Question

Adam, Linda, and Mike are considering starting a bakery together in Burlington, VT called Vermont Bakes. They have come to you looking for advice on the advantages and disadvantages of each business entity. Adam and Linda will each own 40% of the business and Mike will own 20%. Adam would like to contribute cash of $40,000, Linda will contribute land with an FMV of $60,000 and an adjusted basis of $25,000. Mike will contribute services of $20,000. In addition, Linda receives $20,000 of cash. Adam, Linda & Mike have indicated that they would like to take distributions of profits from Vermont Bakes each year in addition to compensation. They plan to pay themselves compensation of $45,000 each and they project that Vermont Bakes will have $10,000 in profits each year that they would like to distribute based on their ownership percentages. The distributions are as follows: Adjusted Basis FMV Adam - Equipment $2,000 $4,000 Linda - Cash $4,000 $4,000 Mike - Cash $2,000 $2,000 In a concise, well-written essay (do not use bullet points - write out your answers in paragraph form): • Explain the advantages and disadvantages of each entity type (C Corporation, S Corporation, Partnership/LLC), including both tax and non-tax considerations we discussed in class. Include in your discussion an explanation of entities are taxed at the entity level and which offer flow through taxation. Explain how are income and losses aggregated when they flow through to the shareholder/member/partner including the effect this has on the owner's basis in the entity (if any). • Explain the tax treatment of property contributions from the shareholder/member/partner to each type entity upon formation. including a discussion of the basis the entity would take in the contributed property and the basis the shareholder/member/owner would have in the entity as a result of the contribution. o Calculate Adam, Linda & Mike's basis in their ownership interest if they were part of a prearranged plan to incorporate Vermont Bakes as a C corporation. Calculate the basis the C corporation would take in the property contributed by Adam, Linda & Mike. Calculate the realized and recognized gain to Adam, Linda & Mike on their contribution to the C corporation (if any). o Calculate Adam, Linda & Mike's basis in their ownership interest if they decided to form Vermont Bakes as a partnership. Calculate the basis the partnership would take in the property contributed by Adam, Linda & Mike. Calculate the realized and recognized gain to Adam, Linda & Mike on their contribution to the partnership (if any). • Explain the tax treatment of cash and property distributions/dividends to a shareholder/member/partner of each type of entity. Include in your discussion an explanation of the concepts of E&P and AAA and the purpose of those calculations. o Calculate Adam's basis in the distributed property assuming Vermont Bakes is a C Corporation and indicate whether the property distribution would result in gain or loss recognition. Assume Adam's basis just prior to the distribution was $1,000. Would your answer change if this was a liquidating distribution? o Calculate Adam's basis in the distributed property assuming Vermont Bakes is a partnership and indicate whether the property distribution would result in gain or loss recognition. Assume Adam's basis just prior to the distribution was $1,000. Would your answer change if this was a liquidating distribution? • Provide Vermont Bakes with a recommendation on which entity you think would best suit their needs including the justification for your recommendation.

Answer 1

CBDT Clarifies that Share of a partner from the firm is exempt u/s 10(2A) in the hands of partner. even if the income is taxable in the hands of the firm.

Income received by partner from the firm

Particulars	Remuneration Allowed
In case of loss before booking the partner’s remuneration.	Maximum of Rs.150000/=
For the first Rs.300000/= of book profit	90% of the book profit or Rs.150000/= which ever is more
On the balance of book profit	60% of book profit