Sixteen years ago, Biff, Buffy, and Buffy, Jr. organized Beach Wear Inc. (BWI) t

Question

Sixteen years ago, Biff, Buffy, and Buffy, Jr. organized Beach Wear Inc. (BWI) to sell beach wear throughout California. The sole class of common stock of BWI is owned by Buffy (60%) and her husband, Biff (20%), and Buffy, Jr. (20%). On December 1 of the tax year specified for the exam, BWI files an S election. As of December 31 of that same tax year, BWI’s balance sheet includes the following:

Asset

Adjusted basis

FWV

Accounts Receivable

$0

$300,000

Payments Due Under

Installment Sale

$450,000

$600,000

Machinery

$0

$225,000

BWI has a net operating loss for the year ended December 31 of the tax year before the year specified for the exam in the amount of $300,000.

a. The NOL reduces the taxable income calculated as if the S Corporation were a C Corporation under 1374(d)(2)(A).

b. The NOL reduces the recognized build-in gain of $375,000 by the $300,000 for purposes of the tax calculation. c. The NOL does not reduce the flow-through of the $300,000. Only the build-in gain tax reduces the flow-through of the $300,000.

d. B and C.

please explain why you choose this answer.

Asset

Adjusted basis

FWV

Accounts Receivable

$0

$300,000

Payments Due Under

Installment Sale

$450,000

$600,000

Machinery

$0

$225,000

Explanation / Answer

Ans - b. The NOL reduces the recognized build-in gain of $375,000 by the $300,000 for purposes of the tax calculation.

Explanation

A net operating loss (NOL) occurs when business deductions exceed business income and it can also occur when certain nonbusiness deductions exceed taxable income for the year. Tax law allows net operating losses to be deducted because they obviously reduce income. A NOL is first used to offset income in the year of the NOL, but if the NOL is greater than the income, then it can be used to offset income in other years.

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