QUESTION 35

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 invested in common stock of another corporation, Apple Computer, which invesment represented a fractional interest in that company. BWI elected S status beginning January 1, of the year specified for the test. BWI purchased the Apple stock for $300,000 in January, 10 years ago. On December 31, of last year, the stock was still worth $300,000. On December 30, the same specified year, the stock was sold for $900,000. BWI had earnings on profits as a C Corporation of $600,000 on December 31, last year. BWI had the following items of income and expenses for December 31, this specified year.

   Operational Income $1,155,000

   Tax Exempt Income 45,000

   Gain from sale of Apple Stock 600,000

   Total Income $1,800,000

   Operational Expense $600,000

   Depreciation 15,000

   Investment Advice 18,000

   Interest Expense (related to operations) 117,000

   Total Expenses 750,000

   Total Net Income $1,050,000

   	a.	Built-in gains tax is due.
   	b.	Excess net passive investment income tax is due.
   	c.	Passive investment income tax is due since the gains from the stock and tax exempt income totaling $645,000 are more than 25% of the $1,800,000 gross receipts.
   	d.	None of the above.