Shannon Properties

Case 3 Accounting 432/732 Shannon Properties

The purpose of this case is to contrast the income tax treatment of a C corporation and its shareholders with that of a general partnership and its partners. The case has two dimensions: (1) to look at the income tax implications of operating the entity and then of terminating it, and (2) to measure the federal and the state income tax components. Initially we will assume that Shannon is a closely held C corporation with a wholly owned subsidiary; then we will assume that Shannon is a general partnership. Operating activities and financial information for the entity will remain the same, only the capital structure and amounts associated with payment of income taxes will change.

Background Information

Shannon Properties was formed on January 15, 1989 under the laws of the state of Iowa. Since January 1991, the company has owned and leased a motel in Des Moines. Subsequently Shannon acquired a small office building in Sioux City (1997) and expanded its motel leasing operations to Sioux Falls, S.D. (1995, 1996) and acquired another small office building and warehouse in Moorhead, MN. (1998, 99). To finance these activities the company secured non recourse debt on the land and buildings. Operations have generally been profitable with positive cash flows. However occupancy levels at the Sioux City office building have proved disappointing.

In 1996 the company acquired 500 acres of investment land west of Edgemont, SD for $110,000. At that time, New Castle Industries was contemplating building a rail line over the land from a terminus in Mule Creek Junction, center of their coal mining operations in eastern Wyoming. Subsequently (2000) the company constructed a spur line to the south through Ardmore, SD. Since the likelihood of recovering the cost was limited, Shannon in November 2003 sold the property to a local rancher, Ferrell Purdue, for $20,000. Exhibit A provides details on the federal income tax treatment of this transaction.

Bob Norgard (57), his wife, Maureen (54), and their two children, Kim (28) and Greg (31) were equal owners of Shannon. Bob managed the day to day activities, while Kim looked after the finances. Because of their strategic locations, Wall Lake Services, a Minneapolis based real estate investment company approached Bob and Kim in October, 2003 about purchasing the Shannon’s land and buildings (except Edgemont) for a price of $7,145,000. After some discussion among the family members, Shannon’s ownership agreed to Wall Lake’s proposal with a date of sale of December 31, 2003. Exhibit A furnishes a breakdown of the sale details by location and shows the federal corporate income tax treatment for each component.

Shannon terminated its operations on December 31, transferred its property to Wall Lake and paid off all its debts (except for income taxes) as of that date. Subsequently the company paid the income tax liabilities and completely dissolved as of March 15, 2004, distributing the remaining cash to the owners. Exhibit B provides details of the operating activities of Shannon for the year ended December 31, 2003.

0e583a7f8483fa4608752421e5151570.doc 1 Part 1 Shannon, Inc. and Subsidiary

Assume that Shannon was incorporated in Iowa and operated in that state and in Minnesota. Assume also that Shannon created a wholly owned subsidiary, Ardmore Properties, for its South Dakota operations. Shannon elected to file consolidated Federal and consolidated Iowa income tax returns. Note that Shannon paid $10,000 in Federal income taxes prior to 12/31/03.

Required:

1. Using the accompanying 12/31/02 and 12/31/2003 trial balances for Shannon and Ardmore and the information contained in the case, prepare the 2001 consolidated federal income tax return including: Form 1120, Page 1, Schedule L, and Schedules M-1 and M-2. You should also use the consolidated tax return template in completing this assignment. Go to my home page, login (acc 330), password (katjie). Go to the computer resources section and download the consolidated tax return template on a floppy disk. It is not necessary to prepare tax trial balances since there are no tax adjustments except for federal income taxes.

2. Answer the following questions in regard to Shannon’s Federal income tax liability:

 Refer to Exhibit A—What is the difference in the Federal income tax treatment of Section 291 gain and Section 1231 gain? Is the Federal tax rate different? Why does Shannon not have Section 1245 or Section 1250 gain?

 Refer to Exhibit A—Note that Ardmore had a capital loss from the sale of the land. If Shannon had not filed a consolidated income tax return, how would you treat this transaction?

 Calculate the amount of taxable income and federal income tax attributable to (1) Shannon’s regular operations and (2) to the sale of the assets to Purdue and Wall Lake.

 Calculate the proceeds available to each shareholder after Federal and state income taxes. Then determine the amount of the gain to the Shannon shareholders from the dissolution of the corporations. (Assume that each shareholder’s basis in the parent corporation is $62,500 and that the holding period is long term). What is the nature of the gain?

 Calculate the final proceeds available to each shareholder after deduction of Federal and Iowa income taxes. Assuming all shareholders are residents of Iowa, use a combined Federal and Iowa income tax rate of 26.4%.

0e583a7f8483fa4608752421e5151570.doc 2 3. Based on the information developed in Part 1, use the Pro Series 2003 software to prepare a consolidated Federal Form 1120 and consolidated Minnesota and Iowa corporate income tax returns. See the accompanying instruction sheets for suggestions on Pro Series, accessing and entering supplementary information and printing your results.

0e583a7f8483fa4608752421e5151570.doc 3