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PROBLEM Architect, a cash basis taxpayer, has been conducting a business as a sole proprietorship for several years. For liability protection and to take advantage

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PROBLEM Architect, a cash basis taxpayer, has been conducting a business as a sole proprietorship for several years. For liability protection and to take advantage of the 21 percent corporate income tax rate, Architect decides to incorporate, and on July 1 of the current year he forms Design, Inc. a C corporation, to which he transfers the following assets: CHAPTER 2 109 0 FORMATION OF A CORPORATION Asset A.B. F.M.V. Accounts Receivable $ 0 $ 60,000 Supplies 20.000 Unimproved Land 60.000 120,000 Total $ 60,000 $ 200,000 The land was subject to contingent environmental liabilities that Architect had not taken into account (i.e., had not deducted or capitalized) for tax purposes at the time of the incorporation. The supplies were acquired nine months ago and their cost was immediately deducted by Architect as an ordinary and necessary business expense. In exchange, Architect receives 100 shares of Design common stock with a fair market value of $100.000. In addition, Design assumes $70,000 of accounts payable to trade creditors of Architect's sole proprietorship and a $30,000 bank loan incurred by Architect two years ago for valid business reasons, and it assumed the environmental liabilities associated with the land. Design elects to become a cash method, calendar year taxpayer. During the remainder of the current year, it pays $30,000 of the accounts payable and collects $40,000 of the accounts receivable transferred by Architect. In the following taxable year. Design paid $20,000 in environmental remediation expenses that qualified for a current deduction under Section 162 when paid or accrued. (a) What are the tax consequences (gain or loss recognized, basis and holding period of the incorporation to Architect and Design, Inc.? (b) Who will be taxable upon collection of the accounts receivable: Architect, Design or both? @) When Design pays the accounts payable assumed from Architect and incurs the environmental remediation costs. may it properly deduct these expenses? (d) Assume that Architect is in the highest marginal individual tax bracket and Design, Inc, anticipates no significant taxable income for the current year. What result if Architect decides to pay (and deduct) personally all the accounts payable and transfers the accounts receivable to the corporation? (e) Would your answers be any different if Architect had been an accrual method taxpayer? ( Is Design, Inc. limited in its choice of accounting method (i... cash or acerual) or taxable year? See 88 441: 448

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