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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
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of 2008, 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 2008 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 qualifying 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, 2008, GTE distributed $30,000 to James and $30,000 to Paul.
Required:
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 2008 tax forms).
• Compute the tax basis of Paul’s stock in GTE at the end of 2008.
• What amount of Paul’s income from GTE is subject to FICA or self-employment taxes?
• What amount of income, including its character, will Paul recognize on the $30,000 distribution he receives on December 1?
• What amount of tax does GTE pay on the $1,000 dividend it received?
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 2008 tax forms).
• Compute the tax basis of Paul’s ownership interest in GTE at the end of 2008.
• What amount of Paul’s income from GTE is subject to FICA or self-employment taxes?
• What amount of income, including its character, will Paul recognize on the $30,000 distribution he receives on December 1?
• What amount of tax does GTE pay on the $1,000 dividend it received?
c. Assume James and Paul formed GTE as a C corporation.
• Complete GTE’s Form 1120, page 1 (note that you should use the 2008 tax form).
• Compute the tax basis of Paul’s stock in GTE at the end of 2008.
• What amount of Paul’s income from GTE is subject to FICA or self-employment taxes?
• What amount of income, including its character, will Paul recognize on the $30,000 distribution he receives on December 1?
• What amount of tax does GTE pay on the $1,000 dividend it received?
