Earl Jackson, the owner of a computer sales business, has contacted your firm to help him determine which type of entity would be most advantageous as he merges with another company to grow his business. Supporting documents are provided in the Resources tab for your analysis. Your coworker, a staff accountant at your firm, Beach & Seas CPAs, has prepared a letter explaining the advantages and disadvantages of each type of entity. Juan Orlando, the managing partner, has asked you to review the letter and the supporting documents to make any necessary corrections before he signs and sends it to the client.

To revise the document, click on each segment of blue, bold, underlined text below and select the needed correction, if any, from the list provided. If the underlined text is already correct in the context of the document, select [Original text] from the list

context of the document, select [Original text] from the list.

Beach & Sea CPAs, LLP

2300 Ocean Drive

Flipperville, FL 33999

January 10, 20X1

Earl Jackson 48684 Clermont Avenue Flipperville, FL 33999

Dear Earl:

Based on our meeting last month, it is our understanding that you are planning to combine your business with AA Computer Service, Inc. (AACS), owned by Kathleen Hamilton, and are seeking an entity with more flexibility than your current sole proprietorship. The new business, E&K ComputerLand (E&K), will be an accrual basis, calendar-year entity.(*A) Both you and Kathleen will continue to be calendar-year taxpayers. Three of the options available to the new combined computer sales and service business are a regular C corporation (C Corp), an S corporation (S Corp) and a general partnership (Pship). However, to be a Pship, AACS must liquidate, as it cannot be a partner of E&K; only individuals can be owners in a Pship.(*B)

When determining which entity form to choose for your new business, there are several factors to be considered. An important factor is the taxation of the business. S Corps are separate taxable entities, so double taxation can occur when the entity has taxable income and distributions are made.(*C) Pships and S Corps are tax reporting entities, meaning the entity level income flows through to the owners and is taxed only once on the owners personal returns.(*D) With C Corps and S Corps, income and losses are allocated according to the capital interest accounts.(*E) This provides more flexibility than with Pships, which requires an allocation based on capital interest accounts.(*F)

The possible loss due to a lawsuit or upon liquidation should be considered when selecting the entity form. S Corps and Pships have the least protection because owners include all liabilities in their basis; whereas a C Corp has the ability to limit liability since owners are liable only to the extent of their investment.(*G) When you decide to expand the ownership of E&K, limited liability may be of great importance to new investors. Speaking of investors, in C Corps and Pships, there can be multiple classes of ownership. However, in S Corps there can only be one class of ownership, and at least one of the owners must be a C Corp.(*H)

I hope this information helps you with your decision as to which entity form is best for E&K ComputerLand. Let us know what decision you make, and we will be happy to help you with the accounting and tax aspects of combining your business with AACS to create E&K.

Sincerely, Juan Orlando, CPA Managing Partner

Answer Options to choose from for each *marked sentence:

(*A)

[Original text] The new business, E&K ComputerLand (E&K), will be an accrual basis, calendar-year entity.

- [Delete text]

- The new business, E&K ComputerLand (E&K), will be an accrual basis, fiscal-year entity.

- The new business, E&K ComputerLand (E&K), will be a cash basis, calendar-year entity.

- The new business, E&K ComputerLand (E&K), will be a cash basis, fiscal-year entity.

- The new business, E&K ComputerLand (E&K), will be a hybrid basis, calendar-year entity.

- The new business, E&K ComputerLand (E&K), will be a hybrid basis, fiscal-year entity.

(*B)

[Original text] However, to be a Pship, AACS must liquidate, as it cannot be a partner of E&K; only individuals can be owners in a Pship.

- [Delete text]

- However, to be a C Corp, AACS must liquidate as it cannot be a shareholder of E&K; only individuals can be owners in a small C Corp.

- However, to be a C Corp, you must incorporate your business because AACS, which is a C Corp, cannot combine with a sole proprietorship.

- However, to be an S Corp, AACS must liquidate, as it cannot be an owner of E&K; C Corps cannot be owners in an S Corp.

- However, to be an S Corp, you must incorporate your business because AACS, which is a C Corp, cannot combine with a sole proprietorship.

(*C)

[Original text] S Corps are separate taxable entities, so double taxation can occur when the entity has taxable income and distributions are made.

