Real Running Gear Corp. Federal Tax Return FACTS Lisa Boyd developed and patented a line of specialized running attire. The attire is constructed for durability and quick wicking and is made of highly reflective materials for night-time use. Lisa set up Real Running Gear Corp (RRG) to manufacture and sell her products. RRG is a small, closely-held manufacturer (the business code number is 339900, and the employer identification number is 11- 1111111). The company is located at 325 Ground Road, Cedar City, Utah 84721. The corporation, which uses a calendar year for tax purposes, has been an S corporation since its incorporation on August 2, 2011. Lisa (social security number 111-11-1111) is president of the corporation. Lisa owned 100% of the stock until September 15th of the current tax year when she sold 5% to Hannah Boyd (Lisa's daughter, social security number 222-22-2222), who serves as vice president of the company. Both officers devote 100 percent of their time to the corporation and live at 333 Opportunity Street, Cedar City, Utah 84720. Annual compensation is $80,000 for Lisa and $40,000 for Hannah. The corporation does not engage in activities to which the at-risk or passive activity loss limitations apply. RRG files its tax return using the accrual method. Inventory has been consistently valued at cost under the FIFO method using the full absorption procedure. Inventory capitalization rules of Internal Revenue code Section 263A do not apply due to the 'small business exception' (average annual gross receipts for the three preceding taxable years do not exceed $10 million). The accounting records are computerized. The corporation did not make payments that would require it to file Form(s) 1099. 1 The corporation's audited income statement and balance sheet for the current year, prepared by the accounting firm of Barnes & Lewis, CPAs, follow: REAL RUNNING GEAR CORP. INCOME STATEMENT For the Current Year Ending December 31 Revenue: Sales (net). Cost of goods sold Gross Profit Operating Expenses: Compensation of officers Other salaries and wages Employee benefits. Rental expense $ 2,500,000 (1,750,000.0) $ 750,000 $ 120,000 275,000 12,000 28,000 Interest expense 13,950 Advertising. 8,000 Key-person life insurance premiums 7,500 Contributions Depreciation Taxes (other than income tax). Repairs and maintenance Miscellaneous expenses Total operating expenses Net Income from Operations 950 30,478 26,000 15,000 4,500 $ (541,378) $ 208,622 Other income and loss: Dividend income $ 3,400 Interest income 620 Gain on sale of investment in stock. 458 Gain on sale of machine 10,750 Casualty loss on machine Net Income (1,000) 2 14,228 $ 222,850 ASSETS REAL RUNNING GEAR CORP. STATEMENT OF FINANCIAL POSITION December 31 Current Year Beginning of Year End of Year Current Assets: Cash & Marketable Securities $ 11,152 $ 110,630 Accounts receivable 29,850 35,450 Inventory 220,000 205,000 Total current assets $ 261,002 $ 351,080 Machinery and Equipment (M&E) Machinery and Equipment $ 330,000 $ 276,000 Less: Accumulated depreciation (27,002) (42,730) Total machinery and equipment (net).. $ 302,998 $ 233,270 Other assets: Life insurance cash surrender value $ 19,000 $ 24,000 Total Assets $ 583,000 $ 608,350 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 20,000 Notes payable (less than one year). 23,500 $ 23,000 25,000 Total Current liabilities $ 43,500 $ 48,000 Notes payable (one year or more). 79,500 37,500 Total Liabilities. $ 123,000 $ 85,500 Common stock (33,000 shares authorized, issued and outstanding, $10 par) $ 330,000 $ 330,000 Retained earnings. 130,000 192,850 Total Shareholders' Equity.. $ 460,000 $ 522,850 Total Liabilities and Shareholders' Equity. $ 583,000 $ 608,350 STATEMENT OF RETAINED EARNINGS Beginning Retained Earnings Net Income for the year. Dividends paid in cash. Ending Retained Earnings 3 $ 130,000 222,850 (160,000) $ 192,850 NOTES 1. Included in employee benefits expense are $650 and $450 premiums for $50,000 (face) group term life insurance premiums for Lisa and Hannah, respectively. Family members are named beneficiaries in the policies. 