Solved: Scuba View, Inc. Federal Tax Return

Facts

Scuba View, Inc. is owned by Marc C. Fisher and his wife, Sylvia A. Fisher.  The corporation manufactures snorkel masks with built-in lighting systems used for general underwater lighting.  When cut on a special way, the lights flash rapidly indicating an emergency situation (business activity code number 339900).  The corporation has reported positive financial and taxable incomes since inception.  The company is located at 150 Reef Road, Big Sur, California 93920.  The company’s employer identification number is 98-7654321, and the calendar year is used for tax purposes.  The date of incorporation was March 14, 2010.

Marc C. Fisher (social security number 111-11-1111) is an 80 percent shareholder and president of the company.  Sylvia A. Fisher (social security number 123-45-6789) is a 20 percent shareholder and vice president of the company.  Both persons devote 100 percent of their time to the corporation.  Marc’s compensation is $153,695 per year, and Sylvia’s compensation is $85,387 per year.

The corporation is not a personal holding company.  While the corporation is a ‘closely held C corporation,’ it does not engage in activities to which the at-risk or passive activity loss limitations apply.

The corporation files its tax return on the accrual method.  Inventory has been consistently valued at cost under the FIFO method using the full absorption procedure.  Inventory capitalization rules of Internal Revenue Code Section 263A do not apply due to the ‘small business exception’ (average annual gross receipts for the three preceding taxable years do not exceed $10 million).  The accounting records are computerized.

The corporation’s audited income statement and balance sheet for the current year, prepared by the accounting firm of Coral & Coral, CPAs, follow:

SCUBA VIEW, INC.

INCOME STATEMENT

For the Year Ending December 31, Current Tax Year

Revenue:

            Sales (net) ……………………………………          $6,859,819                 

            Cost of goods sold ……………………………         (5,715,258)

                        Gross profit ………………………………………………                $1,144,561

Operating expenses:

            Compensation of officers …………………….         $  239,082

            Other salaries and wages ……………..............             525,921

            Rental expense ……………………………….                36,033

            Interest expense ………………………………               91,165

            Fines for improper disposal of waste …………                 2,903

            Advertising ……………………………………                9,187

            Contributions …………………………………               38,425

            Bad debt expense ……………………………..                3,416

            Depreciation expense …………………………             117,755

            Taxes ………………………………………….               82,825

            Repairs and maintenance ……………………..                 7,696

            Miscellaneous expenses ………………………               20,794

                        Total operating expenses …………………………………                $(1,175,202)

                        Net Income from Operations ……………………………..               $    (30,641)

Other income and loss:

            Dividend income ……………………………..         $  114,150

            Interest income ……………………………….                 2,497

            Loss on sale of investment in stock ………….                (2,731)                         113,916

                        Net Income (Loss) before income tax ……………………               $      83,275

            Income tax expense ………………………………………………                        (3,414)

                        Net Income ……………………………………………….               $       79,861

SCUBA VIEW, INC

STATEMENT OF FINANCIAL POSITION

December 31, Current Tax Year

                                                                                    Beginning                                  End

                        ASSETS                                                of Year                                  of Year

Current Assets:

            Cash & Marketable Securities …………….   $ 502,356                                $ 487,595

            Accounts receivable ………………………      242,582                                   273,727

              Allowance for Doubtful Accounts ………     (15,370)                                  (16,864)

            Inventory ………………………………….     555,830                                   672,888

              Total current assets ……………………… $1,285,398                               $1,417,346

Machinery, Building, and Land:

            Machinery ………………………………...   $  333,006                               $  380,397

              Less: Accumulated depreciation ………...      (102,464)                                 (186,655)

            Building …………………………………..   1,174,799                               1,174,799

              Less: Accumulated depreciation ………..       (141,253)                                 (174,816)

            Land ………………………………………         85,386                                     85,386

              Total equipment, building, and land (net)    $1,349,474                              $1,279,111

Other assets:

            Goodwill ………………………………….               -0-                                       24,977

              Total Assets ……………………………..   $2,634,872                              $2,721,434

            LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities:

            Accounts payable …………………………   $   218,930                              $   235,556

            Notes payable (less than one year) ……….         175,895                                   155,402

              Total current liabilities ………………….    $   394,825                              $   390,958

Notes payable (one year or more) ………………..         828,247                                   890,899

            Total Liabilities …………………………..    $1,223,072                              $1,281,857

Common stock (20,000 shares authorized, 10,780

            shares issued and outstanding, $10 par) ….   $   107,800                              $   107,800

Additional paid-in capital …………………………       916,836                                   916,836

Retained earnings …………………………………       387,164                                   414,941

            Total Shareholders’ Equity ……………….   $1,411,800                              $1,439,577

            Total Liabilities and Shareholders’ Equity     $2,634,872                              $2,721,434

STATEMENT OF RETAINED EARNINGS

Beginning Retained Earnings ……………………       $387,164

Net income for the year …………………………..          79,861

Dividends paid in cash ……………………………        (52,084)

Ending Retained Earnings ………………………..      $414,941

NOTES

  1. Scuba View, Inc. made estimated tax payments attributable to the current tax year in the amount of $5,123.  The corporation also had a credit from an overpayment of its prior year Federal income taxes of $462 that it elected to apply against its current year tax liability.
  • All notes payable were issued at par and provide market interest rates.
  • Ignore state income taxes.
  • Dividend income is from the following sources:

