Income Tax Project
The income tax project is due no later than May 1, 2022. Each requirement will be worth 50 points each for a total of 100 points. Points will be awarded for correct responses only.
Review the following accounting and tax data and complete the two requirements below:
While James Craig and his former classmate Paul Dolittle both studied accounting at school, they ended up pursuing careers in professional cake decorating. Their company, Good to Eat (GTE), specializes in custom-sculpted cakes for weddings, birthdays, and other celebrations. James and Paul formed the business at the beginning of 2021 and each contributed $50,000 in exchange for a 50 percent ownership interest. GTE also borrowed $200,000 from a local bank. Both James and Paul had to personally guarantee the loan. Both owners provide significant services for the business. The following information pertains to GTE’s 2021 activities.
• GTE uses the cash method of accounting (for both book and tax purposes) and reports income on a calendar-year basis.
• GTE received $450,000 of sales revenue and reported $210,000 of cost of goods sold (it did not have any ending inventory).
• GTE paid $30,000 compensation to James, $30,000 compensation to Paul, and $40,000 of compensation to other employees (assume these amounts include applicable payroll taxes if any).
• GTE paid $15,000 of rent for a building and equipment, $20,000 for advertising, $14,000 in interest expense, $4,000 for utilities, and $2,000 for supplies.
• GTE contributed $5,000 to charity.
• GTE received a $1,000 qualified dividend from a great stock investment (it owned 2 percent of the corporation distributing the dividend) and it recognized $1,500 in short-term capital gain when it sold some of the stock.
• On December 1, 2021, GTE distributed $20,000 to James and $20,000 to Paul.
• GTE has qualified property of $300,000 (unadjusted basis).
Requirements:
a. Assume James and Paul formed GTE as an S corporation.
• Complete GTE’s Form 1120S page 1, Form 1120 S, Schedule K, and Paul’s Form 1120S Schedule K-1 (note that you should use 2020 tax forms). (25 points)
• Compute the tax basis of Paul’s stock in GTE at the end of 2021. (10 points)
• What amount of Paul’s income from GTE is subject to FICA or self-employment taxes? (5 points)
• What amount of income, including its character, will Paul recognize on the $20,000 distribution he receives on December 1? (5 points)
• What amount of tax does GTE pay on the $1,000 qualified dividend it received? (5 points)
b. Assume James and Paul formed GTE as an LLC.
• Complete GTE’s Form 1065 page 1, Form 1065, Schedule K, and Paul’s Form 1065, Schedule K-1 (note that you should use 2020 tax forms). (25 points)
• Compute the tax basis of Paul’s ownership interest in GTE at the end of 2021. (10 points)
• What amount of Paul’s income from GTE is subject to FICA or self-employment taxes? (5 points)
• What amount of income, including its character, will Paul recognize on the $20,000 distribution he receives on December 1? (5 points)
• What amount of tax does GTE pay on the $1,000 qualified dividend it received? (5 points)