Taylor Fredrickson owns 90% of a medical device company that manufactures artificial heart valves, Heart Valves Inc. Taylor works as the corporate CEO. The business was incorporated in 20x1 and filed as a C Corporation through the end of 20x2. For his 90% ownership, Taylor contributed a  prototype heart valve device he acquired for no cost through a failed research project in his past along with $10,000 cash. The company's minority owner is Jon Sheppard who contributed $150,000 cash to get the company started for his 10% ownership. Jon is an investor who doesn't work in the business. Taylor has been advised and believes he should convert the corporation to a "flow-through" entity as of January 1, 20x3.
Starting in 20x1, Heart Valves Inc. developed the artificial valve technology using contract research and engineering firms. Heart Valves then utilized contract manufacturers to produce the product, "just in time," and ship directly to Heart Valves' customers. Therefore, the company does not have any inventory on hand. The company's operations consist of three employees besides Taylor, and the operations consist of managing research and manufacturing contractors, working through
regulatory and compliance requirements for medical devices, sales and marketing.

 

 

In late 20x1, Taylor loaned the company $300,000 structured as an open line of credit, without a specific payment date but with an annual interest accrual of 5%.
During 20x2, the company obtained a loan from First National Bank, for $550,000 to make additional investments in research and development. The bank has agreed to allow a change in legal entity, if necessary, for Heart Valves to convert to a flow-through entity.
Heart valves had accumulated earnings and profits of $1,300,000 as of December 31, 20x2. It is believed that the company's intellectual property has value, but the amount is unknown. The company otherwise leases office space and equipment and has no significant assets.
As of December 31, 20x2, the company has accumulated $2,310,000 in cash on the balance sheet. Taylor would like to start taking some of his profits out, above the $200,000 annual salary he receives as W-2 wages. The company expects to run a loss of $1,100,000 to $1,400,000 in 20x3 due to spending on new research to develop a new product. For the sake of our exercise, let's assume that the ordinary loss in 20x3 is $1,400,000. They expect to return to running a profit of at least $1,000,000 in 20x4. 

Taylor's questions:
If converting to an S Corporation...

 

a) Is the company qualified to elect to be an S Corporation? In your response address all the requirements to be an S-corporation and whether or not Heart Valve satisfies these requirements. 
b) If the S election can be made, what are the steps necessary to make the S election effective January 1, 20x3? 
c) Based on the information provided, please construct the beginning balance sheet as of January 1, 20X3.

Answer rating: 100% (QA)

a Qualification for S Corporation Election To qualify as an S Corporation Heart Valves Inc must satisfy certain requirements 1 Eligible Entity Type He... View the full answer