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Central Colorado Leasing, Inc. (Central), a calendar year,
accrual basis C corporation, is in the business of leasing heavy construction
equipment and subcontracting certain types of heavy construction services.CENTRAL COLORADO LEASING, INC.Central Colorado Leasing, Inc. (Central), a calendar year,
accrual basis C corporation, is in the business of leasing heavy construction
equipment and subcontracting certain types of heavy construction services. The
average rental period for the equipment is two weeks, and the rental contracts
provide that Central will perform all required maintenance and repair for the
equipment during the rental period. Brothers Jonathan and James Black each own
50 percent of the outstanding stock of Central. Jonathan is the president of
the corporation and James is the vice-president. Currently, the Black brothers
have no interest in making an S election for their corporation. Attached are
Central’s financial statements for the current year.IJonathan Black is involved in a number of successful
business ventures, and he estimates that his adjusted gross income for Federal
tax purposes will fall in the $375,000 – $425,000 range for the next several
years. Jonathan brings a $200,000 capital loss carryover and a $175,000 passive
activity loss (PAL) carryover into the current year.Jonathan owns Bishops Woods, a commercial office building
and complex. His acquisition cost for Bishops was $2,750,000; $500,000 of this
cost was allocated to the land. Through the beginning of this year, Jonathan
has deducted $377,438 of depreciation on the property. Because of a low
occupancy rate, the operation of Bishops has been generating net tax losses for
several years ($50,000 of Jonathan’s PAL carryover is allocable to the office
building).To generate a sizeable §1231/capital gain and use the loss
carryforward, Jonathan is considering selling Bishops Woods to Central. Central
then will move its administrative operations into the vacant office space upon
expiration of its present lease in June.Although Jonathan has not obtained an independent appraisal
of Bishops Woods, he and James have agreed informally to a total purchase price
of $3.25 million. Central will borrow this amount from an unrelated commercial
lender, at market interest rates. The property forms the collateral on the
debt.IIJonathan Black, James Black, James’ three adult children,
and two adult grandchildren are considering the creation of CC Asphalt, a new
corporate venture through which to operate an asphalt paving business. The
seven individuals anticipate capitalizing the corporation so as to become equal
shareholders. The Black brothers have projected that the business will generate
net income before taxes of approximately $80,000 per year. The family members
have agreed upon a strategy to reinvest the after-tax corporate income in the
business, with the expectation of selling their corporate stock at a
substantial profit at a future date.To finance his capital contribution to CC Asphalt, James
plans to borrow $250,000 in cash from Central.
The note will be a properly drafted 1.0 percent demand note, when the
market rate of interest for such loans is 2.5 percent. Jonathan Black has
agreed to these terms for the proposed loan to his brother.Jonathan and James have requested that you identify any
potential tax problems or planning ideas suggested by the facts presented. In
responding to the Black brothers’ request, be as specific as possible in
describing the issues involved, and provide suggestions and/or alternatives you
recommend to minimize risks and maximize opportunities.Central Colorado Leasing, IncBook Balance SheetDecember 31Notes1. Company policy requires that customers make weekly
payment on equipment rentals; therefore receivable balances generally are low.2. Accrued expenses include a $25,000 year-end bonus payable
to President Jonathan Black.3. Jonathan and James Black both drive cars furnished to
them by Central. The two brothers use the cars both for commuting and business
reasons.Central Colorado Leasing, IncBook Income StatementYear Ending December 31Notes1. Officers’ salaries: Jonathan Black $150,000 (includes
$25,000 accrued bonus); James Black $100,000.2. Because of the small corporation exemption [§ 55(e)],
Central is not liable for the alternative minimum tax.Your client, Frank Bearden, owns an Arkansas business that
brokers high-quality fresh fruits and vegetables to restaurants and specialty
grocery storesBEARDEN’S SPECIALTY PRODUCE, INC.Your client, Frank Bearden, owns an Arkansas business that
brokers high-quality fresh fruits and vegetables to restaurants and specialty
grocery stores. Frank’s business does not carry any inventories. Frank’s
attorney has urged Frank to incorporate the business, primarily because of the
limited shareholder liability associated with corporate status, and to
facilitate a business succession plan in the future. Frank has operated the
business as a cash basis sole proprietorship for two decades, and anticipates
incorporating the business on July 1 of the current year. Projected balance
sheet and income statements for the business as of June 30 are attached.IFrank plans to transfer all existing business assets and
liabilities to a newly incorporated entity, Bearden’s Specialty Produce, Inc.
(Produce), in exchange for 1,000 shares of voting common stock. He will serve
as President of the corporation, and he will be a member of the Board of
Directors. Frank wants to adopt an August 31 fiscal year end for Produce
because August tends to be the slowest month of the year for the business, and
accounts receivable typically are at their lowest level. Frank also intends for
Produce to continue to use the cash method of accounting.Frank’s close friend, Maria Garcia, has for some time been
interested in buying into Frank’s business. Maria will not have access to the
cash necessary for this acquisition until October, so Frank has agreed to
proceed with the incorporation, and then sell 400 of his new Produce shares for
$75,000 to Maria sometime before the end of the current year.In discussing the proposed incorporation with you, Frank
specifically asks about the amount of any gain he must recognize, both upon the
incorporation itself, and upon the subsequent stock sale. Naturally, he is
eager to minimize any recognized gain to the extent possible. Frank also wants
to structure the transaction to achieve the best tax outcome for Garcia, as
Frank is eager to have her as a business associate.In addition to addressing these specific concerns, identify
any potential tax problems or planning ideas suggested by the facts. Be
specific in describing the issues involved, give full citations to controlling
law, and provide suggestions and/or alternatives to minimize risks and maximize
opportunities.IIElsewhere in his portfolio, Frank is a limited partner in
Build Arkansas, a real estate development partnership. Build has generated
losses during the past two years. Frank holds a $35,000 suspended passive loss.
Frank earns no passive activity income, and he anticipates that the partnership
will continue to generate losses for several years into the future. He has
asked you to explain the §469 tax consequences of transferring his interest in
Build to Produce as part of the incorporation. The value of the partnership
interest exceeds Frank’s basis in the interest by approximately $50,000.Bearden’s Specialty ProduceProjected Balance SheetJune 30Bearden’s Specialty ProduceProjected Income StatementFor January 1 – June 30
* Legal costs for drafting the corporate charter and by-laws
and for filing the necessary legal papers with Arkansas will total $7,000.
Frank estimates that Produce will incur accounting fees attributable to the
incorporation of $5,200.

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