This case includes both a research and planning section,so your file memo and client letter should include the research section plus planning opportunities.

Mr. Brown owns an expensive bicycle dealership, Brown's Crazy Two Wheeled Shop, that sells top brand racing and mountain bikes, including some motorized high end motocross and racing motorcycles. The retail prices ranges from $3,000 to over $45,000. The dealership is an S-Corporation owned 100% by Mr. Brown. The dealership is very profitable and Mr. Brown sells manufacturer's extended warranties, where the manufacturers pay Mr. Brown's dealership 40% of the warranty price as a commission. The prices of the warranties varies from $400 to over $3,000. The dealership's claims ratio on the retail price is around 25%, i.e. if the policy cost $2,000, claims are expected to be around $500, so the net profit on the policy to the manufacturer after commissions and claims is around $700. The manufacturer assumes the risks and claims associated with the policies.

Mr. Brown has heard from a number of other like dealerships and they are selling the warranties themselves, i.e. the warranty is created and provided through the dealership or through another entity owned by the dealership principal.

Mr. Brown has asked your firm two basic questions, first if he decided to do this, would it be best to sell the warranties and keep the profits in the dealership, or in the alternative create a new company and have Mr. Brown own that company. Second, for both scenarios, what is the tax treatment of the policies. If the policies stay in the dealership, the dealership is at risk for any claims, if the policies are written by Mr. Brown's warranty company, that company becomes the responsible party for the risk. If Mr. Brown creates another company, that company would pay a 40% commission to his dealership.