Case Studies in Taxation, 2013, PwC, LLP FLATIRONS, INC. REQUIRED: Robert and Elizabeth want to know the tax consequences of the proposed transactions. Naturally, they would like to optimize the immediate tax effects. Describe the consequences to all parties of the transactions as they are proposed, and suggest any alterations in the plan you think will improve the tax consequences. PART II Presently, Flatirons does not use separate corporate offices. Maria and Jason each have operated out of their homes, and from small offices within the restaurant locations. Although they spend most of their time on site training new personnel and managing the day-to-day operations, they find it easier to do paperwork and deal with suppliers electronically from their home offices. Maria and Jason also are concerned about confidentiality and data security, in that they do not want employees to overhear conversations about expansion or other contract details. There are no plans at this point to rent other office space for Flatirons, until the expansion proves successful and the owners can reach agreement on the best location for the general offices. Elizabeth is the only employee who will not spend much time at the restaurants on site. She will convert a large room in her home to an office and keep the corporate books and records there. She generally will work out of this home office, but Elizabeth will travel to the various Flatirons locations as needed. Robert primarily will be responsible for opening new restaurants in Dallas, Houston, San Antonio, and Austin. He will spend most of his time on location at the various restaurant sites. Because he will be traveling among the four cities so often, Robert and the other shareholders believe that he needs to keep files for all locations in a central place, probably Microsoft SkyDrive. This way, shareholders can meet by conference call or Skype on a regular basis. Everyone has agreed that Robert needs to live in Texas during the period of opening and establishing the new restaurants. If all goes well, he plans to return to California to open new locations there in the following few years. He has rented an apartment in San Antonio and will travel among the four cities during the expected two-year start-up period. Robert's family will stay in Los Angeles; he plans to return home for a few days every other week. The San Antonio apartment will have a room devoted entirely to Flatirons business. REQUIRED: The corporation will reimburse each employee for all out-of-pocket travel and living expenses incurred, including the rent and utilities for Robert's apartment. The corporation will not reimburse Maria, Jason, or Elizabeth for home office space used. Elizabeth asks for your advice in setting up reimbursement policies and procedures. She has asked you to advise her with respect both to corporate procedures and information she should provide to the employees about the tax treatment of these items on their federal income tax returns. Page 2 of 4 PwC Case Studies in Taxation, 2013, PwC, LLP FLATIRONS, INC. PART III In reopening the converted service stations, Maria and Jason ran into unexpected regulatory requirements for soil and ground water assessment and cleanup. Underground gasoline storage tanks installed before 1988 have a high incidence of leakage after they are approximately five years old. The leakage contaminates ground water. Before obtaining permits to operate a caf on any of the contaminated sites, Flatiron needed to remediate the legacy contamination. The dollar amounts involved in such cleanup activities is significant, and the tax treatment of these costs may affect whether Flatiron can carry out its growth strategy, i.e. whether it will be able to deduct similar costs for the new Texas locations. REQUIRED: The regulatory process included the following steps. Evaluate the possibilities that Flatiron can deduct these expenditures, relative to the Colorado and Montana locations. All of the existing properties were assessed by state agencies as to environmental damage that had occurred. Two of the Colorado properties required more extensive excavation and cleaning. Reimbursements were received from various state and federal agencies that encouraged environmental damage remediation. Keep these in mind as you work this case: I Use the 351 and 1239 rules to compute the gain/loss recognized due to the capital contributions by Robert and Elizabeth. How does Flatirons treat Elizabeth's services for federal income tax purposes? Compute the corporation's basis in the assets that it received from Robert. II The deduction for expenses of an office in the home are found in 280A. Robert might also be able to deduct some 162 travel expenses. How would Flatirons and the employees be treated if an \"accountable plan\" were used for the expense