On June 1^st 1992, Jane Pagnano and Albert Breyer formed Deer Valley Silver Company (Deer Valley), an S Corporation whose principal business consisted of the retail sale of jewelry in the Deer Valley Ski Resort. Since the companys principal sale activities would take place during the winter months, with an extraordinary amount of the sales taking place during the Christmas holiday season, the company was formed with a fiscal year ending on September 30. Deer Valley was formed by Albert contributing $30,000 in cash to the corporation and June contributing $3,000 in cash plus $27,000 of jewelry designed by her in which she had a basis of $5,000. In exchange for their contributions, they were each issued 500 shares of Deer Valley or 50% of the common stock of the corporation.

During its first fiscal year, which covered only the 4 months prior to September 30^th 1992, Deer Valley experienced an expected start-up loss of $20,000. During its second fiscal year, Deer Valley realized net taxable income of $50,000, all derived from sales of jewelry. Until this point, Deer Valleys financial affairs were relatively simple with all income derived from sales of jewelry in rented quarters. In the las fiscal year, which ended on September 30^th 1993, Deer Valley realized $90,000 in net income and saw its financial affairs become somewhat complicated. In addition to the sales transactions and related deductions of rent, utilities, and salary to both owners of $30,000 each, Deer Valley experienced the following financial transactions which were not considered in computing the $90,000 of income mentioned. First, it realized a loss (capital or ordinary) of $5,000 on the sale by it of certain gold futures contracts. Next, it suffered a $4,000 loss on the sale by it of some land it had purchased shortly after its founding to secure reserved parking space for customers. In thanks for its successful start, the corporation made a gift of $10,000 to the University of Minnesota from which its founders had both received their college degrees. In that year, Deer Valley also purchased form $12,000 a cash register, counters and various pieces of equipment used in the jewelry shop. In addition to its income from sales of jewelry, Deer Valley also realized $3,000 of interest on certificates of deposit and $2,000 of interest income on tax exempt municipals in which spare cash was not invested. No distributions were made by Deep Valley in its first two fiscal years, but during its last fiscal, on August 15^th 1993, the corporation distributed to each shareholder $10,000 in cash and $4,000 of inventory consisting of raw silver in which it had an adjusted basis of $3,000.

Jane and Albert, who had previously prepared their own tax returns, consult you to determine how they should report the results of Deer Valleys operations for the fiscal year ending September 30^th 1993. They also seek your advice as to the proper adjusted basis which each has in his or her Deer Valley stock as of October 1^st 1993.

What are the tax consequences for Jane and Albert for Deer Valley as an S corporation. What and how should they report this on their income?