2. All notes payable were issued at par and provide market interest rates. 3. Employees account to the company and are reimbursed by the exact amount of travel and entertainment expenses incurred on business. Included in Miscellaneous Expense are $1,900 for transportation expenses, and $600 for business meals. 4. Dividend income is from minor investments in: Carthartt Corp. owned for 3 years American Insurance Company (key-person life insurance policy dividend/premium refund) Total $ 2,500 900 $ 3,400 5. Contributions were paid in cash to: Save the Prairie Dogs Tea Party Total Contributions $ 700 250 $ 950 6. The key-person life insurance policy provides $500,000 coverage on Lisa Boyd. RRG is the owner and beneficiary of the policy. 7. A schedule attached in the prior year's working papers reconciles Retained Earnings and Accumulated Adjustments Account balances at December 31 of prior year as follows: Balance per Schedule L (Balance Sheet) $ 130,000 Accumulated depreciation for machinery and equipment (M&E) for tax M&E Acquired July 1st two years ago $ 11,634 M&E Acquired February 2nd last year. Accumulated depreciation per books 42,870 $ 54,504 (27,002) Excess of Accumulated Tax over Book Depreciation for M&E. (27,502) Balance per Schedule M (Analysis of the Accumulated Adjustments Account) $ 102,498 8. The balance of the "Other Adjustments Account" (Form 1120S, p. 5, Sch. M-2, col. (b)) at the beginning of the year was $-0-. 9. The following spreadsheet contains depreciation information for financial accounting purposes (not tax). 4 Real Running Gear Corp. Depreciation/Cost Recovery Information Financal Beginning Current Current Year Begin Depreciation of Year Cost Year Cost Information Balance Additions Cost Year End Retirements Cost Balance Depr. Balance Current Year Current Year De pr. De pr. Provisions Retirements Year End Depr. Balance Machinery Acquired on: M1: May 2 years ago $ 30,000 $ (30,000) M2: Feb 1 last year M3: Feb. 1 last year M4: May 1 current year M5: Aug 1 current year 230,000 70,000 230,000 (70,000) $ 4,500 $ 11,500 3,500 1,500 $ 11,500 (6,000) $ 23,000 3,500 (7,000) $ 25,000 21,000 25,000 21,000 1,638 777 1,638 777 Total $ 330,000 $ 46,000 $ (100,000) $ 276,000 $ 19,500 $ 18,915 $ (13,000) $ 25,415 TAX DEPRECIATION INFORMATION The following information is needed to determine current year depreciation and accumulated depreciation for tax purposes. MACRS (Modified Accelerated Cost Recovery System For property placed in service after 1986): Machinery and equipment (7-year statutory life, 200% declining balance switching to straight line, half-year convention). Statutory percentage for assets placed in service during a year are 14.29%, 24.49%, 17.49%, 12.49%, 8.93%, 8.92%, and 4.46% for recovery years 1-8, respectively. Remember, in the year of disposition only take one-half of the normal MACRS amount. The corporation has not elected Internal Revenue Code Sec. (IRC Sec.) 179 expense in the past. However, IRC Sec. 179 expense is to be claimed for machinery and equipment placed in service on May 1st of the current tax year. 10. Machine #3, purchased on February 2nd of the previous year for $70,000, was sold to an unrelated party on November 1st of the current tax year for $72,000. No Form 1099 was received reporting the gross proceeds received. 11. Machine #1, purchased July 7th two years ago for $30,000, was totally destroyed by a flood on April 1st of the current tax year. Proceeds of $23,000 were received from the insurance company. On August 1st of the current tax year $21,000 of the proceeds was invested in a replacement machine. Assume there will be no further qualified reinvestment of the proceeds. No Form 1099 was received reporting the gross proceeds received. 