reimbursements? A \"nonaccountable plan\"? III Should Flatirons capitalize or deduct the costs of cleaning up the environmental contamination to the groundwater? Page 3 of 4 PwC Case Studies in Taxation, 2013, PwC, LLP FLATIRONS, INC. Does the Flatirons clean-up operation put the land to a new or different use, extend the property's useful life, or increase its value? Attach your Word and Excel compatible documents here. Page 4 of 4 PwC Case Studies in Taxation, 2013, PwC, LLP MIMI'S CUPCAKES Your business tax client, Mimi Charpentier, operates a successful sole proprietorship which sells cupcakes to retail customers at three locations in Las Vegas. Mimi's Cupcakes does not carry any inventories, because of the nature of its products. Mimi owns the three small buildings in which the shops exist. One of the stores is slightly larger than the others; it is Mimi's original location, and it still is the site of the kitchen and the loading dock where the Cupcakes trucks daily pick up and deliver merchandise and supplies. The work force of each store is the equivalent of 2.5 employees; the employees are paid reasonably well, and the low-pressure atmosphere of the typical work day results in a very low turnover rate. Mimi's offers only one fringe benefit to the employees - it encourages the employees to use Health Savings Accounts for their medical costs, and Mimi's reimburses the employee for the out-of-pocket deductible amounts, to a $1,000 maximum per employee per calendar year. Mimi's attorney, Gloria Willis, has urged Mimi to incorporate the business, primarily because of the limited shareholder liability associated with corporate status, and to facilitate a business succession plan for the operation. After several years of discussions, Mimi has agreed to go ahead with this idea. She will take a sixty percent ownership interest in the common stock of the new entity; twenty percent interests will be made available to Mimi's daughter Nancy, and to Joan Price, the chief operating officer of the business, who is not related to the other two shareholders. Mimi has operated the business as a cash basis sole proprietorship since 2004, and she anticipates incorporating the business on July 1 of the current year. A summarized projected balance sheet for the business as of June 30 is attached. Willis' practice consists of general work with small business clients. She is not by any means conversant with the federal income tax rules as they apply to individuals and C corporations. In this process, Willis is concentrating on the establishment of the new corporate entity, the retitling of assets as they are transferred from the proprietorship to the corporation, and the mechanics of creating and issuing shares to the new shareholders. Mimi has come to you with various questions about how to set up her databases to prepare for the annual Form 1120 filings, including the Schedule M-1. Corporate gross receipts will allow the continued use of the cash basis of tax accounting. In your interviews with the three shareholders, you discover that Mimi's life expectancy is about two years from the date of incorporation. Nancy recently graduated from community college in restaurant and hospitality management, with an emphasis in financial recordkeeping. Joan is about fifty years old, in good health, and planning to remain in charge of operating decisions for the three stores for the foreseeable future. Neither Mimi nor Joan projects that the corporation would add a fourth store, nor would it expand outside of Las Vegas, but the parties review these issues at least once a year. Page 1 of 3 PwC Case Studies in Taxation, 2013, PwC, LLP MIMI'S CUPCAKES The proprietorship does not carry any debt; its trade payables and receivables are disposed of in a timely fashion. Its web site allows for remote ordering, scheduled pickups, and deliveries of larger orders to customer locations. Mimi's is active on Twitter and Facebook, where the company has about five thousand friends. This presence allows Mimi's to plan and carry out \"spontaneous\" outdoor events on the stores' patios, where high-markup products are made available in plentiful quantities. As Mimi has told you several times, \"this is a simple business, and we know how to keep our customers happy and coming back on a regular basis. I do not want the legal etc aspects of an incorporation to disrupt the good thing that we have here.