Bob’s personal wealth including investments in land, stocks, and bonds is about $14,000,000. He reported an interest income of $20,000 and dividend income of $6,000 last year. The $14,000,000 includes land worth $9,000,000 that Bob bought in 1966 for $450,000.
Bob has hired your firm for professional advice regarding whether he should operate as a sole proprietor, a partnership, an S corporation, or a C corporation. He is also considering transferring a possible 40% interest in his new business to his daughter Mandy, age 23 and single.
Memorandum
A. Recommend a type of business entity for the client to consider based on your tax research. Consider justifying your recommendation using the code and regulations that relate to the business entity.
B. Differentiate between accrual accounting and cash basis. Based on the type of business and the client’s accounting system, what is the impact when revenue is recognized?
C. Based on the decision of accrual vs. cash basis, describe when revenue would be recognized on the sale of inventory, and how the accrual reporting differs from cash basis.
D. Determine the economic impact on the client’s financial situation. Based on your decision, determine the potential tax liability, keeping in mind appropriate IRS code and regulations.
E. Identify the tax consequences on the sale or exchange of the land consistent with capital gain rules. Consider the selling expense, broker’s fees, closing costs, appraisals, and surveys and the correct schedule form to complete.
F. Justify whether or not the client should choose a business entity that has limited liability protection. Be sure to include possible future liability issues based on the potential economic impact and appropriate IRS code and regulations.
G. Describe the tax effect on the recommended business entity and the impact it will have on the client’s personal tax return. Consider addressing how the business entity affects the completion of the 1040 tax form.
II. Conclusion
A. Evaluate the economic impact on the client’s personal returns based on the recommended entity. Justify why the client would not choose the other business entities by informing the client of the differences.
B. Justify your recommendation regarding the client’s daughter having an ownership interest. Provide details supporting the recommendation taking into consideration the jargon and mechanics of the transaction.
C. Summarize, using moral reasoning, cash or accrual basis accounting systems in relation to the selected business entity. Consider how the accounting system impacts revenue recognition, consistent with IRS code and regulations.
D. Describe the after tax effects on the client’s cash flow based on the sale of the land that is needed to provide the funds necessary to start the business. Consider including capital gains tax rules.
E. Explain whether or not the client and his child should take a salary or cash distribution according to tax purposes and IRS code and regulations. Consider the type of business and the tax effect whether it is salary, dividends, or cash withdrawal.