Reference no: EM132727630

Question - TO PROVIDE TAX CALCULATIONS AND EXPLANATIONS/ASSUMTIONS

Assume the following:

1. Individuals are subject to a flat 40% tax on Ordinary Income and a flat 20% tax on Capital Gains

2. Tax Depreciation is assumed to be straight line, subject to the half-year convention, all property is depreciable over 10 years. Assume tax depreciation and E&P are the same.

3. The installment method of accounting is available for all property.

4. Interest begins to accrue on February 12, 2020.

5. Depreciation begins when the property is placed in service, which is February 12, 2020.

6. Corporation elects to have a calendar year ending December 31st.

7. Need to make certain additional assumptions; please be sure to explain WHY you made the assumption.

8. If you assume be sure to carry that assumption and impact of such through the remaining parts.

On February 11, 2019, Mountain Corporation was formed as a C corporation for the purposes of manufacturing wood products. The following Property was contributed to the corporation in exchange for the stock and other property as indicated below:

A. Alicia, an individual, contributed land with an adjusted basis of $800,000 and a Fair Market Value of $1,500,000. Alicia had acquired the land in 1997 after the passing of her grandfather. In exchange for her property, Alicia received 1,500 shares of common voting stock.

B. Thomas, an individual; contributed milling equipment with an adjusted basis of $3,000,000 and a Fair Market Value of $2,000,000. The Land was subject to a liability in the amount of $500,000 that Mountain Corporation assumed in the transaction. Thomas has acquired the equipment in 2017 and used the equipment in his carpentry trade. In exchange for his equipment, Thomas received 1,500 shares of Series A non-voting preferred stock. The preferred stock had a cumulative dividend rate of 10%.

C. David, an individual, contributed, 400 tons of hardwood trees and 600 tons of pine trees. David harvested the trees from his tree farm in December of 2018. David was in the business of Tree Farming and the trees were inventory in his business. The hardwood trees had an adjusted basis of $100,000 and a fair market value of $600,000. The pine trees had an adjusted basis of $400,000, however due to the great Pine Tree blight, the pine trees had a fair market value of $300,000. David received cash in the amount of $300,000 and 600 shares of voting common stock.

D. Rachilla, an individual, contributed a warehouse with an adjusted basis of $100,000 and a fair market value of $200,000. Rachilla acquired the warehouse for her existing business in October of 2018. Rachilla also contributed accounting, tax and managerial services for which the Mountain Corporation and Rachilla agreed to be valued at $2,000,000. Rachilla received 2,000 shares of voting common stock and a note payable for $200,000. The note payable had adequate stated interest of 5% per year and was payable in a lump sum on February 12, 2021.

E. Kataland Inc.; contributed various chainsaws with an adjusted basis of $0 and a fair market value of $150,000 in exchange for 150 shares of Series B non-voting preferred stock with a cumulative 10% dividend. The series B preferred stock was mandatorily callable for its par value of $1,000 in 2029. The chainsaws were acquired by Kataland in 2016.

F. MRG, LP. operated a lumber distribution center since 1999. MRG contributed accounts receivable of $1,000,000 and accounts payable of $500,000. MRG was a cash basis taxpayer. MRG received 500 shares of voting common stock. MRG LP was owned by 2 individuals, Fred and Maryann. Fred and Maryann retired to the Dominican Republic but are US citizens. The accounts payable related to salaries, business cell phone expenses and utilities.

At the time of, and in connection with, its formation, Mountain Inc., borrowed $5,000,000 from the bank and pledged all its assets as collateral. The note was payable in a lump sum on February 11, 2024 and had a stated interest rate of 10% payable only if the corporation was profitable. In the event Mountain was unable to pay interest timely, the Bank receives 500 shares of common stock for each payment missed. If Mountain Inc. is unable to pay the principal back to the bank in 2024, the note is convertible into common stock of 5,000 shares at the Bank's option or it can choose to foreclose on the property.

After formation, Mountain Inc. hired and trained lumberjacks from February 12, 2019 through June 30, 2019. During the training period it incurred salaries of $25,000, and property taxes of $5,000 on the land contributed by Alicia.

On July 1, 2019, Mountain Inc. began its active trade/business operations. The accounts receivable contributed by MRG were collected and the accounts payable were settled for cash payment. Mountain sold all inventory contributed by David for its fair market value. Other than the associated business expenses attributable to the property contributed above (related to interest and depreciation), the only other expenses incurred were for additional salaries of $40,000; additional property taxes of $7,000; supplies of $8,000; and utilities of $5,000.

In year 2 of its operations, January 1, 2020 through December 21, 2020. Mountain Inc had taxable income after ALL expenses, was $1,200,000. Included in Mountain expenses was non-deductible meal expenses of $10,000 (Gross). Mountain also received tax exempt income of $23,000 from an investment of its idle operating cash in municipal bonds. No distributions were made during 2020 tax year. All expenses were paid, including interest to the bank.

In 2021, Mountain Inc. broke even (taxable income $0) from its operations after consideration of ALL Expenses. Included in its expenses were nondeductible meal expenses of $35,000 (Gross) and it received tax exempt interest income of $30,000. Interest to the bank was paid. No other distributions were made during 2021.

In 2022, the great pine tree blight wiped out all Mountain Inc.'s planted pine trees, however the prior year harvest of trees was safe in the warehouse contributed by Rachilla. As a result, the price of Pine trees skyrocketed, and Mountain had a banner year in profits. It had taxable income of $3,000,000 after considering ALL Expenses (except as noted below). Of course, Mountain had to celebrate, and it had a lavish party for its shareholders and employees. The cost of the party was $200,000 but this was not included in the taxable income above. Tax exempt Income was $100,000 for tax year 2022. On December 1st, 2022, Mountain paid all dividends in arrears on the preferred stock. In addition, it paid a cash dividend to all common shareholders in the amount of $15 per share. Since it no longer needed the warehouse, the great pine tree blight left them with no inventory, they decided to distribute the warehouse equally to all common shareholders. At the time of the distribution, the warehouse had an adjusted basis of $75,000 and a fair market value of $50,000. The Chainsaws were also distributed to the common shareholders and had an adjusted basis of $0 and a fair market value of $25,000 at the time of the distribution.

PART 1 - Explain and calculate all federal income tax consequences of the formation to both the shareholders and the Corporation.

PART 2 - Explain the possible tax consequences and issues associated with the borrowing from the Bank and what your conclusion is as to the appropriate federal income tax treatment to the Corporation.

PART 3 - Explain the significance of the Period from February 12, 2019 through June 30, 2019. Explain and calculate all federal income tax consequences for this period to the corporation.

PART 4 - Explain and calculate all federal income tax consequences to the Corporation and shareholders, if any, that occur as a result of the operating results for 2019, 2020, 2021.

PART 5 - Explain and calculate all federal income tax consequences to the Corporation and each shareholder, that occur as result of the operations and various distributions, that occurred during the 2022 tax year.

PART 6 - Calculate the ending tax basis in stock of Mountain road for each shareholder and provide the ending Earnings and Profit of Mountain Inc.