Question: What other tax issues are suggested by a review of Central's financial statements? PLEASE ANSWER THE QUESTION ABOVE BY USING THE INFORMATION PROVIDED BELOW CENTRAL COLORADO LEASING, INC. Central Colorado Leasing, Inc. (Central), a calendar year, accrual basis C corporation, is in the business of leasing heavy construction equipment and subcontracting certain types of heavy construction services. The average rental period for the equipment is two weeks, and the rental contracts provide that Central will perform all required maintenance and repair for the equipment during the rental period. Brothers Jonathan and James Black each own 50 percent of the outstanding stock of Central. Jonathan is the president of the corporation and James is the vice- president Currently, the Black brothers have no interest in making an Selection for their corporation. Attached are Central's financial statements for the current year. I Jonathan Black is involved in a number of successful business ventures, and he estimates that his adjusted gross income for Federal tax purposes will fall in the $375,000 - $425,000 range for the next several years Jonathan brings a $200,000 capital loss carryover and a $175,000 passive activity loss (PAL) carryover into the current year. Jonathan owns Bishops Woods, a commercial office building and complex. His acquisition cost for Bishops was $2,750,000, $500,000 of this cost was allocated to the land. Through the beginning of this year, Jonathan has deducted $377,438 of depreciation on the property. Because of a low occupancy rate, the operation of Bishops has been generating net tax losses for several years ($50,000 of Jonathan's PAL carryover is allocable to the office building). Central Colorado Leasing Inc Jonathan Black 50% James Black 50% Other business ventures Bishops Woods: Land and office complex, with mortgage CENTRAL COLORADO LEASING, INC. To generate a sizeable $1231/capital gain and use the loss carryforward, Jonathan is considering selling Bishops Woods to Central. Central then will move its administrative operations into the vacant office space upon expiration of its present lease in June. Although Jonathan has not obtained an independent appraisal of Bishops Woods, he and James have agreed informally to a total purchase price of $3.25 million. Central will borrow this amount from an unrelated commercial lender, at market interest rates. The property forms the collateral on the debt. II Jonathan Black, James Black, James' three adult children, and two adult grandchildren are considering the creation of CC Asphalt, a new corporate venture through which to operate an asphalt paving business. The seven individuals anticipate capitalizing the corporation so as to become equal shareholders. The Black brothers have projected that the business will generatenet income before taxes of approximately $80,000 per year. The family members have agreed upon a strategy to reinvest the after-tax corporate income in the business with the expectation of selling their corporate stock at a substantial profit at a future date. To finance his capital contribution to CC Asphalt, James plans to borrow $250,000 in cash from Central. The note will be a properly drafted 1.0 percent demand note, when the market rate of interest for such loans is 2.5 percent. Jonathan Black has agreed to these terms for the proposed loan to his brother. Jonathan Black James Black Donna Dwyer Ernie Black Marion Black Grace Dwyer Hank Dwyer CENTRAL COLORADO LEASING, INC. Jonathan and James have requested that you identify any potential tax problems or planning ideas suggested by the facts presented. In responding to the Black brothers' request, be as specific as possible in describing the issues involved, and provide suggestions and/or alternatives you recommend to minimize risks and maximize opportunities. CENTRAL COLORADO LEASING, INC. Central Colorado Leasing, Inc Book Balance Sheet December 31 ASSETS Cash Accounts Receivable Supplies inventory Vehides and equipment 85.000 18.000 50,000 $ 4.200.000 Accumulated Depreciation Furniture and fixtures $ Accumulated Depreciation (1,600,000) 2.600.000 200,000 (90,000) 110,000 $2,863,000 Totals LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable and accrued expenses Customer deposits Equipment mortgage $ 45,000 25,000 1.900.000 Paid-in capital Retained earnings 50.000 843.000 Totals $2.863,000 Notes 1. Company policy requires that customers make weekly payment on equipment rentals; therefore receivable balances generally are low. 2. Accrued expenses include a $25,000 year-end bonus payable to President Jonathan Black. 3. Jonathan and James Black both drive cars furnished to them by Central. The two brothers use the cars both for commuting and business reasons. CENTRAL COLORADO LEASING, INC. Central Colorado Leasing, Inc Book Income Statement Year Ending December 31 Revenues $ 2.455,000 Equipment rentals Subcontracting and services 300,000 $ 2.755,000 Expenses $ 300,000 250,000 Equipment maintenance Officers' salaries Other salaries and wages Insurance Supplies Interest expense Rent expense Warehouse Administrative offices Depreciation Payroll taxes State/local income and other taxes 475,000 105,000 55,000 60,000 65,000 200,000 824,000 50,500 27,500 2.412,000 Net income from operations before federal income tax 343,000 Federal income tax 116,620 Net income after federal income tax 226,380 Notes 1. Officers' salaries: Jonathan Black $150,000 (includes $25,000 accrued bonus); James Black $100,000. CENTRAL COLORADO LEASING, INC. 2. Because of the small corporation exemption ($ 55(e)], Central is not liable for the alternative minimum