Red, Andy, and Brooks decide to go into business together. They are considering

Question

Red, Andy, and Brooks decide to go into business together. They are considering conducting the business through a C corporation, an S corporation, or a partnership.

Red is going to make a contribution of cash of $100 for a 40% interest in the business. Andy is going to contribute equipment with a fair market value of $100 and a tax basis of $60 for a 40% interest in the business. The equipment currently is not subject to any debt. Brooks is going to provide services worth $50 in exchange for a 20% interest in the business.   

Analyze the following questions based on each type of entity (C corporation, S corporation, and Partnership).

1. What is the realized gain and recognized gain for each person based on what they contribute to the respective type of entity and what is each person’s tax basis in their interest in the entity? Assume that all of the contributions are made at the same time and that Brooks receives only a profits interests when analyzing the treatment for a partnership.

2. Assume Andy joins the business several years after Red and Brooks have operated the business. How does this change the tax treatment for Andy for each type of entity?

Explanation / Answer

1. Realized Gain for Red = $100 + (40% of $100) = $140

                              Andy = ($100 - $60) + [($100 - $60) * 40%] = $56

                              Brooks = $50 + (20% of $50) = $60

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