Amy and Brian agreed to pay $385,000 for the company. Ernesto has a tax basis in the BLI stock was $100,000. Included in the sales price was an unrecognized customer list valued at $100,000. The unallocated portion of the purchase price ($65,000) will be recorded as goodwill. The corporate-level tax of 21 percent applies to BLI as a result of the transaction. What amount of gain or loss does Ernesto recognize if the transaction is structured as a direct asset sale by BLI to Amy and Brian and BLI distributes the after-tax proceeds to Ernesto in liquidation of his stock?

a. $380,000; $129,200 b. $170,000 c. $530,000

Question ( In proper order )

Amy and Brian were investigating the acquisition of a tax accounting business, Bottom Line Inc (BLI). As part of their discussions with the sole shareholder of the corporation, Ernesto Young, they examined the company's tax accounting balance sheet. The relevant information is summarized as follows:  

                              FMV                Adjusted Basis            Appreciation  

Cash                 $  10,000         $ 10,000

Receivables         15,000             15,000  

Building                100,000          50,000                      $ 50,000

Land                      225,000       75,000                        150,000

Total                  $ 350,000     $ 150,000                     $ 200,000

Payables           $ 18,000         $ 18,000

Mortgage*             112,000           112,000

Total                  $  30,000      $  130,000  

*The mortgage is attached to the building and land.  

Ernesto was asking for $400,000 for the company. His tax basis in the BLI stock was $100,000. Included in the sales price was an unrecognized customer list valued at $100,000. The unallocated portion of the purchase price ($80,000) will be recorded as goodwill.

a) What amount of gain or loss does BLI recognize if the transaction is structured as a direct asset sale to Amy and Brian? What amount of corporate-level tax does BLI pay as a result of the transaction, assuming a tax rate of 34 percent?

b) What amount of gain or loss does Ernesto recognize if the transaction is structured as a direct asset sale to Amy and Brian, and BLI distributes the after-tax proceeds (computed in question a) to Ernesto in liquidation of his stock?  

c) What are the tax benefits, if any, to Amy and Brian as a result of structuring the acquisition as a direct asset purchase?

Explanation:

[a] The gain recognized by BLI is given in the table below

Gain or Loss Account

Fair market value of the stock received                 $ 400,000

+ Mortgage assumed by corporation                         130,000

Total Amount                                                                530,000

- Aggregate basis of the property transferred           150,000

Gain recognised                                                           380,000

the gain recognised = $380,000

corporate tax = 380,000 × 34%

                       = 380,000 × 0.34

                       = $ 129,200

[b]  Gain or Loss recognized by Ernesto

cash net received by ernesto

$400,000 - $129,200 (Taxes paid) = $270,800

Capital gain is computed thus

$270,000 - $100,000 = $170,000

[c] Tax basis for Amy and Brian is equal to the total fair market value as given in the table below

Cash                                    10,000

Account receivables          150,000

Building                               100,000

Land                                    225,000

Customer List                     100,000

Goodwill                              80,000

Total                                     530,000

summary tax basis for both Amy and Brian is $530,000