Sambad Pavely is a dealer who specializes in selling obsidian to entrepreneurs, manufacturers, and jewelers. He sets up an LLC in Massachusetts under which he conducts his business, Scorpion Glass LLC, which is treated as a partnership for tax purposes. There are currently 100 shares of the company outstanding, all of which Sambad owns. During the first half of the year, he sells $5,500,000 worth of obsidian. The business had the following expenses the first half of the year. Sambad takes a salary for himself of $1,200,000. The business also pays Sambads wife and secretary, Milly $500,000 for a salary. Additionally, $100,000 is paid in rent. He paid $800,000 to purchase the obsidian overseas and $300,000 to ship it via Bronze Island Shipping. Consequently, he also paid $125,000 in kickbacks to get the obsidian through customs. Scorpion Glass LLC also has a line of credit with the Bronze Bank who loaned Scorpion Glass LLC the initial $800,000 to purchase the obsidian as well as a revolving line of credit in order to buy more obsidian, in exchange for annual interest payments on the loan of $300,000. Scorpion Glass LLC also purchased a term life insurance policy of $50,000 on Sambads behalf for a price of $1000. Additionally, Scorpion Glass LLC matched $25,000 into Sambads 401k.

On May 1, one of Sambads warehouses burnt down. Sambad had initially spent $100,000 for the property. Before the property burned down it had a fair market value of $125,000 and an outstanding mortgage of $80,000. As a result, Sambad needed a capital infusion in order to rebuild the torched warehouse and replace the lost infrastructure. John Sand was an old friend of Sambad and thought that his business venture was sound. On July 1, John decided to invest $75,000 in the form of Massachusetts bonds as well as an annuity contract. The annuity was purchased 10 years ago for $100,000. Per the terms of the annuity agreement, the holder will receive equal payments of $12,000 over ten years, beginning ten years after purchase. Also, per terms of the agreement the company was required to purchase an insurance policy in coordination with a buy-sell agreement for $1,000,000 in the case of Sambads death. In exchange, John was to receive the same salary as Sambad going forward as well as 50% of all profits.

Over the second half of the year business was good for Scorpion Glass LLC. It sold $4,000,000 worth of obsidian. It had deductible costs for the second half of the year of $100,000 in rent, $750,000 in salaries for Sambad and John, $500,000 salary for Milly, and $2,500,000 for cost of goods sold. Additionally, the company received an insurance check for the fair market value of the lost warehouse of $500,000. On New Years eve to celebrate Scorpion Glass LLCs success, the company threw an employee party. Sparing no expense, the company spent $500,000 for a chocolate waterfall and installed marble floors Sambad, after having numerous drinks, tried to get some chocolate from the waterfall. However, due to his drunken state and clumsy nature, he dropped his chocolate onto the marble, making the floor slick. He then fell and broke his neck and died.

Milly and John come to you regarding their taxable income and tax liabilities.