Tax Return Problems formerly Appendix C

Corporate Tax Return Problem 1

Required:

Complete Alvins Music Inc.s (AMI) 2021 Form 1120, Schedule D, and Schedule G (if applicable) using the information provided below.

Neither Form 4562 for depreciation nor Form 4797 for the sale of the equipment is required. Include the amount of tax depreciation and the tax gain on the equipment sale given in the problem (or determined from information given in the problem) on the appropriate lines on the first page of Form 1120.

Facts:

Alvins Music Inc. (AMI) was formed in 2011 by Alvin Jones and Theona Smith. Alvin and Theona officially incorporated their store on June 12, 2012. AMI sells (retail) all kinds of music-related products including musical instruments, sheet music, CDs, and DVDs. Alvin owns 60 percent of the outstanding common stock of AMI and Theona owns the remaining 40 percent.

* located at 355 Music Way, East Palo Alto, California 94303.

* Employer Identification Number is 29-5748859.

* business activity is retail sales of music-related products. Its business activity code is 451140.

Officers of the corporation are as follows:

Alvin Jones is the chief executive officer and president with total compensation of $250,000 (Social Security number 123-45-6789).

Theona Smith is the executive vice president with compensation of $150,000 (Social Security number 978-65-4321).

Gwen Givens is the vice president of operations with compensation of $120,000.

Carlson Bannister is the secretary with compensation of $80,000.

All officers devote 100% of their time to the business & all officers are U.S. citizens.

Neither Gwen nor Carlson owns any stock in AMI.

* uses the accrual method of accounting and has a calendar year-end.

* made payments that require Form 1099s, and will file the Form 1099s before the tax return is filed.

* made four equal estimated tax payments of $43,000 each. Its tax liability last year was $175,000. If it has overpaid its federal tax liability, AMI would like to receive a refund.

* paid a dividend of $80,000 to its shareholders on 12/1. AMI had sufficient (E&P) to cover the distribution.

The following is AMIs audited income statement for 2021:

AMI Income Statement For year ending December 31, 2021
Revenue from sales	$ 3,420,000
Sales returns and allowances	(40,000)
Cost of goods sold	(839,500)
Gross profit from operations	$ 2,540,500
Other income:
Capital gains	$ 8,000
Gain from disposition of fixed assets	2,000
Dividend income	12,000
Interest income	15,000
Gross income	$2,577,500
Expenses:
Compensation	$(1,300,000)
Depreciation	(20,000)
Bad debt expense	(15,000)
Meals (fully deductible)	(2,500)
Maintenance	(7,000)
Charitable donations	(27,000)
Property taxes	(45,000)
State income taxes	(60,000)
Other taxes	(56,000)
Interest	(67,500)
Advertising	(44,000)
Professional services	(32,000)
Pension expense	(40,000)
Supplies	(6,000)
Other expenses	(35,000)
Total expenses	(1,751,500)
Income before taxes	826,000
Federal income tax expense	(260,000)
Net income after taxes	$ 568,500

Notes:

AMI has a capital loss carryover to this year from last year in the amount of $5,000.

AMIs inventory-related purchases during the year were $1,134,000. AMI values its inventory based on cost using the FIFO inventory cost flow method. Assume the rules of 263A do not apply to AMI.

Of the $15,000 interest income, $2,500 was from a City of Fremont bond issued in 2018, $3,500 was from a Pleasanton city bond issued in 2019, $3,000 was from a U.S. Treasury bond, and the remaining $6,000 was from a money market account.

AMI sold equipment for $10,000. It originally purchased the equipment for $12,000 and, through the date of the sale, had recorded a cumulative total of $4,000 of book depreciation on the asset and a cumulative total of $6,000 of tax depreciation. For tax purposes, the entire gain was recaptured as ordinary income under 1245.

AMIs dividend income came from Simons Sheet Music. AMI owned 15,000 shares of the stock in Simons Sheet Music (SSM) at the beginning of the year. This represented 15 percent of the SSM outstanding stock.

On July 22, 2021, AMI sold 2,500 shares of its Simons Sheet Music stock for $33,000. It had originally purchased these shares on April 24, 2016, for $25,000. After the sale, AMI owned 12.5 percent of Simons Sheet Music.

AMIs compensation is as follows:

Officers, $600,000

Other, $700,000

AMI wrote off $10,000 in accounts receivable as uncollectible during the year.

Tax depreciation was $31,000. None of the depreciation should be claimed on Form 1125A.

Of the $62,000 of interest expense, $56,000 was from the mortgage on AMIs building and the remaining $6,000 of interest was from business-related loans.

The pension expense is the same for book and tax purposes.

Other expenses include $3,000 for premiums paid on term life insurance policies for which AMI is the beneficiary. The policies cover the lives of Alvin and Theona.

AMIs audited balance sheets as of 12/31/2020 and 12/31/21

	12/31/2020	12/31/2021
Assets
Cash	$ 240,000	$ 169,000
Accounts receivable	600,000	700,000
Allowance for doubtful accounts	(35,000)	(40,000)
Inventory	1,400,000	1,700,000
U.S. government bonds	50,000	50,000
State and local bonds	140,000	140,000
Investments in stock	300,000	275,000
Building and other depreciable assets	1,500,000	1,600,000
Accumulated depreciation	(200,000)	(216,000)
Land	900,000	900,000
Other assets	250,000	270,000
Total assets	$5,145,000	$5,548,000
Liabilities and Shareholders Equity
Accounts payable	$ 250,000	$ 220,000
Other current liabilities	125,000	117,500
Mortgage	800,000	790,000
Other liabilities	200,000	162,000
Capital stock	600,000	600,000
Retained earnings	3,170,000	3,658,500
Total liabilities and shareholders equity	$5,145,000	$5,548,000