Mimi’s Cupcakes Tax Research Memorandum Due Date Wednesday ✓ Solved

Mimi’s Cupcakes Tax Research Memorandum Due Date Wednesday Dec

The purpose of this is to enable you to meet the following goals: understand the role of a tax practitioner; identify the tax issues involved in a scenario; conduct comprehensive tax research utilizing online tools; articulate and defend a tax position in writing.

Prepare a memorandum to the tax manager outlining the information you found in your research. Format the memo to include: Restatement of Facts (paraphrase); Identify at least three main issues based on these facts; Provide a conclusion for each issue; Include the analysis that led you to the conclusion for each issue, referring to the primary authority that best addresses the issue. Primary authority would include items such as the Internal Revenue Code, Regulations, Court Cases, etc. IRS Topics and Publications are NOT primary authority for this project.

Your business tax client, Mimi Charpentier, operates a successful sole proprietorship which sells cupcakes to retail customers at three locations in Las Vegas. Mimi’s Cupcakes does not carry any inventories, because of the nature of its products. Mimi owns the three small buildings in which the shops exist. One of the stores is slightly larger than the others; it is Mimi’s original location, and it still is the site of the kitchen and the loading dock where the Cupcakes trucks daily pick up and deliver merchandise and supplies. The work force of each store is the equivalent of 2.5 employees; the employees are paid reasonably well, and the low-pressure atmosphere of the typical workday results in a very low turnover rate.

Mimi offers only one fringe benefit to the employees – it encourages the employees to use Health Savings Accounts for their medical costs, and Mimi reimburses the employee for the out-of-pocket deductible amounts, to a $2,000 maximum per employee per calendar year. Mimi's attorney, Gloria Willis, has urged Mimi to incorporate the business, primarily because of the limited shareholder liability associated with corporate status, and to facilitate a business succession plan for the operation. After several years of discussions, Mimi has agreed to go ahead with this idea.

Required: You will be meeting shortly with Mimi, Nancy, and Joan to discuss the tax aspects of the incorporation. Be sure to review options available for operating the business and the tax consequences of these options. Concentrate on issues of asset basis, as well as effects that incorporation might have on sales/use and self-employment tax obligations. Be prepared with some initial suggestions about succession planning and the tax implications related to the transfer of shares in Mimi’s Cupcakes Inc.

Paper For Above Instructions

Tax Research Memorandum

To: File

From: [Your Name]

Date: [Enter Date]

Re: Mimi Charpentier and Tax Year [Year]

Facts: Mimi Charpentier is the owner of Mimi's Cupcakes, a sole proprietorship operating in Las Vegas, comprising three retail locations. The store does not maintain inventory due to the nature of the products and has stable employment conditions with low turnover. Mimi's attorney, Gloria Willis, has encouraged her to incorporate the business to afford limited shareholder liability and ease succession planning. After considering various factors, they have agreed to proceed with incorporation scheduled for January 1, 202[1]. Mimi's financial situation and operational status raise numerous tax considerations that must be analyzed and addressed before the incorporation.

Issue & Conclusion #1:

Issue: What are the tax implications of transferring assets from a sole proprietorship to a corporation?

Conclusion: Transferring assets can trigger taxable events, resulting in potential gains recognized by Mimi.

Analysis: Under IRC §351, no gain or loss is generally recognized when property is transferred to a corporation in exchange for stock, provided that the transferors collectively control at least 80% of the corporation immediately after the exchange. In Mimi's case, if she transfers properties such as buildings and equipment to the corporation in exchange for stock, she should be able to avoid immediate taxation, provided she satisfies the control requirement. However, any cash received or debt assumed by the corporation may create taxable gain (Treas. Reg. §1.351-1). Therefore, an evaluation of asset fair market value versus the basis will be essential before executing the transfer. Mimi should account for this during her meeting with other shareholders to ensure the transaction maintains its tax-free status.

Issue & Conclusion #2:

Issue: How should Mimi handle the tax basis of assets after incorporation?

Conclusion: After incorporation, the tax basis of assets transferred retains its original basis unless adjusted post-transaction.

Analysis: When assets are transferred under IRC §351, the corporation takes on the transferor's basis. This means the original tax basis of the assets remains intact, which is beneficial for depreciation considerations. Any future depreciation deductions available will continue to correspond with the original basis of the asset (IRC §362). Since Mimi has operated as a cash basis sole proprietorship, maintaining accurate records of both the original purchase price and any improvements or depreciation taken on those assets will be vital in determining future tax obligations.

Issue & Conclusion #3:

Issue: What are the potential sales/use and self-employment tax implications post-incorporation?

Conclusion: Incorporating will alter Mimi's self-employment tax liability, and she may be subject to corporate taxation.

Analysis: Post-incorporation, while Mimi will no longer be liable for self-employment taxes on corporate income, she will be subject to corporate taxes on profits. Distributions will be taxed at the individual level when dividends are paid to her as a shareholder. Additionally, the corporation must pay taxes on all income earned, diverging from the sole proprietorship's pass-through taxation structure (IRC §11). The sales tax consequences will depend on whether the corporation continues to maintain similar operations. Given the potential tax burdens, it's crucial for Mimi to outline strategies for compensation to minimize tax liabilities while ensuring compliance. A thorough analysis of projected income and expenses following incorporation will help in effective tax planning.

Issue & Conclusion #4:

Issue: What are viable succession planning strategies for Mimi's Cupcakes post-incorporation?

Conclusion: Establishing a clear succession plan will provide for seamless ownership transitions and tax efficiency.

Analysis: It’s recommended that Mimi consider a buy-sell agreement between shareholders, particularly regarding her limited life expectancy. This agreement would dictate the terms under which shares would be bought and sold in the event of death or disability, thereby preventing disputes among remaining shareholders and preserving business continuity (IRS Revenue Ruling 77-287). Additionally, utilizing trusts or insurance to fund the buy-sell arrangement can further reduce tax burdens and facilitate smooth ownership transitions, allowing her daughter Nancy and Joan to take on leadership without the threat of significant tax liabilities.

Issue & Conclusion #5:

Issue: What are the capital gains implications for asset contributions to the corporation?

Conclusion: Gains recognized on asset transfers may result in immediate tax implications if properties are not correctly structured.

Analysis: If any assets are transferred with liabilities exceeding the basis, it can create recognized gain (IRC §357). This highlights the significance of structuring the transfer correctly to avoid unintentional taxation. It is advisable for Mimi to examine each asset's contribution closely, ensuring they're valued appropriately and that liabilities do not exceed their respective bases. Clear documentation will help validate this during tax filings to mitigate future audits.

References

• Internal Revenue Code (IRC) §351
• Internal Revenue Code (IRC) §11
• Internal Revenue Code (IRC) §362
• Treas. Reg. §1.351-1
• Treas. Reg. §1.441-1T(a)(2)
• IRS Revenue Ruling 77-287
• House Committee on Ways and Means, H.Rep. No 432, 98th Cong., 2d Sess. (March 5, 1984)
• Treasury Regulation – final Reg. Sec. 1.704-3(c)
• Revenue Procedure – Permanent cite Rev. Proc. 88-12, 1988-1 C.B. 17
• Commissioner v. Duberstein, 363 U.S. 278, 80 S. St. 1190, 60-2 USTC ¶9515