- [Delete text]

- C Corps are separate taxable entities, so double taxation can occur when the entity has taxable income and distributions are made.

- Pships are separate taxable entities, so double taxation can occur when the entity has taxable income and distributions are made.

- C Corps and S Corps are separate taxable entities, so double taxation can occur when the entity has taxable income and distributions are made.

- S Corps and Pships are separate taxable entities, so double taxation can occur when the entity has taxable income and distributions are made.

- C Corps and Pships are separate taxable entities, so double taxation can occur when the entity has taxable income and distributions are made.

(*D)

[Original text] Pships and S Corps are tax reporting entities, meaning the entity level income flows through to the owners and is taxed only once on the owners personal returns.

- [Delete text]

- C Corps are tax reporting entities, meaning the entity level income flows through to the owners and is taxed only once on the owners personal returns.

- S Corps are tax reporting entities, meaning the entity level income flows through to the owners and is taxed only once on the owners personal returns.

- Pships are tax reporting entities, meaning the entity level income flows through to the owners and is taxed only once on the owners personal returns.

-C Corps and S Corps are tax reporting entities, meaning the entity level income flows through to the owners and is taxed only once on the owners personal returns.

- C Corps and Pships are tax reporting entities, meaning the entity level income flows through to the owners and is taxed only once on the owners personal returns.

(*E)

[Original text] With C Corps and S Corps, income and losses are allocated according to the capital interest accounts.

- [Delete text]

- With S Corps and Pships, income and losses are allocated on a per-share, per-day ownership basis.

- With C Corps and Pships, income and losses are allocated based on the initial investments in the entity.

- With S Corps, income and losses are allocated based on the balances in the ownership accounts.

- With Pships, income and losses are allocated based on the ownership agreement, and special allocations are permitted.

- With C Corps, income and losses are allocated by the board of directors.

(*F)

[Original text] This provides more flexibility than with Pships, which requires an allocation based on capital interest accounts.

- [Delete text]

- This provides more flexibility than with C Corps, which requires an allocation based on the board of directors declarations.

- This provides more flexibility than with S Corps, which requires an allocation based on per-share, per-day ownership.

- This provides more flexibility than with Pships, which requires an allocation based on the ownership accounts.

- This provides more flexibility than with S Corps, which requires an allocation based on the ownership agreement.

- This provides more flexibility than with C Corps, which requires an allocation based on initial investments in the entity.

(*G)

[Original text] S Corps and Pships have the least protection because owners include all liabilities in their basis; whereas a C Corp has the ability to limit liability since owners are liable only to the extent of their investment.

- [Delete text]

- C Corps have the least protection because upon liquidation, owners must contribute to the entity to the extent of any losses; whereas S Corps and Pships are only liable to the extent of recourse debt.

- General Pships have the least protection because there is unlimited liability for the owners; whereas C Corps and S Corps have the ability to limit liability since the owners are liable only to the extent of their investments.

- S Corps have the least protection because upon liquidation, owners are liable to the extent of recourse debt; whereas C Corps have the most protection due to the owners being liable only to the extent of their investment.

- S Corps and Pships have the least protection because owners include all liabilities in their basis; whereas C Corps owners are only liable to the extent of their investment plus short-term debts (accounts payables).

- C Corps and S Corps have the least protection because to the extent of recourse debt, the owners are liable; whereas Pships owners increase their protection by including all liabilities in their basis.

(*H)

[Original text] However, in S Corps there can only be one class of ownership, and at least one of the owners must be a C Corp.

- [Delete text]

- However, in S Corps there can only be one class of ownership, and the owners must be within the same family or limited extended group.

- However, in S Corps there can only be one class of ownership, and this class must all have the same voting rights

- However, in S Corps there can only be one class of ownership, and revenue cannot be of a passive nature.

- However, in S Corps there can only be one class of ownership, and not more than 75 owners of which none are C Corps.

- However, in S Corps there can only be one class of ownership, and not more than 100 owners of which none are nonresident aliens.

