Directions: Create a Tax Research Memo based on the information provided below (the attached information is to assist in creating the Tax Research Memo)
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Your clients Millie and Bob have asked you to prepare a tax research memo to help them understand some complex tax issues. In the Word document titled AC312 Unit 3 Tax Research Memo #1 you will find a summary of the issues Millie and Bob would like you to research along with the pertinent facts you require to reach a proper conclusion.
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You have also been provided the relevant Internal Revenue Code sections in pdf format. You will NOT need to reference any additional source of authoritative guidance to provide a complete and accurate analysis for your client.
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Closely study the Tax Research Memo - Helpful Tips Word document as well as the grading rubric for this research memo assignment as you complete your tax research memo for Millie and Bob using Microsoft Word. You may also find it beneficial to review the Word document titled Sample Tax Research Memo to better help you visualize the proper layout and format of a professional tax research memo.
Your friend Millie is starting a new business venture with her best friend Bob, and you have agreed to provide tax consulting services on an as-needed basis. Millie and Bob plan to name the company Oh Gnome You Didn't ("Gnome"), although they haven't yet decided on the type of legal entity for the business. The business plan is for Gnome to design and construct whimsical gnome gardens for its clientele. Millie will manage Gnome's operations full-time as an employee in exchange for reasonable compensation. Unfortunately, Bob has gnomophobia, better known as the fear of garden gnomes it's a real thing). Therefore, Bob intends to stay far away from Gnome's gnomes, and will not participate in Gnome's day- to-day operations. Millie would prefer to incorporate Gnome as a C-corporation because the new 21% corporate tax rate is much lower than her individual marginal tax rate of 35%. Bob would also like to incorporate Gnome, but he wants to avoid double taxation on shareholder distributions; therefore, his preference is for Gnome to make an election to be an S-corporation in its initial tax year. Millie and Bob are currently modeling the after-tax return impact of choosing a C-corporation versus an S-corporation, and they have requested your assistance to help them understand some confusing tax rules. Their specific questions they need your advice on are as follows: 1. "We've heard something about a new tax law that lets you deduct 20% of your income, but we've also been told that the deduction isn't available to all businesses. Will Gnome's income qualify for this deduction if (A) it is a C-corporation or (B) it is an S-corporation?" 2. "We're also unsure about the 3.8% net investment income tax on individuals. Will either of us be liable for this tax if (A) Gnome is a C-corporation or (B) Gnome is an S-corporation?" 3. "We're worried about messing up the election if we decide that Gnome should be an S- corporation. When exactly does our S-corporation election have to be made if we want to ensure Gnome will be treated as an S-corporation beginning with its initial tax year?" Supplementary Information Millie is a single taxpayer, and her adjusted gross income ("AGI") is estimated at $100,000. Bob is married and files a joint tax return with his wife; together their AGI is estimated at $425,000. The key to becoming a well-respected leader in the tax field, or any business/accounting/finance field, is to be able to accurately and efficiently communicate technical concepts, issues, and proposed resolutions using layman's terms. Facts The Facts section should ONLY include facts required for the reader to make an informed decision about the accuracy of your research conclusions. You should not include any facts that are inconsequential. When the facts include numerical details such as multiple dates or amounts, you should consider using a bulleted format or table layout to enhance comprehension of the details. Issue The Issues section is where you will list the questions your client has asked you to address. When there is more than one issue to resolve, using a numbering format is an effective way to organize the memo. Avoid "creating" issues that aren't relevant to the matter at hand; but on the other hand, you should be all-inclusive with your issue identification. Conclusion The Conclusion section is where you will provide the solutions to the client's issues. If you used a numbered format in the issues section, you should follow the same format. Do not provide conclusions for any issues not identified in the Issues section. You should INCLUDE the solution but EXCLUDE the reason for the solution. Example: if the solution to an issue is 4 and the computation was 8 + 127 +32-41= 4, you would state "The answer is 4" in the Conclusion section. The computation belongs in the Analysis section. Analysis The Analysis section is where you will defend your conclusion(s). You should analyze each issue separately, if you used a numbered format in the Issues section, you should follow the same format. Analysis The Analysis section is where you will defend your conclusion(s). You should analyze each issue separately; if you used a numbered format in the Issues section, you should follow the same format. Your