Question

Bob has a very successful used car business located at 210 Ocean View Drive in Pensacola, Florida. Last year, you filed a Schedule C for Bob that had $1,200,000 in taxable income. The business will have an income growth rate of 10% per year over the next several years. Bob’s personal wealth, including investments in land, stocks, and bonds, is about $14,000,000. Last year, he reported interest income of $20,000 and dividend income of $6,000. The $14,000,000 includes land worth $9,000,000 that Bob bought in 1966 for $450,000. The stocks and bonds have a tax basis of $1,200,000 and they are currently worth $5,000,000. All of the investments have been owned for more than a year. In addition to his investments, Bob paid $140,000 for his home in 1972 and it is now worth $600,000. The used car business is currently valued at $53,000,000 including the land and building, which are worth $41,000,000. Bob’s tax basis in the land and building is $2,000,000 and $400,000, respectively. The inventory is worth $12,000,000, with a cost basis of $5,000,000; the remaining assets, which include office furniture and equipment, make up the remainder of the business’s total value. The office furniture and equipment are fully depreciated. Bob wants your professional advice regarding whether he should continue to operate as a sole proprietor or convert the business to a partnership, an S corporation, or a C corporation. Based on one of the business entities selected, Bob wants to include Mandy—his daughter—in the business as an owner and manager with a possibility of 40% interest. One of his concerns is what would happen to his business after he passes away. Mandy’s personal tax information is as follows: Mandy Jones DOB: June 30, 1990 SSN: 999-99-9999 Marital Status: Single Home Address: 5990 Langley Road, Pensacola, FL 35203 You will need to describe the tax and limited liability effects on a chosen business entity should Bob decide to reduce the amount of tax paid per year, as well as the protection of personal assets should there be a possible claim against the company’s assets.

Please help me to Interpret the tax law pertaining to a S corporation business and justify my recommendation using details consistent with tax law, code, and regulations.

Answer 1

Advantages & Disadvantages

• Bob is advised to use S corporation, as his form of business does not have inventory, which makes it appropriate and simpler to use the cash method of accounting, which is simpler, compared to the accrual accounting method.
• Under the cash accounting method, income is taxable after it has been received and expenses deductible paid
• In S corporation, company can follow cash basis only till their turnover is below $5 million. It gets cumbersome to shift to accrual basis when turnover exceeds the limit after few initial years.
• Cash basis can only be used in the business where there is no inventory as laid down by IRS. This narrows down its scope to only service sector like of CPA and Doctor
• In cash basis, more often than not, corporation has to maintain two sets of books. One of cash basis for IRS and one of accrual basis for their own montitoring