Question

Ellie and Linda are equal owners in Otter Enterprises, a calendar year business. During the current year, Otter Enterprises has $320,000 of gross income and $210,000 of operating expenses. In addition, Otter has a long-term capital gain of $15,000 and makes distributions to Ellie and Linda of $25,000 each. Discuss the impact of this information on the taxable income of Otter, Ellie, and Linda if Otter is:

a. A partnership.
b. An S corporation.
c. A C corporation.

Answer 1

The tax treatment for Otter Enterprises and its owners varies by entity type. A partnership and an S corporation allow income to pass through to owners' individual tax returns while a C corporation entails double taxation—once at the corporate level and again on distributions (as dividends) for the individuals.

Step-by-step explanation:

When evaluating the impact on the taxable income of Otter Enterprises and its owners, Ellie and Linda, it's important to consider the entity type as it influences how income and expenses are treated for tax purposes.

Partnership

In the case of a partnership, the net income of the business is passed through to the owners. The income would be calculated by taking the gross income ($320,000), adding the capital gain ($15,000), and subtracting the operating expenses ($210,000). This results in a net income of $125,000. As Ellie and Linda are equal partners, they each would report $62,500 on their individual tax returns. The distributions of $25,000 each do not affect their taxable income, as they have already been taxed on the full amount of their share of the net income.

S Corporation

The S corporation follows a similar tax treatment as the partnership, where income and gains pass through to the shareholders, regardless of distribution. The net income calculation is the same, resulting in each owner reporting $62,500 of income on their individual tax returns—the distributions are again not additionally taxed.

C Corporation

However, for a C corporation, the income is taxed at the corporate level. The net income (after expenses and capital gains) is taxed directly to Otter Enterprises. Distributions to Ellie and Linda in a C corporation (typically dividends) would also be subject to taxation on their individual tax returns, leading to double taxation.

Answer 2

a and b

At the level of entity, otter pays no taxes either on the capital gains or on the business income.

Members will pay taxes on the capital gains and on business income.

c

The distribution of $25,000 each will be taxable in the hands of members as it is a dividend income.

Business Income and Capital gain of entity will have no impact for Linda and Ellie on their income tax returns.

Step-by-step explanation:

a A partnership and b. An S corporation

At the level of entity, otter pays no taxes either on the capital gains or on the business income.

Members will pay taxes on the capital gains and on business income.

Taxable income of each member:

Ellie

Business Income is $55,000

Capital Gain is $7,500

Linda

Business Income is $55,000

Capital Gain is $7,500

Business Income = Gross Income - Operating expense

= $320,000 - $210,000

= $110,000

Note: Distribution of $25,000 will have no impact, as it only decrease their basis in the firm or company.

c. A C corporation

Ottor pays for the business income which amounts to $110,000 as well as the Capital gain of $15,000 at the applicable tax rates.

Members pays taxes only when they receive the distribution which is dividends.

The distribution of $25,000 each will be taxable in the hands of members as it is a dividend income.

Business Income and Capital gain of entity will have no impact for Linda and Ellie on their income tax returns.