\" But, in your dealings with Mimi over the years concerning her Forms 1040 and employment tax obligations, you know that she expects you to give her suggestions about how her tax liabilities would be affected by decisions that she makes, and that she expects to \"get it right the first time\" when she makes her choices. At Mimi's latest appointment with her cardiologist, Cathy Duvall MD mentioned that her clinic was about to incorporate, but that Duvall would retain her individual ownership of the clinic's land and building. Duvall was certain that there were tax and legal advantages to structuring the corporation that way, but she could not really explain to Mimi what those advantages were. PART I You will be meeting shortly with Mimi, Nancy, and Joan to discuss the tax aspects of the incorporation, and to address any other of their concerns that are pertinent to your expertise. REQUIRED: Mimi certainly will ask you to cover the issue of which assets to contribute to the new corporation, with the explanations that Duvall could not provide. Concentrate on those issues for this meeting, offering at least two alternative plans for the asset transfers. At the meeting, Nancy will look to you for information on issues of asset basis, as well as any effects that the incorporation might have on sales/use and self-employment tax obligations. Ignore any exposure to the corporate or individual alternative minimum tax, though. The \"elephant in the room\" will be the issue of Mimi's continued involvement in the business. You should be prepared with some initial suggestions as to business succession planning, and the later transferability of the shares in Mimi's Cupcakes Inc. Page 2 of 3 PwC Case Studies in Taxation, 2013, PwC, LLP MIMI'S CUPCAKES Projected Balance Sheet ($K) Mimi Charpentier, dba Mimi's Cupcakes June 30 Consider these points as you complete this case: The core of the deliverables should be a comparison of the effects of Mimi's withholding of certain assets from the corporation. You need to consider issues concerning multiple taxes (like employment taxes) and the differing types of assets that a simple business like Cupcakes may hold (like its intellectual property), as well as the following: I Does 351 apply to the proposed incorporation? What will be the effects in the tax basis of the transferred assets if 351 does apply? Remember that a corporation is subject to double taxation under 336 when it later is liquidated. Once assets are transferred to a C corporation, dividend income and other recognized gains can be created by 311 when the assets are returned to the shareholders. Be sure to take into account the non-tax implications of your recommendations, for the corporation and all of its shareholders Attach your Word compatible document here. Page 3 of 3 PwC Case Studies in Taxation, 2013, PwC, LLP WISE-HOLLAND CORPORATION On June 15, 2013, Marianne Wise and Dory Holland came to your office for an initial meeting. The primary purpose of the meeting was to discuss Wise-Holland Corporation's tax situation. Marianne and Dory each own 50% of Wise-Holland Corporation, an S corporation. Dory and her husband Phil will continue to use another tax accountant for their on-going personal tax work, but Marianne wants to engage your services for her personal tax return. Marianne is not married. Wise-Holland is a calendar year corporation established in Naples, Florida on January 1, 2001. The corporation's principal business is locating and selling unique interior design items. Marianne and Dory have been friends since college, where they were both art majors. After graduation, they each held various positions where they gained experience in interior design before joining together to start this business. They are pleased but stunned by the financial success of their business, because the initial business plan was crafted simply to focus on what they liked to do and have more flexible schedules than they had as employees of others. They feel very dependent on their accountants and other financial advisers, because they have no experience or training in financial matters. Marianne is unhappy with the tax accountant (Amanda Klinger) who prepared her individual tax return and has advised her on tax issues for the past ten years. Specifically, Marianne is dissatisfied because she had received a notice of deficiency from the IRS disallowing deductions on her 2009 tax return. The disallowance related to an investment that Marianne had made in that year in the Lucky Partnership, a venture that operates medical clinics throughout the state. Lucky was a small partnership and not subject to the unified audit and litigation procedures. Because Lucky also was under audit, Marianne signed a waiver extending the statute of limitations for her 2009 individual return for three more years. Now, she and Dory just received an audit notice for Wise-Holland's 2008 S corporation tax return. You have never prepared or reviewed Marianne's individual return or Wise-Holland's corporate return. After your initial meeting with Marianne and Dory, you gathered all Page 1 of 6 PwC Case Studies in Taxation, 2013, PwC, LLP WISE-HOLLAND CORPORATION essential information to begin your engagement. You have obtained the following documents. Marianne's