Question

Cynthia, a sole proprietor, was engaged in a service business and reported her income on the cash basis. On February 1, 2013, she incorporates her business as Dove Corporation and transfers the assets of the business to the corporation in return for all of the stock in addition to the corporation’s assumption of her proprietorship’s liabilities. All of the receivables and the unpaid trade payables are transferred to the newly formed corporation. The balance sheet of the corporation immediately after its formation is as follows:
Dove Corporation
Balance Sheet
February 1, 2013
Assets
Basis to Dove Fair Market Value
Cash $ 80,000 $ 80,000
Accounts receivable 0 240,000
Equipment (cost $180,000; 120,000 320,000
depreciation previously claimed $60,000)
Building (straight-line depreciation) 160,000 400,000
Land 40,000 160,000
Total $400,000 $1,200,000
Liabilities and Stockholder’s Equity
Liabilities:
Accounts payable—trade $ 120,000
Notes payable—bank 360,000
Stockholder’s equity:
Common stock 720,000
Total $1,200,000
Discuss the tax consequences of the incorporation of the business to Cynthia and to Dove Corporation.

Answer 1

Answer:

Cynthia and Dove Corporation

Any profits generated by Dove Corporation will be taxed to the corporation and also taxed to Cynthia as a shareholder whenever Dove distributes the profits as dividends. Taxing Dove and Cynthia creates a double taxation burden for both Dove and Cynthia. Dove Corporation does not get a tax deduction when it distributes dividends to Cynthia.  Furthermore, Cynthia cannot deduct any corporation loss when incurred.  These are unlike when the business was only a sole proprietorship.

Explanation:

a) Data and Calculations:

Dove Corporation

Balance Sheet

February 1, 2013

Assets

                                                    Basis to Dove     Fair Market Value

Cash                                                 $ 80,000              $ 80,000

Accounts receivable                         0                           240,000

Equipment (cost $180,000;              120,000               320,000

depreciation previously claimed $60,000)

Building (straight-line depreciation) 160,000              400,000

Land                                                    40,000               160,000

Total                                               $400,000          $1,200,000

Liabilities and Stockholders' Equity

Liabilities:

Accounts payable—trade            $ 120,000

Notes payable—bank                    360,000

Stockholders' equity:

Common stock                              720,000

Total                                          $1,200,000