Clara and Charles decide to form a business. They each plan to contribute

$15,000 in exchange for a 50% interest. The business will borrow $20,000 to cover the balance of its working capital needs. In their business plan, Clara and Charles show that the business will have a loss of $54,000 in its first year. In the second year, however, the business will have a profit of $60,000 and they will each be able to withdraw $5,000 from the business. Clara is in the 35%

marginal tax bracket and Charles is in the 25% marginal tax bracket.

Determine 1.The taxes paid by the business (if any) in the first and second year; 2. Clara’s and Charles’s income tax savings in the first year and their bases in the business at year-end; and 3. Clara’s and Charles’s income tax they will pay in the second year from business operations and their bases in the business at year-end if they organize the business as:

a. a partnership

b. an S corporation

c. a C corporation AppendixLO1