VAN HORN INDUSTRIES Reggie, Sarah, Theo, and Ursula Van Horn incorporated a new business in 2012; Van Horn Industries was formed as a calendar-year Missouri C corporation with a contribution of land and a large building by Reggie, and cash from the other three shareholders. Reggie and Sarah are married to each other, and Theo and Ursula are their single adult children. Reggie and Sarah are full-time shareholder-employees, while Theo, a dentist, and Ursula, an engineer, are investors only. The family members get along well, and no ownership or operating changes are planned for the foreseeable future. The companys offices and operations are based in a single building near Sunset Hills MO. Reggie and Sarah file joint income tax returns, and Theo and Ursula file as single. Theo operates his dental practice through a national chain (The Smile Superstore) that pays him a $125,000 salary. Ursula is employed by a consulting firm that specializes in roads and bridges; her annual salary is $145,000. There are no other sources of gross income during the period of this analysis for any of the Van Horns. Industries pays 60 percent of its C taxable income as salaries to Reggie (60%) and Sarah (40%). The remaining taxable income is distributed as cash dividends to the four shareholders. As a C corporation, Van Horn Industries pays a flat 34 percent federal corporate income tax. For 2016, Theo and Ursula are subject to a 28 percent marginal income tax rate; Reggie and Sarah are in the 33 percent bracket. Use the 2016 tax rates for the entire period of Industries life, regardless of inflation adjustments and other law changes. Van Horn Industries offers logistical services to Amazon, the US Postal Service, AutoCare, a mobile car and truck maintenance service, and AnimalHelpers, a mobile veterinary and first-aid service for pets that live in suburban residences. Industries has stayed ahead of the curve in providing logistical, planning, and online recordkeeping for its clients, and the business has proven to be virtually recession proof. Prospects for the company in the next decade appear bright at this point: the company is to go-to provider of its services in a contiguous five-state area. The company has received takeover offers from unrelated competitors over the years, especially from those who provide similar services to WalMart. But Reggie and Sarah are not interesting in retiring for many years, and all of the family members are happy with the mix of hands-on and hands-off owners that Industries has been using. The company is on good terms with the union that represents its drivers, and Industries has found a good mix of full-time and part-time drivers to carry out its contracts. An office group of about ten employees are paid slightly below market wages, but a good fringe benefit package means that the companys steady growth has been supported at each stage by its workforce. With a steady record of profits and the future bright, the Van Horns have become uncomfortable with the amount of income taxes that they are paying, i.e., combining the corporate income tax with their own individual taxes paid. Based on advice from their CPA, Julee Woods, they would like to know whether to convert the C corporation to an LLC, so as to eliminate the double taxation that they perceive exists in their case. The date of the proposed conversion is January 1, 2017. Today it is June 25, 2016. You have been engaged to work with CPA Woods to provide information about the tax results of the proposed structural conversion. Your review of the corporate books and records finds that the needed information is complete and accurate as prepared by Industries. It includes the following items. I Provide a series of tables that will allow a comparison of the after-tax costs and benefits of a conversion to LLC status on the upcoming January 1. Ignore state and local income taxes and any AMT effects. On the last day of the tax year before the conversion, Industries will transfer all of its assets and liabilities to the new LLC. For federal income tax purposes, these events will be treated as a deemed distribution, whereunder the entity sells off its assets at full FMV and distributes the net cash proceeds to the shareholders in exchange for their shares. The shareholders then contribute cash to the LLC in exchange for interests therein, and the new entity uses the cash to purchase all of the net assets of the prior C corporation. II CPA Woods has told you that the elder Van Horns are planning to operate the company for ten years after the C-to-LLC conversion. Because the children likely then will not be interested in carrying on the business as owners, the assumption is that Industries will be liquidated at that time. Add the consequences of this final, actual liquidation to your analysis. Van horn industries Financial records, and other pertinent assumptions As of June 25, Prior to the C to LLC conversion Shares owned Shares of annual Shares of annual Basis in Van Federal Salaries paid income after salaries horn stock income Paid as dividends tax Reggie 40% 60% 40% 2,000,000 33% Sarah 30% 40% 30% 1,500,000 33% Theo 10% 10% 500,000 28% Ursula 20% 20% 1,000,000 28% Last C year, taxable income after salaries and payroll taxes 400,000 First LLC year, taxable income before salaries 650,000 LLC year 2-10, annual increase in entity taxable income 15% Share of C, LLC taxable income paid as deductible salaries 60% Annual after tax internal rate of return, Van Horn Industries 5% Annual increase in Social Security wage base 1% 2016 Social Security wage base 118,500 Social Security tax rate, both halves 12.4% Standard Medicare tax rate, both halves 2.9% Additional Medicare tax rate on individuals 0.9% Years from incorporation to conversion 5 Years from conservation to liquidation 10 Within three months of incorporation, the following items were in place, and they do not change from year to year. Cash 230,000 Receivables 198,000 Goodwill 0 Operating payables 100,000 Mortgage, Land and Building 1,000,000 At the same time, Industries had acquired and placed in service the following items. Specific rates of annual price appreciation/decline are indicated. All cost recovery is computed using straight-line assumptions. MACRS life Initial Tax basis Annual FMV increase (decrease) Inventory 150,000 1.0% Equipment 7 850,000 -5.0% Office furniture 7 300,000 -5.0% Land 1,700,000 7.0% Building 39 3,000,000 2.0%