analysis of each issue should begin with relevant Internal Revenue Code statutory/regulatory cites. If you require further support for your conclusion, you may then refer to "weaker" defenses (i.e. revenue rulings/procedures, court cases, IRS web site references, etc.) It is extremely important to SUMMARIZE the authoritative guidance information for the client using "PLAIN LANGUAGE" and EXPLAIN how the guidance applies to the client's issue in YOUR OWN WORDS. Other Advice for Professional Tax Memos Throughout the memo, be as succinct as possible. The tax rules and regulations are difficult enough to analyze as it is, there is no need to include "fluffy" language; there is no need to include inapplicable authoritative guidance; there is no need to create issues that the client isn't interested in resolving now. To: Spartan Corporation's Tax Director From: Katy Chowning, CPA Date: November 4th, 2017 Facts Spartan Corporation ("Spartan") made the following cash distributions with respect to its stock during its 2016 tax year: June 14 - $1,000 (dividend distribution) July 1* - $2,000 (25% share redemption) August 31st - $4,000 (dividend distribution) Spartan's accumulated earnings and profits ("E&P") on January 15, 2016 was $2,000, and current E&P for the 2016 tax year was $12,000. Question What is Spartan's accumulated E&P at January 15, 2017? Conclusion Spartan's accumulated E&P at January 19, 2017 is $7,625. Analysis When a corporation makes a distribution to a shareholder with respect to its stock, the portion of the distribution characterized as a dividend is includable in the gross income of the shareholder. IRC $316(a) defines a dividend as any corporate distribution that comes from either accumulated E&P or the E&P for the current taxable year. Therefore, Spartan must calculate its current and accumulated E&P to accurately determine the income character of any distributions made with respect to its stock. IRC $312(a) states in summary that a corporation should decrease its E&P by the amount of money it distributes with respect to its stock. Per Treas. Reg. $1.316-2(a), distributions are first considered to be made from current E&P. If applicable, distributions that exceed current E&P are made from accumulated E&P. Spartan calculated current E&P of $12,000 for 2016. The June 14 and August 31% distributions total $5,000. Therefore, the full amount of these distributions was made from current E&P. 1 Spartan has determined the June and August cash distributions qualify as dividend distributions pursuant to IRC 6316(a). These distributions are also referred to as "ordinary distributions" in this memorandum. 2 Spartan has determined the share redemption represents a qualifying exchange under IRC 5302(a). This distribution is also referred to as a "redemption distribution" in this memorandum. 3 Please be advised that Spartan's E&P calculations were not independently verified by the tax adviser. The conclusions reached in this memorandum should only be considered in the context of the facts represented above. The decrease to E&P for distributions made in redemption of stock is limited to the ratable share of accumulated E&P that is attributable to the redeemed stock. Stated differently, the amount of Spartan's E&P reduction related to the July 1s redemption transaction will be the lesser of $2,000 (the amount of cash distributed) or 25% of Spartan's accumulated E&P as of July 1s (i.e. 25% of stock was redeemed, so E&P cannot be reduced by more than 25%). A revenue ruling was issued by the Internal Revenue Service ("IRS") to address instances when both ordinary distributions and redemption distributions are made during the same taxable year. The IRS concluded that ordinary distributions take priority over redemption distributions subject to IRC $302(a). In adherence with the conclusions in this revenue ruling, Spartan must first reduce its current E&P by the $5,000 in ordinary distributions made during 2016. Spartan must then determine the proper amount of E&P reduction related to the redemption distribution. Rev. Rul. 74-338, 1974-2 CB 101 provides a relevant example for how to determine the ratable share of accumulated E&P attributable to redeemed stock. There are 3 general steps to follow, as demonstrated below: Step 1: Calculate the current E&P balance available for the redemption distribution (i.e. after considering reductions in E&P for all ordinary distributions). Current E&P for 2016 = Ordinary Distributions = Current E&P Available = $12,000 (5,000) $7,000 Step 2: Calculate the decrease in E&P related to the redemption distribution. Accumulated E&P 1/1/2016 = Current E&P (Pro-rated thru 7/1/2016) = Accumulated E&P 7/1/2016 = Pro-rata portion for redemption = $2,000 3,500 ($7,000 from Step 1 x 6/12) $5,500 $1,375 ($5,500 x 25%) Step 3: Calculate the accumulated E&P available for future distributions. Accumulated E&P 1/1/2016 = Current E&P for 2016 = Ordinary Distributions = Redemption Distribution = Accumulated E&P 1/1/2017 = $2,000 12,000 (5,000) (1,375) $7,625 4 IRC 5302(a) or IRC 5303 must apply to the redemption for $312(n)(7) to apply - Spartan has represented that the redemption was a qualifying exchange under IRC $302(a). This was not independently verified by the tax adviser but is assumed to be correct for purposes of the conclusions reached in the memo. SIRC $312(n)(7) 6 Rev. Rul. 74-339, 1974-2 CB 103 7 Excludes any reductions related to distributions. Lesser of pro-rata portion or the amount of cash distributed (i.e. $1,375
