ACC 547 week 5 S-corporations and Partnerships COMPLETE Answers
Case Study C9-59
On the advice of his attorney, Dr. Andres, a local pediatrician, contributed several office
buildings, which he had previously owned as sole proprietor, to a new Andres Partnership
in which he became a one-third general partner. He gave the remaining limited partnership
interests to his two sons, Miguel and Esteban. Last year, when the partnership was
formed, the boys were 14 and 16. The real estate is well managed and extremely profitable.
Dr. Andres regularly consults with a full-time hired manager about the business,
but neither of his sons has any dealings with the partnership. Under the terms of the partnership
agreement, the boys can sell their partnership interest to no one but their father.
Distributions from the partnership have been large, and Dr. Andres has insisted that the
boys put all their distributions into savings accounts to pay for their college education.
Last year’s return (the partnership’s first) was filed by Mr. Jones, a partner in the local
CPA firm of Wise and Johnson. Mr. Jones, who was Dr. Andres’s accountant for a decade,
retired last summer. Dr. Andres’s business is extremely profitable and is an important part
of the client base of this small-town CPA firm. Ms. Watson, the young partner who has
taken over Dr. Andres’s account, asked John, a second-year staff accountant, to prepare
the current year’s partnership return.
John has done considerable research and is positive that the Andres Partnership does
not qualify as a partnership at all because the father has retained too much control over
the sons’ interests. John has briefly talked to Mr. Jones about his concerns. Mr. Jones said
he was really rushed in the prior year when he filed the partnership return and admitted
he never looked into the question of whether the arrangement met the requirements for
being taxed as a partnership. After hearing more of the details, Mr. Jones stated that John
was probably correct in his conclusion. Dr. Andres’s tax bill will be significantly larger if
he has to pay tax on all the partnership’s income. When John approached Ms. Watson
with his conclusions, her response was, “Oh, no! Dr. Andres already is unhappy because
Mr. Jones is no longer preparing his returns. He’ll really be unhappy if we give him a big
tax increase, too.” She paused thoughtfully, and then went on. “My first thought is just to
leave well enough alone and file the partnership return. Are you positive, John, that this
won’t qualify as a partnership? Think about it and let me know tomorrow.”
Required: Prepare a list of points you want to go over with the tax partner that would
support finding that the business activity is a partnership. Prepare a second list of points
that would support finding that the business activity is not a partnership.
Case Study 11-56
Comparison of Entity Formations. Cara, Bob, and Steve want to begin a business on
January 1, 2006. The individuals are considering three business forms—C corporation,
partnership, and S corporation.
• Cara has investment land with a $36,000 adjusted basis and a $50,000 FMV that she
is willing to contribute. The land has a rundown building on it having a $27,000 basis
and a $15,000 FMV. Cara has never used the building nor rented it. She would like to
get rid of the building. Because she needs cash, Cara will take out a $25,000 mortgage
on the property before the formation of the new business and have the new business
assume the debt. Cara obtains a 40% interest in the entity.
• Bob will contribute machinery and equipment, which he purchased for his sole proprietorship
in January 2001. He paid $100,000 for the equipment and has used the
MACRS rules with a half-year convention on this seven-year recovery period property.
He did not make a Sec. 179 expensing election for this property. The FMV of the
machinery and equipment is $39,000. Bob obtains a 39% interest in the entity.
• Steve will contribute cash of $600 and services worth $20,400 for his interest in the
business. The services he will contribute include drawing up the necessary legal documentation
for the new business and setting up the initial books. Steve obtains a 21%
interest in the entity.
To begin operations, the new business plans to borrow $50,000 on a recourse basis
from a local bank. Each owner will guarantee his or her ownership share of the debt.
What are the tax and nontax consequences for the new business and its owners under
each alternative? Assume that any corporation will have 200 shares of common stock
authorized and issued. For the partnership alternative, each partner receives a capital,
profits, and loss interest. How would your answer to the basic facts change if instead
Steve contributes $2,600 in cash and $18,400 in services?
Tax Strategy Problem C10-58
Consider the following balance sheet for DEF Partnership:
Cash $60,000 $ 60,000
Receivables –0– 60,000
Land A 10,000 20,000
Land B 10,000 20,000
(….. full problem details are attached in the PDf file)…..
Note: Land A, B, and C are Sec. 1231 property, and each partner’s outside
basis is $30,000.
Suppose Daniel wishes to exit the partnership completely. After discussions with Edward
and Frances, the partners agree to let Daniel choose one of three options:
1. Daniel takes a liquidating distribution of $60,000 cash.
2. Daniel takes a pro rata liquidating distribution of $20,000 cash, $20,000 receivables,
and Land A (FMV $20,000).
3. Daniel sells his entire partnership interest to Doris for $60,000 cash.
a. Determine the tax consequences to Daniel of each option including gains (losses) realized,
recognized, and deferred; character of gains (losses); and bases of assets.
b. Discuss the relative merits of each option to Daniel, that is, what are the advantages
and disadvantages of each option? What factors could sway your recommendation one
way or the other?
Note: See Case Study Problem C10-59 for another situation involving various exit strategies.