Step-by-step solution file
You are the in-charge accountant for an attestation engagement
You are the in-charge accountant for an attestation engagement when a tax issue arises. Your S corporation client, which previously had positive taxable income, has incurred a $1 million new operating losses. The two shareholders each have a tax basis in their stock of $300,000. What will happen to the excess tax losses? How might you advise your client to utilize these losses? How would this advise fit with the SAVANT concept?
ACC 685_ Tax Planning
Name: ID: Question 1 (25 Points)
Galadriel Elvin, a wealthy entrepreneur, was returning home after taking the eldest of her three
children to start college on the other side of the country when she noticed that the person sitting
next to her in the first-class cabin was absentmindedly fiddling with a pink substance. When she
asked about it, Bill Halfacre explained that he had developed it because he was spending a small
fortune on batteries for his young children?s toys. Simply dipping regular alkaline batteries in
the substance for an hour had proven to more than double the effective life of the batteries.
When Galadriel mentioned that this was a great idea, Bill replied that he was a bit depressed
because he had been trying to connect with someone who could help him develop and market the
product, but had been unsuccessful. Galadriel encouraged him, and discovered that he had lived
a varied and interesting life. He had earned several degrees in chemistry, but had spent all his
time since graduating surfing throughout the world, and tinkering with various inventions. (He
had inherited enough money that he had not had to work since he finished school five years ago,
but the money was running out.)
By the time the plane landed, Galadriel and Bill had set a time to meet with Galadriel's
lawyer, Elsa Treebeard, to discuss a venture to market Bill's products. They also invited one of
Galadriel's colleagues, Jim Pippin, to attend the meeting. Jim had worked with Galadriel on
several occasions: he makes a lot, but keeps very little, money. He is a marketing whiz who has
strong connections to several distributors to large office supply outlets. Galadriel's concern with
Jim has always been that he plays things a bit fast and loose.
At the meeting, the group developed projections of profits and losses for the first five years
of the business. The expectation is that annual losses will range from $100,000 to $200,000 over
these five years, with break-even in about Year 5. The business will be capitalized with about
$200,000 in cash, along with computers, equipment, furniture, and fixtures (fair market value of
$100,000 and basis of $25,000) contributed by Galadriel. Bill will contribute the patent at an
agreed value of $150,000. Jim has nothing to contribute but time. He will receive a 25% interest
for contributing all of his time for a year to get the business going. Thereafter, he will be
compensated based on sales and profits. Elsa believes they will be able to borrow $200,000
initially and perhaps an additional $100,000 per year during the development period. The money
will be used for working capital and manufacturing equipment. They feel that they may be able
to attract new investors once some of the initial work has been completed.
Galadriel thinks Jim brings some needed talents to the venture, but she is very uneasy about
being exposed to liabilities that he might create. Bill says he has nothing to lose so the
association with Jim does not concern him. Galadriel has about $500,000 in income each year. Bill's income is about $25,000 a year and Jim has earned anywhere from $0 to $200,000
annually over the last few years.
How might taxes impact the results of the major strategic decisions faced by the three
ventures as they start up the business?
Question 2 (25 Points)
Benoit Pharmaceuticals, Inc. was formed in 1990 by Richard Benoit, PhD. Formerly a research
scientist with a major pharmaceutical, he decided to strike out on his own. He owned 100% of
the stock of the Princeton, New Jersey based manufacturer. The firm had been hugely successful
by manufacturing aspirin and acetaminophen products.
Flush with cash, Benoit felt that it was the time to take a chance on a product that might be a
home run. Two researchers at Johns Hopkins had been doing promising work in oncology, and
might be able to develop some effective cancer treatments. He felt that he could hire them away,
set up an R&D facility, and within five years get back 10 times his investment. The scientists
plus support staff would earn $500,000 per year, annual operating costs would be another
$100,000, and an up-front investment of $1 million in lab equipment would be necessary. His
tax consultant estimated that a $400,000 tax benefit would occur in the first year, with $200,000
in tax benefits occurring in each of the next five years. The tax benefits would come primarily
from a tax credit for research and development. The investment was risky, with an industry
average success rate of 50% in oncological products.
Although there was enough free cash flow to finance the investment internally, Benoit
preferred to finance it with external financing. Borrowing would be at 12%. Or he could spin
the R&D operation off into a separate subsidiary, issuing stock to venture capitalists. The
venture capitalists would expect an eventual return of 200%. If the subsidiary were formed as a
partnership, some of the tax benefits might flow through to the venture capitalists.
What would you recommend? Question 3 (50 Points)
1. 2. You are the in-charge accountant for an attestation engagement when a tax issue
arises. Your S corporation client, which previously had positive taxable income, has
incurred a $1 million new operating losses. The two shareholders each have a tax
basis in their stock of $300,000. What will happen to the ?excess? tax losses? How
might you advise your client to utilize these losses? How would this advice fit with
the SAVANT concept? One of your clients is a plastic surgeon in a highly lucrative practice with four other
plastic surgeons. Together, the net income for the practice is $20 million. Assume that
taxable income is about one half of this amount, that the firm (a corporation) has not paid
dividends in its five-year history, and the surgeons have paid themselves salaries of
$100,000 per year (each). What tax problems might arise? How could they be remedied?
This question was answered on: Feb 21, 2020
This attachment is locked