• Prepare a memorandum to the tax manager outlining the information you found in your research.
• Format the memo to include:
  • Restatement of Facts (paraphrase)
  • Identify at least three main issues based on these facts
  • Provide a conclusion for each issue
  • Include the analysis that led you to the conclusion for each issue. This analysis should refer to the primary authority that best addresses the issue.
  • Primary authority would include items such as the Internal Revenue Code, Regulations, Court Cases, etc. These also should be paraphrased in order to highlight your understanding of the primary authority and how it relates specifically to the issue. Tax Topics and IRS publications are NOT primary source material.

Hawaiian Memories, Inc. (HMI) is a C corporation that was formed in 2012 in Maui. The company markets to tourists its specialty photography of the islands of Hawaii. The initial incorporators were

Angie Lee and Bob Lin, a married couple, who now own 1,000 shares of voting common stock and 100 shares of preferred stock each. The company has eight employees who collectively own 500 shares of nonvoting stock. Most of the employees have worked for the company for several years. They purchase the stock when the company offers it at the end of each year. Two employees own 100 shares each; the other six own 50 shares each.

None of the HMI shareholders are related to each other by blood or marriage, except for Angie and Bob. All individual shareholders are native Hawaiians except for Inge; she is a Swedish citizen and has lived on Maui and worked for HMI for three

years. Inge plans to move back to Sweden in one year and try to develop markets for HMI products there.

Another stockholder is the Plantation Sugar Partnership (PSP). PSP owns 500 nonvoting common shares; it supplies raw sugar in bulk to HMI. Bob Lin and his sister Katie each own 50% of PSP.

Plantation Sugar Partnership

500 non‐voting common

Angie

1,000 voting common 100 preferred

Hawaiian Memories Inc

Bob

1,000 voting common 100 preferred

Carl, Donna

100 non‐voting common each

Ernie, Frank, Gertie, Hannah, Inge, Jerry

50 non‐voting common each

Bob

50%

Katie

50%

The corporation uses a June 30 year end. All of the HMI shareholders use calendar years. Financial statements for the year ended June 30, 2017 are attached. HMI does not expect that it will generate any significant increases in investment or passive activity income in the coming years.

This was the first year of corporate operating losses in some time. Bob and Angie expect one or two more years of losses and then steady increases in a positive amount of net income.

Bob lives in Hawaii and manages operations there. Angie moved to San Francisco in 2013 to develop mainland markets for their products. Both earn annual salaries of $150,000. The shareholders and all

employees are provided accident and health insurance. The company contributes 10% of each employee's salary to a defined contribution 401(k) plan each year.

I

On October 1, 2017, Bob and Angie came to your office for the first time. They have just filed the corporate return for the fiscal year ended June 30, 2017 and are interested in having you take over all the future tax work for the corporation. They inform you that
they have just read an article in Tourism Retailing about the tax
and cash‐flow benefits of pass‐through losses. They have filed an
election to be an S corporation, effective on July 1, 2017.

Bob and Angie signed the consent for the S election because they
were the only shareholders with voting stock. Their reasoning for
making the S election is that they expect losses for a year or two
as they try to expand, and they would like to use the losses
already incurred as well as the prospective losses against their other income.

Review all relevant information and identify any issues related to an HMI conversion to S status. Advise Bob and Angie about whether the entity should elect S status.

II

Now instead assume the following: Memories elected S status, effective for the taxable year beginning July 1, 2018. HMI had wanted to keep its fiscal year, but it could not document significant seasonality. So the first S tax return will be for six months, reflecting the new calendar tax year.

A C corporation return was filed for the fiscal year ending June 30, 2018. That return showed a zero taxable income for current year operations.

The balance sheet for June 30, 2018 only differs from the June 30, 2017 statement as presented by $40,000 additional depreciation deductions claimed. HMI plans to sell the investment land in 2019 to raise cash, because Bob and Angie feel that the appreciation potential in the land will have flattened by then. They expect the property to be worth about $800,000 in 2019.

Angie and Bob anticipate that there will be net tax losses from operations of $200,000 during the six‐ month period ending December 31, 2018. Projected operating losses for calendar tax year 2019 total $60,000, without consideration of the land sale.

Convey to HMI the tax effects of such a 2018 conversion to S status. Provide a restated HMI balance sheet as of June 30, 2018, and compute the passthrough to the shareholders for the 2019 HMI calendar year.