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Corporate Taxes - Essay Example

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As a result of the current economic downturn, Susan, sole owner of Bluegill Corporation, needs to invest an additional $80,000 for working capital requirements of the business. In addition, her total stock investment into Bluegill is $100,000 and as the full-time operations manager, she receives a salary of $40,000 annually…
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Corporate Taxes
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Download file to see previous pages 29) or the Code, otherwise the business is taxed under the Subchapter C of the Code. Moreover, during liquidation process, the liability of a sole owner of an S or C corporation is determined by the amount of money the owner has invested in the business, hence personal assets are not subject to the rights of creditors to seize or place a lien.
Furthermore, when an entity undergoes bankruptcy proceedings and files for Chapter 11, the assets of the corporation is transferred to the bankruptcy estate, however "a transfer (other than by sale or exchange) of an asset from the debtor to the estate shall not be treated as a disposition for purposes of any provision assigning tax consequences to a disposition and the estate shall be treated as the debtor would be treated with respect to such asset" (IRC section 1398(f)).
Given the above tax laws, rulings and regulations, if Susan treats her additional $80,000 as an additional stock investment, which will then increase the value of her total stock to $180,000, the for tax purposes, she will not be able to report the loss of the additional stock investment or the total value of her stock as a loss in her individual tax return. Section 1398(f) of the Code specifies that the bankruptcy estate will accrue the losses - both from operations and other items - of the business of the year that the bankruptcy process commenced. Hence, given the treatment of the $80,000 additional investment as a stock investment, on the year that Bluegill files for bankruptcy this amount and the rest of Susan's equity investment in the corporation will become the losses of the estate rather than her losses.
However, the tax implications would be different if the $80,000 additional tax investment is treated by Susan as a loan to Bluegill Corporation. In this circumstance, Susan, to the extent of the $80,000 loan, is considered as a debtor. Hence, the tax treatment is different. However, the remaining stock value of Susan of $100,000 will still be treated the same way as identified above. For the $80,000 loan, during the bankruptcy proceedings, Susan can then assume a creditor's right to seize or attach lien on the corporation's assets. Any loss resulting from the bankruptcy of Bluegill with respect to the $80,000 loan can be reported in Susan's individual income tax return.
There is a way for Susan, however, to claim the losses from her total stock investment in her individual tax return in case Bluegill files for bankruptcy. To be able to do this, Susan needs to file the bankruptcy right after the end of Bluegill's fiscal year. Corporation's fiscal year ends every December 31. Hence, Susan needs to file for bankruptcy right after this time.
Whether the additional $80,000 investment can be considered a bona fide loan or a capital contribution or both, several factors need to be considered. First, whether the business was undercapitalized during the additional contribution. If capitalization was sufficient, then the additional investment can be considered as a bona fide loan. Another factor is the intention of Susan in giving the additional investment to Bluegill.
In Adelson v. United States (Fed.Cir. 1984) 737 F.2d 1569, the court made a distinction on the difference of a loan and capital. The court stated that "a loan is ...Download file to see next pagesRead More
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