12. Interest expense was on loans for the following purpose: Purchase M&E Invest in stock of Carhartt Corp. Invest in Iron County, Utah water and sewer bonds Cover shortage in working capital Total $ 6,000 1,300 150 6,500 $ 13,950 5 13. On June 5th, 550 shares of Carthartt Corp. common stock were sold for $2.50 a share. The company bought 2,000 shares of the stock on June 2nd three years ago for $10,000. The stock was split 3-for-1 on February 21st of the current tax year. 14. On May 15th three years ago RRG purchased at par $15,300 of Iron County, Utah water sewer bonds. Interest of $620 was received on the bonds during the years. ALTERNATIVE MINIMUM TAX (Tax Preferences and Adjustments) For this practice set, ignore effects of the above cost recoveries on the Alternative Minimum Tax (i.e., leave the applicable spaces blank for these items in the Adjustments and Tax Preferences Items section of Schedules K and K-1). CHECK FIGURES 1120S Line 21 Ordinary Business Income Schedule M-1 line 8 $200,102 $178,060 REQUIRED From the above information, prepare RRG's Federal income tax return (Form 1120S), including all forms, schedule and supporting statements as indicated below. Unless otherwise noted, assume RRG makes all available elections to minimize the shareholders' current taxable income. Round amounts to the nearest dollar. If additional information is needed, make realistic assumptions and fill in all required data. The tax return is worth 150 points. Below is a list of required forms/schedules along with possible points for each form/schedule. Grades are calculated by multiplying 150 x [points earned/300]. Form Points Book to Tax Income Statement Reconciliation 45 1120s page 1 28 1120s page 2 12 1120s page 3 1120s page 4 12 1120s page 5 Form 1125-A Schedule K-1 Lisa Schedule K-1 Hannah Form 4797 page 1 Form 4797 page 2 Form 4562 Schedule D Section 1033 election Schedule K line 16c support M-1 line 2 & 3b supporting schedules M-2 line 3 & 5 supporting schedules Total 1322226325867 10 24 24 10 300 6 Real Running Gear Corp. Federal Tax Return FACTS Lisa Boyd developed and patented a line of specialized running attire. The attire is constructed for durability and quick wicking and is made of highly reflective materials for night-time use. Lisa set up Real Running Gear Corp (RRG) to manufacture and sell her products. RRG is a small, closely-held manufacturer (the business code number is 339900, and the employer identification number is 11- 1111111). The company is located at 325 Ground Road, Cedar City, Utah 84721. The corporation, which uses a calendar year for tax purposes, has been an S corporation since its incorporation on August 2, 2011. Lisa (social security number 111-11-1111) is president of the corporation. Lisa owned 100% of the stock until September 15th of the current tax year when she sold 5% to Hannah Boyd (Lisa's daughter, social security number 222-22-2222), who serves as vice president of the company. Both officers devote 100 percent of their time to the corporation and live at 333 Opportunity Street, Cedar City, Utah 84720. Annual compensation is $80,000 for Lisa and $40,000 for Hannah. The corporation does not engage in activities to which the at-risk or passive activity loss limitations apply. RRG files its tax return using the accrual method. Inventory has been consistently valued at cost under the FIFO method using the full absorption procedure. Inventory capitalization rules of Internal Revenue code Section 263A do not apply due to the 'small business exception' (average annual gross receipts for the three preceding taxable years do not exceed $10 million). The accounting records are computerized. The corporation did not make payments that would require it to file Form(s) 1099. 1 The corporation's audited income statement and balance sheet for the current year, prepared by the accounting firm of Barnes & Lewis, CPAs, follow: REAL RUNNING GEAR CORP. INCOME STATEMENT For the Current Year Ending December 31 Revenue: Sales (net). Cost of goods sold Gross Profit Operating Expenses: Compensation of officers Other salaries and wages Employee benefits. Rental expense $ 2,500,000 (1,750,000.0) $ 750,000 $ 120,000 275,000 12,000 28,000 Interest expense 13,950 Advertising. 