3. The Ace Sporting Goods Store (an S corporation) is owned by Dick and Harry. D

Question

3. The Ace Sporting Goods Store (an S corporation) is owned by Dick and Harry. Dick and Harry each own one-half of Ace's stock and have a $2,000 basis in their respective shares. At incorporation, Dick loaned $4,000 to Ace and received a five year, 12% note from the corporation.

(a) If Ace has an $8,000 loss from business operations this year, what will be the results to Dick and Harry? Do you have any suggestions for Harry? Would it matter if on December 15 Ace borrowed $4,000 from its bank on a full recourse basis? What if Dick and Harry personally guaranteed the loan? Compare §§752(a) and 722.

(b) If Ace has $6,000 of net income from business operations next year, what will be the results to Dick and Harry?

(c) What difference would it make in (a), above, if the $8,000 loss was made up of $2,000 of losses from business operation and a $6,000 long-term capital loss? See Reg. §1.704-1(d)(2).

(d) What would be the effect in (a), above, if Ace's S corporation status was terminated at the end of the current yea

Explanation / Answer

Solution.

(a) If Ace has an $8,000 loss from business operation this year, then thre result to Dick and Harry would be sharing the amount of $8,000 loss in eqaul ratio (1:1). Hence the liability of Dick and Harry would be $4,000 and $4,000 each.

Suggestion to Harry for the making correct decision related to profit sharing sharing ratio befor joining the Ace firm.

Yes it would matter if on December 15 Ace borrowed $4,000 from its bank on a full recourse basis then the liability of $4,000 also increased for the Dick and Harry as there is a loss in the firm and not able to repay any kind of liability.

If Dick and Harry personally guarantee the loan then they have to pay the amount of loan personally from their persoal estate.

By comparing the U.S. Code §§752 any increase in a partner's share of the liablilities of a partnership, or any increase in a partner's individual liablilities by reason of the assumption by such partner of partnership liabilities, shall be considered as a contribution of money by such parter to the partnership.

(b) If Ace has $6,000 of net income from business operations next year, then the result to Dick and Harry would share the net income of $6,000 after paying the debt amount of the firm. Which is $480 ($4,000 X 12%)

(c) If the above $8,000 loss was made up of $2,000 of lesses from business and long term capital loss is $6,000 then the total loss would be same treated as above because the total loss would be same $8,000 (6,000+2,000)

(d) If the Ace's corporation terminated at the end of the current year then the all liabiliity must be paid by selling the said assets which had the Ace firm and reming loss or profit distrubited between the partners Dick and Harry in their profit sharing ration (1:1)

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