QUESTION 34

1. Sixteen years ago, Biff, Buffy, and Buffy, Jr. organized Beach Wear Inc. (BWI) to sell beach wear throughout California. The sole class of common stock of BWI is owned by Buffy (60%) and her husband, Biff (20%), and Buffy, Jr. (20%). On December 1 of the tax year specified for the test, BWI files an S election. As of December 31 of that same tax year, BWIs balance sheet includes the following:

   Asset AB FMV

   Accounts Receivable $ 0 $300,000

   Payments Due Under

   Installment Sale $450,000 $600,000

   Machinery $ 0 $225,000

   During the next tax year, BWI collected the accounts receivable receiving $300,000. BWI also collected the one of two payments still due on the installment sale of $300,000. BWIs taxable income for the same tax year is $900,000.

   BWI of the statement above holds real estate for investment at the time of its S election. Its S election is effective January 1 of the tax year specified as the next year (after the year specified for the test). During that same tax year, it sells land for $915,000 less 10% costs with a basis of $300,000. Installment payments are made of $165,000 in the same tax year, $150,000 in the next tax year, $150,000 in Year 3, $450,000 in Year 4. BWIs income from operations was $300,000 in Year 1, a loss of $150,000 in Year 2, income of $450,000 in Year 3, and income of $600,000 in Year 4.

   	a.	In Year 2, BWI will owe no built-in gain tax under 1374(d)(2)(A).
   	b.	In Year 3, BWI will owe built-in gain tax based on $150,000 collected times 57.21% gross profit percentage times 21% or $18,021.
   	c.	In Year 3, BWI will owe twice as much built-in gain tax as answer B or $36,042.
   	d.	A and B.
   	e.	A and C.