S CORPORATION TAX RETURN PRACTICE PROBLEM

Instructions:

Please complete the 2017 tax return for Modern Day Clothing, Inc., based upon the facts presented

below. If required information is missing, use reasonable assumptions to fill in the gaps. Ignore any

Alternative Minimum Tax (AMT) calculations or reporting.

Modern Day Clothing, Inc. (MD) is organized as a corporation in the state of North Carolina and is taxed

as an S corporation with a calendar-year end. MD operates four small boutique clothing outlet stores

(family clothing stores) in the North Carolina cities of Charlotte, Durham, Raleigh, and Winston-Salem.

MDs address, employer identification number, date of incorporation, and effective date of its S

corporation election are as follows:

Modern Day Clothing, Inc.

1515 North Lincoln Highway

Charlotte, North Carolina 28201

EIN: 14-2953556

Date Incorporated- February 2, 2000

Effective date of the S election was January 1, 2017.

MD has been at the same address since inception.

MD has only common shares issued. There are currently 10,000 shares of MD common stock

outstanding and issued. There were no stock transfers during the current tax year.

MD is owned by the following unrelated four shareholders:

Jennifer Lyons

85 Shady Elm

Charlotte, North Carolina, 28201

SSN 524-31-3493

Number of common shares owned 4,300

Chief Executive Officer

2017 W-2 wages $112,000

Robert Newberry

RD Route 843

Rural Hall, North Carolina 27045

SSN 482-26-5241

Number of common shares owned 2,300

Chief Financial Officer

2017 W-2 wages $90,000

Lamar Taylor

35 S. Main Street

Mt. Airy, North Carolina 27030

SSN 545-16-4239

Number of common shares owned 2,200

Chief Operations Officer

2017 W-2 wages $80,000

2

Lacrecia Williams

9851 Old Colonial Highway

Charlotte, North Carolina, 28201

SSN 429-82-9384

Number of common shares owned 1,200

Not an officer of the company

MD reported the following information for the year:

MD uses the accrual method of accounting.

MD is not a subsidiary nor is it in an affiliated group with any other entity.

MD does not own directly 20%, or, directly and indirectly, 20% or more of any other entity

(including corporations or partnerships).

MD has never issued any restrictive stock.

MD has never been required to file a Form 8918.

MD has never issued any publicly traded debt.

MD was taxed as a C corporation from inception through the effective date of the S election.

MD had net unrecognized built-in gain from prior years of $400,000 as of January 1, 2017. The

entire gain was attributable to unimproved land that MD owned. The land was originally

purchased for $250,000 on June 16, 2001. On August 1, 2017, MD sold the unimproved land for

a sales price of $850,000 (net of selling commissions). MD did not receive a Form 1099-B

reflecting the sale. The land was held by MD as an investment asset only and was not

connected with its clothing business.

MD had $500,000 of Accumulated Earnings and Profits as of 12/31/2016.

MD had an Accumulated Adjustments Account balance at 12/31/2016 of $125,000.

MD had an Other Adjustments account balance at 12/31/2016 of $7,000.

MD did not have any non-shareholder debt that was cancelled or was forgiven nor had the

terms modified so as to reduce the principal amount of the debt during the tax year.

MD has never made nor caused to be made a qualified subchapter S subsidiary election (Qsub).

MD has never caused a Qsub election to be revoked or terminated.

MD made payments in the current year that required the filing of Forms 1099. All of those

Forms 1099 were filed timely.

Additional information:

None of the expenses incurred by MD during the year relate to the production or carrying of the taxexempt

securities held in portfolio. The tax-exempt securities are maintained in a separate brokerage

account distinct from other holdings.

MD maintains its inventory on the cost method. MD uses specific identification for its inventory and has

never changed its inventory method. MD has never written down any subnormal goods. The rules of

Section 263A (UNICAP) do not apply to MD.

MD leases all of its real property.

On December 1, 2017, MD made a distribution to all common stockholders of $85 per common share.