8,000 Key-person life insurance premiums 7,500 Contributions Depreciation Taxes (other than income tax). Repairs and maintenance Miscellaneous expenses Total operating expenses Net Income from Operations 950 30,478 26,000 15,000 4,500 $ (541,378) $ 208,622 Other income and loss: Dividend income $ 3,400 Interest income 620 Gain on sale of investment in stock. 458 Gain on sale of machine 10,750 Casualty loss on machine Net Income (1,000) 2 14,228 $ 222,850 ASSETS REAL RUNNING GEAR CORP. STATEMENT OF FINANCIAL POSITION December 31 Current Year Beginning of Year End of Year Current Assets: Cash & Marketable Securities $ 11,152 $ 110,630 Accounts receivable 29,850 35,450 Inventory 220,000 205,000 Total current assets $ 261,002 $ 351,080 Machinery and Equipment (M&E) Machinery and Equipment $ 330,000 $ 276,000 Less: Accumulated depreciation (27,002) (42,730) Total machinery and equipment (net).. $ 302,998 $ 233,270 Other assets: Life insurance cash surrender value $ 19,000 $ 24,000 Total Assets $ 583,000 $ 608,350 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 20,000 Notes payable (less than one year). 23,500 $ 23,000 25,000 Total Current liabilities $ 43,500 $ 48,000 Notes payable (one year or more). 79,500 37,500 Total Liabilities. $ 123,000 $ 85,500 Common stock (33,000 shares authorized, issued and outstanding, $10 par) $ 330,000 $ 330,000 Retained earnings. 130,000 192,850 Total Shareholders' Equity.. $ 460,000 $ 522,850 Total Liabilities and Shareholders' Equity. $ 583,000 $ 608,350 STATEMENT OF RETAINED EARNINGS Beginning Retained Earnings Net Income for the year. Dividends paid in cash. Ending Retained Earnings 3 $ 130,000 222,850 (160,000) $ 192,850 NOTES 1. Included in employee benefits expense are $650 and $450 premiums for $50,000 (face) group term life insurance premiums for Lisa and Hannah, respectively. Family members are named beneficiaries in the policies. 2. All notes payable were issued at par and provide market interest rates. 3. Employees account to the company and are reimbursed by the exact amount of travel and entertainment expenses incurred on business. Included in Miscellaneous Expense are $1,900 for transportation expenses, and $600 for business meals. 4. Dividend income is from minor investments in: Carthartt Corp. owned for 3 years American Insurance Company (key-person life insurance policy dividend/premium refund) Total $ 2,500 900 $ 3,400 5. Contributions were paid in cash to: Save the Prairie Dogs Tea Party Total Contributions $ 700 250 $ 950 6. The key-person life insurance policy provides $500,000 coverage on Lisa Boyd. RRG is the owner and beneficiary of the policy. 7. A schedule attached in the prior year's working papers reconciles Retained Earnings and Accumulated Adjustments Account balances at December 31 of prior year as follows: Balance per Schedule L (Balance Sheet) $ 130,000 Accumulated depreciation for machinery and equipment (M&E) for tax M&E Acquired July 1st two years ago $ 11,634 M&E Acquired February 2nd last year. Accumulated depreciation per books 42,870 $ 54,504 (27,002) Excess of Accumulated Tax over Book Depreciation for M&E. (27,502) Balance per Schedule M (Analysis of the Accumulated Adjustments Account) $ 102,498 8. The balance of the "Other Adjustments Account" (Form 1120S, p. 5, Sch. M-2, col. (b)) at the beginning of the year was $-0-. 9. The following spreadsheet contains depreciation information for financial accounting purposes (not tax). 