individual tax returns for tax years 2007 through 2011. These returns were timely extended and filed on October 15 of the appropriate year. Marianne's filing status was Single for all of these returns. Her annual taxable income during these years was approximately $150,000 - $200,000. S corporation tax returns for tax years 2007 through 2012. These returns were timely filed on March 15 of the appropriate year. An installment note for the sale of land, building, and equipment by Marianne in 2010. A notice of tax deficiency from the IRS for Marianne's 2009 tax return. An audit notice dated June 1, 2013, for Wise-Holland's 2008 tax return. Various information and financial records necessary to compute 2012 taxable income for Marianne Wise. A review of these documents and discussions with Marianne and Dory provided the following additional information. None of the taxpayers has engaged in a tax shelter or other reportable transaction. Notice of Deficiency - Marianne's 2009 tax return The deficiency notice for the 2009 return shows $20,000 federal income tax due resulting from the disallowance of loss flow-throughs from Lucky. The stated reason for the disallowance was that there was no profit motive supporting the partnership. In addition to the tax deficiency, the notice reflects interest and a 20 percent penalty for substantial understatement of tax liability. Marianne relied on Amanda Klinger to make a good faith effort to evaluate the legitimacy of the losses from Lucky; Marianne was not negligent in claiming the Lucky losses on her individual return. Marianne is perturbed because Amanda assured her that the tax return positions were reasonable and there was little risk the IRS would disallow the deductions. Marianne also disagrees with the penalty because she maintains that she did not intentionally understate her tax liability. When she discussed the penalty with Amanda in January 2013, Amanda told her to pay the tax deficiency, including the interest and penalties, as there was no defense available for her benefit. Marianne and Phil immediately made that payment. The IRS disallowance affects only the 2009 tax year. Page 2 of 6 PwC Case Studies in Taxation, 2013, PwC, LLP WISE-HOLLAND CORPORATION Installment Sale - 2010 In early 2010, Marianne sold land, building, and equipment for $300,000 to an unrelated third party, June Lockmann. Marianne received an installment note payable at the rate of $60,000 per year for five years, i.e. payments would be received from 2010 through 2014. The installment sale was reported in Marianne's 2010 tax return. The basis of the property was $150,000. The total gain and character of the gain is as follows. S elling Price B asis Total Gain R ealized $ S ection 1245 gain S ection 1231 gain Total Gain R ecognized 300,000 150,000 150,000 $ $ 100,000 50,000 150,000 $ Marianne brought a $75,000 capital loss carryover into 2010. Therefore, Amanda decided to prepare Marianne's returns reporting $30,000 of 1231 gain in 2010 and $20,000 in 2011, to utilize the capital loss carryover as quickly as possible. Amanda reported the transaction in this way. RETURNS AS FILED--EFFECT ON GROSS INCOME 2010 Total Gain Recognized 2011 $30,000 = 2012 $30,000 $30,000 $150,000 / 5 tax years Section 1245 $0 +$10,000 +$30,000 Section 1231 +$30,000 +$20,000 $0 Capital Loss Carryforward -$30,000 -$20,000 $0 $0 +$10,000 +$30,000 Net Effect on Gross Income Audit Notice - Wise-Holland's 2008 tax return The audit notice for Wise-Holland questions certain deductions claimed on the return on the basis that they are nondeductible personal items. Based on your review of the detail and discussions with Marianne and Dory, you conclude that certain deductions for materials Page 3 of 6 PwC Case Studies in Taxation, 2013, PwC, LLP WISE-HOLLAND CORPORATION and supplies should have been characterized as personal expenditures and are not deductible by the S corporation. When Wise-Holland's return originally was prepared, Marianne and Dory believed that these deductions were valid business expenditures, and they made a good-faith effort to segregate their personal expenditures from their business expenditures. You do not believe the IRS can make any adjustment at this time, because it has been more than three years since Wise-Holland filed its 2008 tax return. Ambiguous Tax Issue - Wise-Holland's 2011 tax return In your review, you identified an expense in the financial statement that presents an ambiguous tax issue for the S corporation's 2011 tax return - the corporation deducted an item that might be interpreted as being capitalizable. The amount of tax relating to this issue is approximately $10,000, and you estimate that it will exceed 10% of the total tax liabilities for Marianne and Dory for the year. In reviewing the relevant facts and law, you found six trial court