Analyze this situation for tax problems and look for any ways to reduce tax Bob and Chad

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Analyze this situation for tax problems and look for any ways to reduce tax

Bob and Chad consider each other their “life-partner”. They have never formalized their relationship but now they can if they want to.

Bob operates a successful business and until recently Chad was employed by a large law firm. Because of economic slowdown, Chad was let-go by his firm. He was given a sizeable severance package in November 2015 but has not worked since.

In 2014 Bob needed a new machine for his business, cost 2.5 million. Instead of buying the machine himself, Chad formed a new corporation, Machine Corp. Machine Corp. elected subchapter S status (qualified sub-S election) Chad invested $100. Bob then loaned Machine Corp. $50,000, interest free. Machine borrowed 2,450,000 from the bank and purchased the machine. Machine Corp. pays the bank 245,000 per year principle plus interest. Machine Corp. then rents the machine to Bob for 600,000 per year. Machines of that type should rent for 275,000 to 300,000 per year.

Because of rapid write-offs under MACRS, Chad does not anticipate making a profit until 2021.

Machine Corp’s pro forma income statement was

Income 600,000

Interest to bank 75,000

Administrative and Misc 25,000

MACRS 575,000

Net loss (75,000)

After paying the rent to Machine Corp. Bob is making 150-175,000 a year profit. While he was working, Chad was able to reduce his income by losses sustained by Machine Corp.

Problem for you to address: If you were an IRS agent what issues are there in this fact patter?