Assignment 1: S- Corporations
Instructions:
You should
explain in specific detail and show all your work where applicable. Be sure and discuss all options available to
the perspective clients.
Case Study:
Adam owns
60% and Boris owns the other 40% of S Corp.
Adam and Boris are your clients.
You had assisted the two shareholders in setting up the S corp.
The S corp
was funded with undeveloped land with the view to developing the land. The development, however, never
occurred. The land is still the only
asset of the Corp. The land is still
undeveloped, nor is the land rented.
Thus, for the current year, the Corp has no income and no deductions. As a result, Boris wants to cash out. But for the most part, Adam wants to stick it
out. Based on this state of business
affairs, your clients are considering a number of ways for Boris to cash
out. Several approaches to achieve this
objective have been suggested to Adam and Boris by some corporate folks in your
law firm. You have now been called in to
address the tax consequences of each of these approaches. Adam and Boris also want to know if they will
have any taxes to pay under any of the approaches. For this purpose, you can assume that both
Adam and Boris will be subject to a 15% tax rate unless otherwise noted.
The land has
a current value of 200,000 and a basis of 90,000 to the S corp. Both Adam and Boris have zero basis in their
respective S stock. {Note a zero basis
in stock may not be realistic but for purposes of this exercise it will work to
make it easier.} The S corp is on a
calendar year, cash basis of accounting.
Based on the case study above, answer the
following questions below in great detail:
1. Approach 1
Adam is
ready to buy Boris out with an 80,000 cash payment. Gain on the stock sale is subject to the 15%
tax rate (as noted above). Adam is now
the sole shareholder in the S corp.
2. Approach 2
In the
alternative, the S corp sells the land to a 3rd party for 200,000
and then distributes 120,000 to Adam and 80,000 to Boris in exchange of all
their stock. The S corp then ceases to
exist. That is, both Adam and Boris cash
out. Adam decides to give it up as well.
3. Approach 3
In the
alternative, Adam and Boris agree that the S corp could redeem Boris out, using
the 40% of the land as the means to do so.
Boris will then look for a buyer of his 40% interest in the land as a
way of getting the cash he wants. Adam
will continue as a shareholder in the S corp and the S corp will now co-own the
land with Boris. The shareholders are
ready to do the deal on May 1 (1/3 through the corp’s calendar year).
4. Approach 4
What if the
sole asset in the S corp is not land, but an unoccupied building, subject to
the 25% capital gains rate on any gain?
What are the tax consequences to Adam and Boris in approaches 1-3 above?
5. Compare the treatment of Boris with that of
Adam. Anything else to think about?