cases that support the IRS position (to capitalize). One old District Court decision in Florida supports the taxpayer's position (to deduct in full in the current year). The only appellate court decision (10th Circuit) supports the IRS position (reversing a Tax Court decision). The Wise-Holland expenditure is quite similar to those discussed in the court cases, although none of the court cases represent a fact pattern identical to Wise-Holland's. In your view, there is a meaningful distinction between the Wise-Holland expenditure and that presented in the 10th Circuit case. You have assessed that Wise-Holland's chances of prevailing on the issue would be very small if the matter were litigated. After you explained your preliminary evaluation of the weakness of their position, Marianne and Dory stated that they want you to prepare the return taking the immediate deduction, which will require disclosing the position on the return. Your discussion with them included only an analysis of the tax issue, and not other matters like the low probability of the return being audited by the IRS. Professional Issues In considering whether to take on Wise-Holland and Marianne Wise as tax clients, you have done some research that indicates that in certain circumstances, the preparer of a passthrough entity's tax return and Schedules K-1 can be deemed to be the preparer of an individual's Form 1040 on which the data from the passthrough entity's return was entered. Tax return preparer includes any person who prepares a substantial portion of a return for compensation.1 Whether a schedule, entry, or other portion of a return is a substantial portion is determined by: 1 whether the preparer knew or should have known that the resulting tax result is a substantial portion of the tax to be shown on the return. the size and complexity of the item relative to the taxpayer's gross income. 7701(a)(36). Page 4 of 6 PwC Case Studies in Taxation, 2013, PwC, LLP WISE-HOLLAND CORPORATION the size of the attributable understatement relative to the taxpayer's reported tax liability.2 The question then is whether the K-1 numbers constitute a "substantial portion" of the return. Today it is September 1, 2013. You hold a valid CPA license in your state, and you are classified by the IRS as a tax return preparer. PART I REQUIRED: Determine your general responsibilities concerning all of these matters, as a CPA under the AICPA's Statements on Standards for Tax Services (SSTSs, latest version effective 2010) and under Treasury Department Circular 230. Prepare a chart, table, or graphic summarizing taxpayer and tax practitioner reporting standards. Also evaluate the potential penalties applicable to practitioners and taxpayers under the Internal Revenue Code. PART II REQUIRED: Identify all procedural and reporting issues that exist in the Wise-Holland facts. In particular, you should address the following issues. Relevant statutes of limitations Applicable interest provisions PART III REQUIRED: Evaluate the first three issues (Notice of Deficiency, Installment Sale, and Audit Notice) from the perspective of the taxpayer, taking into account the pertinent tax practitioner responsibilities and penalties. PART IV REQUIRED: For the deduct-or-capitalize issue, analyze the conclusions that a CPA must draw in deciding how to advise a client regarding an ambiguous tax position, and in determining whether he or she can sign a tax return and comply with statutory standards, the SSTSs, and Circular 230. Analyze all possible results, from a conclusion that a position has substantial authority to a conclusion that a position is frivolous. 2 Preparer penalties that are pertinent here are found in 6694, taxpayer penalties start with 6662. They are similar but not identical to the rules of Circular 230, nor to the AICPA's SSTSs. Special sanctions relate to the filing of frivolous returns. Taxpayer and tax preparer penalties under the Code are not always identical. Reg 301.7701-15(b)(3). Page 5 of 6 PwC Case Studies in Taxation, 2013, PwC, LLP WISE-HOLLAND CORPORATION II Can a taxpayer avoid an understatement penalty because of reliance on the advice of a tax professional? When do interest payments begin to accumulate? Can the IRS waive penalties? Interest liabilities? When a tax understatement is discovered, is the CPA obligated to inform the client? The IRS? III Was there an error on Marianne's return concerning the installment sale? What are the proper responses to the discovery of an error on a tax return? Recompute the 2010 - 2012 taxable income amounts regarding the installment note, by correcting the error. What now is Marianne's capital loss carryover into 2013? Does the audit notice fall within the statute of limitations period? IV Review the use of Form 8275 in dealing with an ambiguous tax filing position. Page 6 of 6