Jerry and Matt Decide to Form a Business

question 74

Multiple Choice

Jerry and Matt decide to form a business. Jerry will contribute $4,200 for a 35% interest and Matt will contribute $7,800 for a 65% interest. The business will take out a $25,000 loan to cover the balance of their working capital needs. They expect that the business will have a loss of $38,000 for the first year. In the second year, the business will have a profit of $52,000 and it will distribute $5,200 to Matt and $2,800 to Jerry. Jerry is in the 32% marginal tax bracket and Matt is in the 24% marginal tax bracket. Their marginal tax brackets will not change as a result of profit or loss from this business. What is Matt's stock basis at the end of the second year if they organize the business as an S corporation?

• A) $0
• B) $11,700
• C) $28,600
• D) $33,800
• E) $44,850

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Definitions:

Source of Cash

Any activity or operation within a business that generates cash inflow.

Inventory Acquisition

The process of obtaining and adding goods or materials to a company's stock for further sale or use.

Cash Increase

An uptick in the amount of liquid assets (cash and cash equivalents) that a company or individual has on hand.

Current Ratio

Current ratio is a liquidity ratio that measures a company's ability to pay short-term obligations or those due within one year, by comparing current assets to current liabilities.