3

On July 1, 2017, MD purchased $640,000 of new equipment (5-year MACRS property) that it used to

expand its Charlotte store. Not including the $640,000 of new additions during the year, MDs

calculated regular and AMT tax depreciation for the current year is $275,000. MD desires to maximize

its current year cost recovery deductions relating to the equipment additions.

Other than the unimproved land, MD did not dispose of any assets during the year.

MD maintains a life insurance policy on the life of the CEO, Jennifer Lyons. MD is the beneficiary of that

policy.

During the current year, MD gave $32,000 in cash to the Red Cross to assist with hurricane disaster

clean-up in the North Carolina area.

All of the accrued wage amounts on the balance sheet as of December 31, 2017 were paid on January

15, 2018.

The accrued bonus amounts on the balance sheets as of December 31, 2016 and 2017, respectively,

were paid on July 1, 2017 and July 1, 2018, respectively.

As of December 31, 2016 and 2017, respectively, MD had accrued vacation on its books of $19,000 and

$21,000. As of March 15, 2017 and March 15, 2018, respectively, MD had paid $3,000 and $9,000 of

those accrued amounts. None of these accrued amounts relate to officers compensation.

MD paid $140,000 ($35,000 each on 4/15/2017, 6/15/2017, 9/15/2017 and 12/15/2017) to the U.S.

Treasury for current year estimated federal tax payments and $20,000 to the state of North Carolina for

current year estimated state income tax payments.

There were no changes in stock ownership during the year.

The three officers in the company devoted 100% of their time to the company.

4

Financial Statements (kept on a GAAP basis):

Modern Day Clothing, Inc.

Balance Sheet

Assets: 12/31/2016 12/31/2017

Cash $ 340,000 $ 385,000

Accounts Receivable-Credit Cards 205,000 232,000

Accounts Receivable-Trade 63,000 58,000

Less: Allowance for Bad Debts (13,000) (11,500)

Inventory 2,908,000 3,010,000

Tax-exempt Securities 100,000 100,000

U.S. Treasury Bonds 200,000 200,000

Fixed Assets 4,010,000 4,650,000

Less: Acc. Depreciation (2,875,000) (3,055,000)

Land-Unimproved (tax and GAAP basis) 250,000 0

Prepaid Rent 165,000 168,000

Total Assets: $5,353,000 $5,736,500

Liabilities and Shareholders Equity:

Accounts Payable 99,000 93,000

Accrued Employee Wages 27,000 31,000

Accrued Officer Bonuses 110,000 145,000

Accrued Employee Vacation 19,000 21,000

Note Payable-First Bank of NC (Credit Line) 536,000 812,000

Note Payable-First Bank of Charlotte 3,655,000 3,139,750

Capital Stock 1,000 1,000

Additional paid-in Capital 99,000 99,000

Retained Earnings 807,000 1,394,750

Total Liabilities and Shareholders Equity $5,353,000 $5,736,500

5

Income Statement for the year ending December 31, 2017

Item Amount

Income:

Gross Sales $8,936,500

Less: Returns (354,000)

Net Sales 8,582,500

Cost of Goods Sold (4,910,500)

Gross Profit 3,672,000

Gain on Sale of Unimproved Land 600,000

Interest Income-Bank 3,750

Interest Income-U.S. Govt 6,000

Municipal Bond Interest Income 2,650

Total Income: 4,284,400

Expenses:

Officer Salaries 317,000

Employee Salaries 437,000

Repairs and Maintenance 12,600

Bad Debts 22,000

Rent 765,000

Payroll Taxes 84,500

Licensing Fees 10,750

Property Taxes 12,500

Interest Expense 175,500

Depreciation 180,000

Office Supplies 5,300

Employee Training 13,750

Key Man Life Insurance 12,000

Advertising 58,500

Employee Benefit Programs 133,000

Meals and Entertainment 3,750

Travel 8,500

Charitable Contribution 32,000

Federal Income Taxes (built-in gains tax) 140,000

State Income Taxes (built-in gain tax) 20,000

Insurance 18,000

Utilities 243,000

Telephone 142,000

Total Expenses: $2,846,650

Net Income (loss): $1,437,750