McGraw-Hill's Taxation of Business Entities 3rd Edition by Connie Weaver, Brian Spilker, Edmund Outslay, John Robinson, Ronald Worsham, Benjamin Ayers, John Barrick

Exercise 31

While James Craig and his former classmate Paul Dolittle both studied accounting
at school, they ended up pursuing careers in professional cake decorating. Their
company, Good to Eat (GTE), specializes in custom-sculpted cakes for weddings,
birthdays, and other celebrations. James and Paul formed the business at the beginning
of 2010, and each contributed $50,000 in exchange for a 50 percent ownership
interest. GTE also borrowed $200,000 from a local bank. Both James and
Paul had to personally guarantee the loan. Both owners provide significant services
for the business. The following information pertains to GTE's 2010 activities:
• GTE uses the cash method of accounting (for both book and tax purposes)
and reports income on a calendar-year basis.
• GTE received $450,000 of sales revenue and reported $210,000 of cost of
goods sold (it did not have any ending inventory).
• GTE paid $30,000 compensation to James, $30,000 compensation to Paul,
and $40,000 of compensation to other employees (assume these amounts
include applicable payroll taxes if any).
• GTE paid $15,000 of rent for a building and equipment, $20,000 for advertising,
$14,000 in interest expense, $4,000 for utilities, and $2,000 for supplies.
• GTE contributed $5,000 to charity.
• GTE received a $1,000 qualifying dividend from a great stock investment
(it owned 2 percent of the corporation distributing the dividend) and it
recognized $1,500 in short-term capital gain when it sold some of the stock.
• On December 1, 2010, GTE distributed $30,000 to James and $30,000 to Paul.
Required:
a. Assume James and Paul formed GTE as an S corporation.
• Complete GTE's Form 1120S, page 1; Form 1120 S, Schedule K; and Paul's
Form 1120S, Schedule K-1 (note that you should use 2010 tax forms).
• Compute the tax basis of Paul's stock in GTE at the end of 2010.• What amount of Paul's income from GTE is subject to FICA or selfemployment
taxes
• What amount of income, including its character, will Paul recognize on
the $30,000 distribution he receives on December 1
• What amount of tax does GTE pay on the $1,000 dividend it received
b. Assume James and Paul formed GTE as an LLc.• Complete GTE's Form 1065, page 1; Form 1065, Schedule K; and Paul's
Form 1065, Schedule K-1 (note that you should use 2010 tax forms).
• Compute the tax basis of Paul's ownership interest in GTE at the end of 2010.• What amount of Paul's income from GTE is subject to FICA or selfemployment
taxes
• What amount of income, including its character, will Paul recognize on
the $30,000 distribution he receives on December 1
• What amount of tax does GTE pay on the $1,000 dividend it received
c. Assume James and Paul formed GTE as a C corporation.
• Complete GTE's Form 1120, page 1 (note that you should use the 2010
tax form).
• Compute the tax basis of Paul's stock in GTE at the end of 2010.• What amount of Paul's income from GTE is subject to FICA or selfemployment
taxes
• What amount of income, including its character, will Paul recognize on
the $30,000 distribution he receives on December 1
• What amount of tax does GTE pay on the $1,000 dividend it received