4 Real Running Gear Corp. Depreciation/Cost Recovery Information Financal Beginning Current Current Year Begin Depreciation of Year Cost Year Cost Information Balance Additions Cost Year End Retirements Cost Balance Depr. Balance Current Year Current Year De pr. De pr. Provisions Retirements Year End Depr. Balance Machinery Acquired on: M1: May 2 years ago $ 30,000 $ (30,000) M2: Feb 1 last year M3: Feb. 1 last year M4: May 1 current year M5: Aug 1 current year 230,000 70,000 230,000 (70,000) $ 4,500 $ 11,500 3,500 1,500 $ 11,500 (6,000) $ 23,000 3,500 (7,000) $ 25,000 21,000 25,000 21,000 1,638 777 1,638 777 Total $ 330,000 $ 46,000 $ (100,000) $ 276,000 $ 19,500 $ 18,915 $ (13,000) $ 25,415 TAX DEPRECIATION INFORMATION The following information is needed to determine current year depreciation and accumulated depreciation for tax purposes. MACRS (Modified Accelerated Cost Recovery System For property placed in service after 1986): Machinery and equipment (7-year statutory life, 200% declining balance switching to straight line, half-year convention). Statutory percentage for assets placed in service during a year are 14.29%, 24.49%, 17.49%, 12.49%, 8.93%, 8.92%, and 4.46% for recovery years 1-8, respectively. Remember, in the year of disposition only take one-half of the normal MACRS amount. The corporation has not elected Internal Revenue Code Sec. (IRC Sec.) 179 expense in the past. However, IRC Sec. 179 expense is to be claimed for machinery and equipment placed in service on May 1st of the current tax year. 10. Machine #3, purchased on February 2nd of the previous year for $70,000, was sold to an unrelated party on November 1st of the current tax year for $72,000. No Form 1099 was received reporting the gross proceeds received. 11. Machine #1, purchased July 7th two years ago for $30,000, was totally destroyed by a flood on April 1st of the current tax year. Proceeds of $23,000 were received from the insurance company. On August 1st of the current tax year $21,000 of the proceeds was invested in a replacement machine. Assume there will be no further qualified reinvestment of the proceeds. No Form 1099 was received reporting the gross proceeds received. 12. Interest expense was on loans for the following purpose: Purchase M&E Invest in stock of Carhartt Corp. Invest in Iron County, Utah water and sewer bonds Cover shortage in working capital Total $ 6,000 1,300 150 6,500 $ 13,950 5 13. On June 5th, 550 shares of Carthartt Corp. common stock were sold for $2.50 a share. The company bought 2,000 shares of the stock on June 2nd three years ago for $10,000. The stock was split 3-for-1 on February 21st of the current tax year. 14. On May 15th three years ago RRG purchased at par $15,300 of Iron County, Utah water sewer bonds. Interest of $620 was received on the bonds during the years. ALTERNATIVE MINIMUM TAX (Tax Preferences and Adjustments) For this practice set, ignore effects of the above cost recoveries on the Alternative Minimum Tax (i.e., leave the applicable spaces blank for these items in the Adjustments and Tax Preferences Items section of Schedules K and K-1). CHECK FIGURES 1120S Line 21 Ordinary Business Income Schedule M-1 line 8 $200,102 $178,060 REQUIRED From the above information, prepare RRG's Federal income tax return (Form 1120S), including all forms, schedule and supporting statements as indicated below. Unless otherwise noted, assume RRG makes all available elections to minimize the shareholders' current taxable income. Round amounts to the nearest dollar. If additional information is needed, make realistic assumptions and fill in all required data. The tax return is worth 150 points. Below is a list of required forms/schedules along with possible points for each form/schedule. Grades are calculated by multiplying 150 x [points earned/300]. Form Points Book to Tax Income Statement Reconciliation 45 1120s page 1 28 1120s page 2 12 1120s page 3 1120s page 4 12 1120s page 5 Form 1125-A Schedule K-1 Lisa Schedule K-1 Hannah Form 4797 page 1 Form 4797 page 2 Form 4562 Schedule D Section 1033 election Schedule K line 16c support M-1 line 2 & 3b supporting schedules M-2 line 3 & 5 supporting schedules Total 1322226325867 10 24 24 10 300 6