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Tax Questions: S & C Corporation and Others.

Tax questions

1. Joe has received an offer to sell his company to Microsoft Inc. for $40 million. The selling price will consist of 20% cash and the balance in Microsoft stock. Joe asks your advice on the different tax structure possibilities for the sale of the company and your recommendation for which method he should consider?

2. a) Mary and Peter formed a new corporation MP, INC on February 8, 2010 and did not elect Subchapter S. On December 20, 2010, they come to you and ask if an S corporation makes sense for them. MP Inc, earned $100,000 during 2010. Discuss the tax implication of making the S election for 2011.

b) If MP, Inc loses $100 in 2010; would your answer be different?

3. One June 1, 2010, John sold his stock in LIU,Inc. to Apple, Inc for $5 Million. When the stock was sold, LIU had an unused net operating loss carry forward of $1,375,000. To what extent can Apple use the operating loss carry forward of LIU? (The long- term tax exempt interest rate is 7%)

4. Leslie is an employee of Granger, Inc. a public company. During 2010, Leslie received qualified employee stock options to purchase the stock of Granger for $1 per share. On December 8, 2010 Leslie exercise her right to acquire 10,000 shares of Granger for $1. On this date, the fair market value of Granger was $5 per share. Discuss the tax consequences to Leslie at the grant date and exercise date.

Solution Preview

In the first question, Joe who is selling his business to Microsoft Inc. wants you to give him advice on the different tax structure possibilities for the sale of the company. The different tax structure possibilities that Joe may consider can be either that of a:

1) C Corporation or,
2) S Corporation.

In other words, if Joe is operating as a sole proprietorship or a partnership, and he is planning to sell his business he may want to think about incorporating it. The C Corporation is a legal entity and if he incorporates the business, the corporation - and not him the individual owner - will be responsible for tax liabilities and debts. Therefore, the corporation will be taxed separately and the company would file its own tax returns. C Corporations have their own tax brackets, which depending on the situation, may be lower than individual tax rates (this will prove to be beneficial to Joe). But, not only may Joe want to incorporate the business but even better, he may want to go on further and decide to change the tax structure of the company to an S Corporation.

You may note that, with only a few exceptions, an S corporation is not a taxpaying entity. In other words, an S corporation does not pay taxes directly on its profit, but rather the profit is passed on to the shareholders who pay the taxes on their individual income taxes. Likewise, when an S corporation sells it assets, the capital gain is passed on to the shareholders as income and they are required to pay tax on this amount (this means that no second layer of taxation occurs when an S corporation sells its assets); unlike with a regular corporation where tax is paid on the capital gains/profits and then shareholders are also required to pay tax on dividends or other earnings received (note that a C-Corp is not a pass-through entity). Joe has to bear in mind though that the Internal Revenue Service (IRS) has imposed restrictions on S corporations to ensure that companies don't use S status to avoid corporate taxes. To qualify for an S election, a corporation can have only one class of stock, no more than 35 stockholders, and cannot own 80 percent or more of a subsidiary.

For the actual sale of the business Joe may want to consider whether he should accept only cash as payment for the business, or only Microsoft Stocks or a combination of both. This is important because as the seller of the business Joe wants to ensure that the actual tax liability to be incurred on the gain from the sale of the asset or business is minimized. If he accepts a full cash payment he might find himself paying a big tax liability, especially if he is still operating as a sole proprietor (since, the individual tax bracket may be higher than that of a corporation). However, if he accepts installment payments and/or shares of Microsoft Inc.'s stock he may be able to defer the taxes paid on the gain from the sale until he has received all of ...

Solution Summary

This solution provides and in depth explanation for four tax questions related to S and C Corporations; tax implications of making an S Election; use of operating loss carryforward; and tax consequences as it pertains to the grant date and/or excercise date of a stock option.