ADDITIONAL DOCUMENTATION ON NEXT PAGE

ENTITY AGREEMENT DRAFT Incomplete

(Not for legal use; planning purposes only)

THIS AGREEMENT (the "Agreement") made and entered into this __________day of __________,in the year __________(the "Execution Date"), among

Earl Jackson of 48684 Clermont Ave, Flipperville, FL33999, owner of Jackson Computer Sales

AND

AA Computer Services, Inc. of 2400 Ocean Drive, Flipperville, FL33999, whose sole shareholder is Kathleen Hamilton of 6203 Front Street, Flipperville, FL 33999

Thereby set forth their desire to combine Jackson Computer Sales and AA Computer Services, Inc. to create a new entity of E&K ComputerLand to be located at 2400 Ocean Drive, Flipperville, FL33999.The ownership percentages will be based on the net fair value of the assets contributed to E&K ComputerLand.

Legal Entity

The parties agree that the combination of Jackson Computer Sales and AA Computer Services, Inc. will result in E&K ComputerLand, carrying on business in the form of a __________legal entity with all the rights, privileges and obligations prescribed by the state law of Florida. All documents, licenses, and registrations necessary to create the legal entity will be filed with the State of Florida.

Tax Entity

In accordance with the law of the Internal Revenue Code (IRC),E&K ComputerLand will elect to be taxed as a(n)__________entity and file a Form__________tax return.

Accounting Method:

As required by the IRC, the entity will use the accrual method for determining its gross profit from sales of inventory and the cash method for all other aspects of the business, where possible. Valuing inventory will use the lower of cost or market and first-in, first-out methods.

Tax Year:

The ending date of the tax year will be determined based on the tax law requirements. If

there are options, March 31 is preferred, followed by June 30 and October 31. A calendar year is the least desired.

Notes for Completing Draft

Income:

If the entity created is

C Corporation: Earl and Kathleen will receive salaries. Any net income in excess of reasonable business needs being retained will be paid as dividends based on common share ownership.

S Corporation: Earl and Kathleen will receive salaries. All income and expenses will be allocated based on tax law with only common stock issued to owners.

Partnership: Earl and Kathleen will receive guaranteed payments. All income and expenses will be allocated based on this agreement. Profit and loss allocations to be based on ownership

percentages with rights to adjust as partners deem necessary. In addition, all of the depreciation on the building located at 2400 Ocean Drive, Flipperville, FL 33999, will be allocated to Kathleen, and income from initial inventory will be allocated to Earl.

EMAIL From: Kathleen Hamilton [KH@AACS.com]

Sent:Thursday, January 5, 20X1 7:50 PM

To:Juan Orlando

Subject: Re: Combination of Businesses

Hello Juan,

Here is the information you requested about AA Computer Services (AACS).

Set up as a regular corporation within Florida.

Files an 1120 tax return with a March 31 year-end with about $300,000 of gross

income.

Uses cash basis of accounting primarily because it is a service business.

For the few sales of products, accrual basis is used.

AACS has a $300,000 mortgage on its building. Earl will move in his business here and our new company will be at this location. No other liabilities.

Im not expecting to have to liquidate to combine with Earls business. Please let me know if this is not the case.

As requested by the lawyers, I had AACS appraised by Jefferson & Sons. The appraisal came in at $700,000. The formal write-up with all the details was sent directly to the lawyers, and I had another copy sent to you.

As for tax information for me, I just have a salary from AACS, which is basically whatever net income AACS has for the year after all other expenses. I have some investment income and that is it.

Let me know if you need anything else.

Kathy

EMAIL From: Earl Jackson [EJIII@flipperville.com]

Sent: Friday,January 6, 20X1 4:31 PM

To:Juan Orlando

Subject:Re: Combination of Businesses

Dear Juan,

I just got the appraisal from Jefferson & Sons and they valued my business at $500,000. Of course, this does not take into consideration that I owe $200,000 on my business loan. They said that Kathy Hamilton told them to send a copy of her appraisal and mine to Beach & Sea and Davis, Garcia & Brown, so you should receive a copy of both at the same time.

You asked about my taxes for Jackson Computer Sales. Most of the $400,000 gross revenue comes from sales of computers, monitors, peripherals, and accessories. I also sell tablets. All of its income and expenses have been reported on my personal return on my Schedule C. I pay self-employment taxes on the net amount, which has been about $100,000.

If there is anything else you need, just let me know.

Have a great weekend,

Earl