Bob’s decision to move his business from a Sole Proprietorship to an S-Corporation

/in /by

Scenario

Beechwood Bake Shop – Backstory

Bob has been running a small bakery as a sole proprietorship for several years. His business has grown steadily each year. He is well known for his cookies and cupcakes. In addition, he has Betty, whom he has known for years, provide custom cakes.

Bob owns the small shop that Beechwood operates out of. In addition, he has opened up a satellite location on the other side of town. The original location has a kitchen where everything is made, and the satellite location receives a daily delivery of finished product to sell. There is a van, owned by Bob, which is used for the daily delivery, as well as delivery of the custom cakes to various locations when needed.

Additional Location

The satellite location is a small storefront that is owned by Betty. Betty’s family has owned the property for years. It is completely paid off and she does not charge any rent for the location. She knows that Bob has always talked about growing the company from a sole proprietorship to a corporation, and they have an unwritten agreement that if/when that happens, Betty will become a part owner in exchange for providing the store front.

Family Component

Bob’s daughter, Jessie,  has recently moved back to town and has been working at Beechwood. In addition to putting in hours just working the counter at the satellite location, she has begun reaching out to local businesses, primarily restaurants and grocery stores, about selling the cookies, cupcakes, and cakes. She has been quite successful in bringing in some new business, and Bob has started looking to hire another baker to help out with the additional volume.Bob is delighted with Jessie’s dedication and success, since he was hoping to one day leave the business to her.

In addition to Bob, Betty, and Jessie, each location has the equivalent of 1.5 employees working. 

Instructions

Bob’s attorney, Haley Boling, has been after him for years to incorporate. She has explained (many times) that moving from a sole proprietorship to a S-Corporation will not only help to limit Bob’s potential liabilities, but it can also make it easier to build a business succession plan. 

Bob has decided that now is the time to make the change and has agreed to meet with Haley to “get the ball rolling.” At their meeting, they hammer out the following things:

Additional Information

  • The company will become an S-corporation.
  • Only including common stock.
  • The ownership interest for the common stock of the new company will be:
    • 60% to Bob, 20% to Betty, and 20% to Jessie
  • Haley will handle the legal establishment of the new entity including:
    • Retitling/transferring assets from the proprietorship to the corporation.
    • Filing any necessary state/federal forms.
    • Creating and issuing shares to the stockholders.

Your role

Everything is moving right along in the discussions when a big snag comes up. Haley informs Bob that she does not feel comfortable providing tax advice or answering tax questions for the changes that will occur. Haley recommends you, in her place, since she has worked with you on numerous other occasions and those experiences have all turned out well. Bob agrees, and they reach out to you. You tell, Haley and Bob to send you their questions and you will respond accordingly.

The Assignment

Please complete the assignment following the instructions:

Write 1–3-page academic summary using the scenario above regarding Bob’s decision to move his business from a Sole Proprietorship to an S-Corporation: 

Support your summary by supplying the following information:

  1. Identify two Pros and two Cons of Business Ownership in an S-Corporation:
    • From a tax perspective, what are the pros and cons of putting the buildings in the company’s name or keeping them in Bob’s and Betty’s name and charging rent?
    • Will / should the stockholders (Bob, Betty, and Jessie) receive a paycheck?
      • How will this impact the taxes that they pay?
      • How will it impact the taxes that Beechwood Bakery pays?
  2. Identify four impacts of the owners receiving a paycheck on the taxes paid for an S-Corporation. Historically, since the company operated as a sole proprietorship, Bob was responsible for paying income taxes on the profits.
    • How will that work move this forward as an S-Corporation?
      • Who will be responsible for paying the income taxes?
      • Will Beechwood Bakery itself pay any income taxes?
  3. Identify four ways income taxes are handled within an S-Corporation?
  4. Identify the four income tax forms required for a S-Corporation in this scenario.
  5. Identify a 351 transfer within a S-Corporation and how it applies to this scenario.
 
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