tax. Question: What other tax issues are suggested by a review of Central's financial statements? PLEASE ANSWER THE QUESTION ABOVE BY USING THE INFORMATION PROVIDED BELOW CENTRAL COLORADO LEASING, INC. Central Colorado Leasing, Inc. (Central), a calendar year, accrual basis C corporation, is in the business of leasing heavy construction equipment and subcontracting certain types of heavy construction services. The average rental period for the equipment is two weeks, and the rental contracts provide that Central will perform all required maintenance and repair for the equipment during the rental period. Brothers Jonathan and James Black each own 50 percent of the outstanding stock of Central. Jonathan is the president of the corporation and James is the vice- president Currently, the Black brothers have no interest in making an Selection for their corporation. Attached are Central's financial statements for the current year. I Jonathan Black is involved in a number of successful business ventures, and he estimates that his adjusted gross income for Federal tax purposes will fall in the $375,000 - $425,000 range for the next several years Jonathan brings a $200,000 capital loss carryover and a $175,000 passive activity loss (PAL) carryover into the current year. Jonathan owns Bishops Woods, a commercial office building and complex. His acquisition cost for Bishops was $2,750,000, $500,000 of this cost was allocated to the land. Through the beginning of this year, Jonathan has deducted $377,438 of depreciation on the property. Because of a low occupancy rate, the operation of Bishops has been generating net tax losses for several years ($50,000 of Jonathan's PAL carryover is allocable to the office building). Central Colorado Leasing Inc Jonathan Black 50% James Black 50% Other business ventures Bishops Woods: Land and office complex, with mortgage CENTRAL COLORADO LEASING, INC. To generate a sizeable $1231/capital gain and use the loss carryforward, Jonathan is considering selling Bishops Woods to Central. Central then will move its administrative operations into the vacant office space upon expiration of its present lease in June. Although Jonathan has not obtained an independent appraisal of Bishops Woods, he and James have agreed informally to a total purchase price of $3.25 million. Central will borrow this amount from an unrelated commercial lender, at market interest rates. The property forms the collateral on the debt. II Jonathan Black, James Black, James' three adult children, and two adult grandchildren are considering the creation of CC Asphalt, a new corporate venture through which to operate an asphalt paving business. The seven individuals anticipate capitalizing the corporation so as to become equal shareholders. The Black brothers have projected that the business will generatenet income before taxes of approximately $80,000 per year. The family members have agreed upon a strategy to reinvest the after-tax corporate income in the business with the expectation of selling their corporate stock at a substantial profit at a future date. To finance his capital contribution to CC Asphalt, James plans to borrow $250,000 in cash from Central. The note will be a properly drafted 1.0 percent demand note, when the market rate of interest for such loans is 2.5 percent. Jonathan Black has agreed to these terms for the proposed loan to his brother. Jonathan Black James Black Donna Dwyer Ernie Black Marion Black Grace Dwyer Hank Dwyer CENTRAL COLORADO LEASING, INC. Jonathan and James have requested that you identify any potential tax problems or planning ideas suggested by the facts presented. In responding to the Black brothers' request, be as specific as possible in describing the issues involved, and provide suggestions and/or alternatives you recommend to minimize risks and maximize opportunities. CENTRAL COLORADO LEASING, INC. Central Colorado Leasing, Inc Book Balance Sheet December 31 ASSETS Cash Accounts Receivable Supplies inventory Vehides and equipment 85.000 18.000 50,000 $ 4.200.000 Accumulated Depreciation Furniture and fixtures $ Accumulated Depreciation (1,600,000) 2.600.000 200,000 (90,000) 110,000 $2,863,000 Totals LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable and accrued expenses Customer deposits Equipment mortgage $ 45,000 25,000 1.900.000 Paid-in capital Retained earnings 50.000 843.000 Totals $2.863,000 Notes 1. Company policy requires that customers make weekly payment on equipment rentals; therefore receivable balances generally are low. 2. Accrued expenses include a $25,000 year-end bonus payable to President Jonathan Black. 3. Jonathan and James Black both drive cars furnished to them by Central. The two brothers use the cars both for commuting and business reasons. CENTRAL COLORADO LEASING, INC. Central Colorado Leasing, Inc Book Income Statement Year Ending December 31 Revenues $ 2.455,000 Equipment rentals Subcontracting and services 300,000 $ 2.755,000 Expenses $ 300,000 250,000 Equipment maintenance Officers' salaries Other salaries and wages Insurance Supplies Interest expense Rent expense Warehouse Administrative offices Depreciation Payroll taxes State/local income and other taxes 475,000 105,000 55,000 60,000 65,000 200,000 824,000 50,500 27,500 2.412,000 Net income from operations before federal income tax 343,000 Federal income tax 116,620 Net income after federal income tax 226,380 Notes 1. Officers' salaries: Jonathan Black $150,000 (includes $25,000 accrued bonus); James Black $100,000. CENTRAL COLORADO LEASING, INC. 2. Because of the small corporation exemption ($ 55(e)], Central is not liable for the alternative minimum tax