Apple Corp.   (< 20% interest)…………………………………………        $67,188

Yahoo Corp.  (< 20% interest)……………………………………………...   25,616

Plexiglas, Inc. (Scuba View, Inc. owns 85% of Plexiglas’s stock) …              21,346

            Total …………………………………………………………         $114,150

  • An analysis of the Allowance for Doubtful Accounts reveals:

Balance, January 1st...……………………………………………………     $15,370

Transactions:

Provision for bad debts ………………………………………………              3,416

Recoveries of bad debts ……………………………………………..                (726)

Accounts written off as uncollectible ……………………………….              (1,196)

            Balance, December 31st …………………………………………... $16,864

  • Goodwill of $24,977 arose on purchase of another business on January 1st of the current tax year.  Amortization is not being taken for financial purposes.
  • Assume that deductions for tax depreciation (i.e., Modified Accelerated Cost Recovery) for the year total $139,486.  For this practice set do not complete Form 4562 (Depreciation and Amortization).
  • Meals and entertainment costs of $1,707 included in Miscellaneous Expenses are subject to the 50% disallowance rule.
  • Contributions included:

Sierra Club …………………………………………………………..           $32,959

Government of Ethiopia …………………………………………….               3,759

Big Sur Food Bank ………………………………………………….               1,707

            Total ………………………………………………………...            $38,425

All contributions were paid in cash during the year except for the Food Bank contribution which was pledged by the corporation (i.e., approved by the Board of Directors) on December 17th of the current tax year and paid on May 2nd the following year.

  1. Included in interest income is $1,410 from $32,343 of Sacramento, California General Obligation Bonds held throughout the current year.  These bonds are included in the marketable securities account.
  1. On May 19th of the current tax year the corporation sold 100 shares of Plastic Corp. common stock for $9,393.  The stock was purchased on July 23rd, 2012 for $12,124.
  1. Plexiglas, Inc. is a subsidiary of Scuba View Inc., formed in 2013, and operated in Lucia, California for the purpose of manufacturing specialized Plexiglas panes used in the making of snorkel masks.  Historically Plexiglas, Inc. has been profitable and had a taxable income of $87,366 and an Alternative Minimum Taxable Income [Form 4626, Ln. 7] of $87,937.  Scuba View, Inc. and Plexiglas, Inc. have agreed to share equally any limitations on item(s) that the income tax law restricts across the corporations so long as the equal allocation results in utilization of maximum benefits available.  However, if a corporation does not have sufficient investment, income, or tax liability to realize the benefit of the additional limitation.  Sales by Plexiglas, Inc. to Scuba View, Inc. are at “arms-length” prices (i.e., fair market values).  Scuba View, Inc. has not elected to file a consolidated income tax return with Plexiglas, Inc.  Plexiglas, Inc. (EIN 12-3456789) is located at 48 Coastal Highway, Lucia, California 93920.
  1. Form 4626 (Alternative Minimum Tax—Corporations) must be included in the return.  For that purpose, assume the adjustment for depreciation of tangible property placed in service after 1986 (Form 4626, Line 2a) is a $25,479 positive adjustment.  Assume the Adjusted Current Earnings (ACE) Adjustment on Line 4e is $-0-.  [This assumption removes ACE adjustment from this practice set].
  1. Disregard any penalty on underpayment of estimated tax.
  1. Assume that compensation of officers and other salaries and wages do not relate to production activities.  This assumption removes the Domestic Production Activities deduction from this practice set.
  1. The corporation made payments that requires it to file Forms 1099.  It has filed Forms 1099 in compliance with the law.

REQUIRED

  1. BOOK TO TAX RECONCILIATION WORKSHEET

Using the Income Statement provided above create a spreadsheet to reconcile income for financial reporting purposes (book income) to taxable income.  The first column label P/L Books.  The next two columns label as Adjustments, one for Temporary and one for Permanent adjustments.  The fourth column label P/L Tax.  The fifth column label reference and use it to indicate the source (notes 1-15) for the adjustment.

  • TAX RETURN

From the above information, prepare Scuba View, Inc.’s Federal income tax return, including all supporting statements, schedules, and forms.  Unless otherwise noted, assume Scuba View, Inc. follows the policies of making all elections to minimize its current income taxes and, to the extent possible, of confirming procedures for financial and tax accounting.  Round amounts to the nearest dollar.  If additional information is needed, make realistic assumptions and fill in all required data.  Forms needed:

Form 1120

Schedule O

Form 4626

Form 1125-A

Schedule G

Form 1125-E

Supporting schedule for 1120 line 26 other deductions

Supporting Schedule for Schedule M-1 line 5 expenses

CHECK FIGURES

1120 page 1 line 30 Taxable Income  $22,305

1120 Schedule M-1 line 10 Income    $95,695

GRADING

This tax return is worth 150 points.  Each form is worth a set number of points as indicated below. Total points earned per form is divided by the total points available for all forms (255) and then multiplied by 150 points to arrive at the grade for this assignment.

Form                                        Points

1120 page 1                             32

1120 page 2                                7

1120 page 3                             17

1120 page 4                             18

1120 page 5                             56

Schedule O page 1                     6

Schedule O page 2                    18

Schedule O page 3                    14

Schedule O page 4                      5

Form 4626                                 13

Form 1125-A                            10

Schedule G                               10

Form 1125-E                             14

Support for line 26                      6

M-1 line 5 support                       7

Book to Tax Reconciliation     22

Total Points                             255