Kingston Carpets Inc. (Kingston) has been operating a retail carpet business out of the same location for the past 18 years. It has been very successful in gaining business from the local developers, who use Kingston almost exclusively to provide their flooring. In addition, Kingston is used extensively by the area insurance adjusters for carpet replaced due to fire and other damages. This business did not come to Kingston overnight. The owners, Andy and Sue Greene, have always spent much of their time promoting their business to these markets. Both Andy and Sue are avid golfers. They each belong to a different golf club, in order to be members at the clubs where most of their customers play. They find that golf is an activity that has paid off, since they have conducted a significant amount of business through their contacts at the golf clubs. They will often use these clubs for lunch and dinner meetings with customers, as well as for the companys seasonal holiday party. Last year, the company bought a building across the street from its original retail store. The previous owner had been leasing out the building and had not spent much money on repairs over the last five years. As a result, while Kingston paid a relatively low price for the property, it has had to spend a considerable amount on repairs over the past year. Prior to this purchase, Kingston had been leasing its space. To maintain their image of success, Sue and Andy both drive expensive cars and often entertain customers at their cottage or on their boat. This approach seems to work, and their customers are always asking when the next outing will be. Besides treating their customers well, Sue and Andy also treat their employees well. All employees belong to the group benefit plan that provides extended health care, dental, life insurance, and disability coverage. Because of the low coverage from the companys group life and disability insurance, Andy and Sue have had the company take out individual policies on both of them. The beneficiary on the life insurance policies is the company, and on the disability policies the beneficiaries are Andy and Sue. One of their valued employees was recently divorced and during the divorce her family home was sold. In order to keep her concentrating on business, Andy and Sue had the company loan her enough to buy a house. The loan was secured by the house and no interest was charged. At that time, the company did not have enough cash to make this loan so it had to borrow the funds at prime plus 1/2%. In addition to all of this, Andy and Sue have been actively involved in a number of charitable and political activities and have made donations to both. Even these activities have turned into business opportunities. Last year, they gave a donation to a local charity and shortly thereafter they received an order for the new carpet that was to go in the charitys offices.

REQUIRED: Advise Sue and Andy on the tax implications of their situation and that of Kingston Carpets.