S Corporation Tax Return Problem

John Forsythe (SSN 555-55-5555) began a custom cabinet manufacturing business, Johns Cabinets (EIN 86-1122334 and Business Code 321000), four years ago as of July 1 of the current tax year. John incorporated the business, and the corporation made a timely election to be taxed as an S corporation. The business has been highly successful, but to bring in additional capital for expansion, it sold 10,000 shares that were issued at incorporation for his contribution of money and property valued at $120,000.

The business used the additional capital to purchase $20,000 of new woodworking machines (7-year property) on October 15 and $60,000 as a down payment on the purchase of a new building for its manufacturing and office operations located at 7620 N. Commerce Place, Beavercreek, OH 45440. The business claimed only the basic MACRS depreciation deductions for these acquisitions. The total cost of the building was $320,000 and the S corporation began using it on October 1.

In the month the business began, the S corporation purchased $60,000 of used woodworking machinery. It elected to use ADS for cost recovery on the 7-year property to reduce any potential losses in the first years of the business. On September 15 of the current year, the business sold one of the old machines that had cost $10,000 originally for $5,000. When moving to the new building, a second machine that had cost $5,000 originally fell off the truck used to move it and was a total loss. The loss was not covered by insurance.

John works full-time in the business and takes a salary of $9,000 per month. Wages for his seven employees were $220,000. (None of these employees made less than $7,000 or more than the FICA maximum.)

Additional data for the completion of the S corporation tax return are

Sales revenue $850,000

Sales returns 12,000

Purchases 335,000

Rent 36,000

Repairs 4,000

Insurance* 21,000

Truck rental 3,000

Taxes and licenses** 14,000

Advertising 2,000

Interest expense 4,000

Charitable contribution 10,000

Meals and entertainment 1,000

Fines for improper permitting 2,000

Beginning inventory (at cost) 25,000

Ending inventory (at cost) 30,000

*Includes $500 for Johns group term life insurance of $200,000 and $3,000 for medical and dental insurance premiums for him and his family. The balance is for insurance for other employees.

**Excludes Social Security and FUTA taxes (calculated at 6% for the year) for John and the other employees.

For its books prepared for banks and other creditors, the company shows $2,000 as an addition to its allowance for bad debt for the current year, depreciation of $8,200, a gain on the sale of the machine of $1,500, and a loss of $2,500 on the destruction of the machine.

The corporation is a calendar-year S corporation and uses the hybrid method of accounting, recording all but its sales and cost of goods sold on the cash method of accounting. It has a balance of $35,700 in its accumulated adjustments account at the beginning of the year.

Johns home address is 100 Main Street, Kettering, OH 45435 and Toms home address is 222 Williams Street, Fairborn, OH 45422.

Required

Prepare Form 1120S for this corporation, excluding Schedule L. Complete the schedule K-1s for John and Tom as well as any other required forms. Assume that the Section 263A rules do not apply and that you do not have to apportion any other costs to inventory. Use the latest available tax forms from the IRS Web site at www.irs.gov.