The Earth Bag Corp. Federal Tax Return FACTS: Gladys Jackson, a graduate in biology and textiles, developed and patented a vegetable based biodegradable cloth. The cloth is made into reusable grocery bags, which decrease the amount of waste caused by plastic and paper bags that are only used once. Gladys set up the Earth Bag Corp. to manufacture and sell her product. The Earth Bag Corp. is owned by the Jackson family. The corporation is a small, closely-held manufacturer (the business code number is 339900, and the employer identification number is 11-1111111). The company is located at 80 Green St., Austin, Texas 78701. The corporation, which uses a calendar year for tax purposes, has been an S corporation since its incorporation on July 1, 2008. Gladys Jackson (social security number 123-45-6789) is president of the corporation. Gladys owned 100% of the stock until September 13, 2017 when she sold 1% to Pete Jackson (Gladys uncle, social security number 123-45-6788), who serves as vice president for the company. Both officers devote 100 percent of their time to the corporation and live a 35 Eco Drive, Austin, Texas 78710. Annual compensation is $55,080 for Gladys and $27,540 for Pete. The corporation does not engage in activities to which the at-risk or passive activity loss limitation apply. The corporation files its tax return on the accrual method. Inventory has been consistently valued at cost under the FIFO method using the full absorption procedure. Inventory capitalization rules of Internal Revenue Code Section 263A do not apply due to the 'small business exception' (average annual gross receipts for the three preceding taxable years do not exceed $ 10 million). The accounting records are computerized. ADDITIONAL INFORMATION: 1. Employees account to the company and are reimbursed by the exact amount of travel and entertainment expenses incurred on business. Included in Miscellaneous Expenses are $1,259 for transportation expenses, $230 for meals, and $138 for entertainment. 2. Dividend income is from minor investments in: Cotton Corp. $1,534 American Insurance Company (a dividend on the key-person life insurance policy) . . 644 Total . . . . . $2,178 3. Contributions were paid in cash to: Humane Society . . . 459 Republican Party 184 Total Contribution $ 6434. The key-person life insurance policy provides $500,000 coverage on Gladys Jackson. The company is the owner and beneficiary of the policy. 5. A schedule attached in the prior year's working papers reconciles Retained Earnings and Accumulated Adjustments Account balances at 12/31/13 as follows: Balance per Schedule L (Balance Sheet) . . . . $90,277 Accumulated depreciation for machinery and equipment (M&E) for tax M&E Acquired 07/01/15 . ... $ 7,119 M&E Acquired 02/01/16 . . . . . . . 28.615 $35,734 Accumulated depreciation per books. . . . . . . . . . 17,778 Excess of Accumulated Tax over Book Depreciation for M&E . . . . . . . . . . (17,956) Balance per Schedule M (Analysis of the Accumulated Adjustments Account) . .. ... $ 72,321 6. The balance in the "Other Adjustments Account" (Form 11205, p. 4, Sch. M-2, col. (b) at the beginning of the year was $-0-. 7. Depreciation information is attached. 8. Machine #2, purchased on 02/01/16 for $45,900, was sold to an unrelated party on 11/01/17 for $46,818. 9. Machine #1, purchased on 07/01/15 for $18,360, was totally destroyed by fire caused by a short in an electrical circuit on 04/01/17. Proceeds of $14,229 were received from the insurance company. On 08/01/17 $13,770 of the proceeds were invested in a replacement machine. Assume there will be no further qualified reinvestment of the proceeds.10. Interest expense was on loans for the following purposes: Purchase M&E . . . . . . $ 4,945 Invest in stock of Cotton Corp. 826 Invest in Trenton County, New Jersey water and sewer bonds . . . .. 92 Cover shortage in working capital . . . . . . 4,584 Total . . . . . . . ... $10,447 11. On June 5, 2017, 450 shares of Cotton Corp. common stock were sold. The company bought 1,800 shares of the stock on June 2, 2011 for $5,508. The stock was split 3-for-1 on February 21, 2015. 12. On May 15, 2011 The Earth Bag Corp. purchased at par $8,500 of Austin, Texas water and sewer bonds. Interest of $344 was received on the bonds during the year. 13. Assume that compensation of officers and other salaries and wages do not relate to production activities. This assumption removes the Domestic Production Activities deduction from this practice set.The Earth Bag Corp - RECONCILIATION FROM BOOK TO TAX Per Audited M-1 Tax Return 1120S SCH. K Fin. State Adjust. 2014 Non-S/S S/S Income Lines2-11(a) Sales (Net) $1,731,211 $1,731,211 Cost of Goods Sold ($1,281,877) ($1,281,877 Gross Profit $449,334 $449,334 Dividend Income $2,178 $2,178 Interest Income $344 $344 Gain on sale of Stock $1,856 $1,856 Gain Machine #2 $6,656 $6,656 Cas. loss Mach. #1 ($459) ($459 Officers Compensation ($82,620) $82,620) Other Sal. & Wages ($187,881 ($187,881) Employee Benefits ($8,418) ($8,418) Rental Expense ($19,575) ($19,575) Interest Expense ($10,447) ($10,447 Advertising Expense ($5,357) ($5,357 Key Person Life Ins. Pre. ($5,080 ($5,080) Contributions $643) ($643) Depreciation Expense ($25,046 ($25,046) Taxes (Not income taxes ($17,762 ($17,762) Rep. & Maint. Exp. ($9,998 ($9,998 Miscellaneous Expense ($3,030) $3,030) N. I. Per Books $84,052 Total Adjustments $0 $84,052 Taxable Income Before Separation $84,052 $0 $0The Earth Bag Corp Book Depreciation Original Cost Basis Depreciation Beginning 2014 2014 Ending Beginning 2014 2014 Ending 1-1-14 Additions Retirements 12-31-14 1-1-14 Additions Retirements 12-31-14 7/1/2012 18,360 18,360 0 2,754 918 (3,672) 0 2/1/2013 200,308 45,900 154,408 15,024 17,736 (5,738) 27,022 5/1/2014 89,760 89,760 5,882 5,882 8/1/2014 13,770 13,770 510 510 Totals 218,668 103,530 64,260) 257,938 17,778 25,046 9,410) 33,414 The Earth Bag Corp Tax Depreciation Original Cost Basis Depreciation Beginning 2014 2014 Ending Beginning 2014 2014 Ending 1-1-14 Additions Retirements 12-31-14 1-1-14 Additions Retirements 12-31-14 7/1/2012 18,360 18,360 0 0 2/1/2013 45,900 (45,900 0 154,408 154,408 179 5/1/2014 89,760 89,760 8/1/2014 Totals 218,668 89,760 (64,260) 244,168