Sean, a Sole Proprietor, Is Engaged in a Service Business

question 24

Essay

Sean, a sole proprietor, is engaged in a service business and uses the cash basis of accounting. In the current year, Sean incorporates his business by forming Aqua Corporation. In exchange for all of its stock, Aqua receives: assets (basis of $400,000 and fair market value of $2 million), trade accounts payable of $110,000, and loan of $390,000 due to a bank. The proceeds from the bank loan were used by Sean to provide operating funds for the business. Aqua Corporation assumes all of the liabilities transferred to it.

a. Does Sean recognize any gain on the incorporation? Explain.
b. What basis does Sean have in the Aqua stock?
c. What basis does Aqua Corporation have in the assets it receives?

---

Definitions:

Employer Payroll Taxes

Taxes that employers are required to pay on behalf of their employees, such as social security and Medicare taxes.

Federal Taxes

Taxes imposed by the federal government on income, sales, imports, and other activities.

Social Security Taxes

Compulsory payments made by employers and employees to fund the Social Security program, which provides retirement, disability, and survivorship benefits.

FUTA Tax Rate

The percentage rate at which employers are taxed under the Federal Unemployment Tax Act, funding state workforce agencies.