Purchase of Smithon Manufacturing, Mr. Jones Wants

¶ … purchase of Smithon Manufacturing, Mr. Jones wants to know if he should outright purchase all of the stock.

1(a). Smithon Manufacturing requires new equipment, which will cause debt for the first two years. If Mr. Jones decides to purchase all shares of the company, he will inherit the company's debt. Already the owner of Johnson Services company, one option is to issue debt to pay for the Smithon company. Issuing debt has its benefits, including reduction in taxable income due to issuance of interest payments to debt owners. In issuing debt, Mr. Jones would raise Johnson Services company's debt-to-equity ratio, which raises the chances of bankruptcy and may have difficulties receiving corporate loans in the future (Sharp Investing, 2007).

Mr. Jones wishes to change the structure of Smithon Manufacturing from a C corporation to an S corporation. AC corporation is a separate legal entity, and shareholders have liability protection from debts and obligations. Unfortunately, a C corporation is double taxed; it pays corporate income taxes as well as dividend taxes from shareholders (All Business, 2011). An S corporation passes all federal taxes through their shareholders. The shareholders are required to report all income and losses on their personal taxes. This way, double taxation is avoided (IRS.gov, 2010).

When changing the business to an S corporation, Mr. Jones will need to receive approval from the Internal Revenue Service to change his fiscal year date. Otherwise, he must remain using the December 1 date as the end of the fiscal year (IRS.gov, 2008).

1(c). If Mr. Jones purchases stock and converts the business to an S corporation, he will avoid double taxation that a C corporation would require. At the same time, the S corporation would require Mr. Jones to file a Schedule E. form with his 1040 form at the end of the year. This is where the business income will be reported (IRS.gov, 2010).

1(d). In the event that Mr. Jones decides to complete a statutory merger, in which one entity will continue to exist rather than being replaced, a Schedule D, Form 941 will need to be filed. This is required to allow the Internal Revenue Service and the Social Security Administration to verify that wage totals match employee W-2s and that appropriate taxes have been filed. If completing a statutory merger, the company will be required to file for a new employee identification number (EIN) (IRS.gov, 2011).

2(a). Mr. Jones wants to know whether or not the merger would allow Smithon Manufacturing to use Johnson Services' net operating loss carry forwards. When experiencing a net operating loss, Smithon Manufacturing may use this ideal circumstance to offset future income of the company. There is, however, a limitation; Section 382 determines limitations based on multiplying the total value of the company by the tax-exempt long-term bond rate at the time Mr. Jones were to purchase the company (W.B. Grimes, 2011).

2(b). If Mr. Jones uses Johnson Services stock to acquire Smithon Manufacturing, he would make the shareholders of Smithon Manufacturing the new shareholders of Johnson Services. Depending on the agreement set up with Smithon Manufacturing, the shareholders may have considerable say in the business decisions of Johnson Services. If Mr. Jones already has considerable amounts of shareholders with Johnson Services, he will need to ensure he does not go over the federal one hundred shareholder limit for S corporations (IRS.gov, 2010). If Mr. Jones determines this limit is not reached, he may further consider the idea. Smithon Manufacturing is set to have losses for the next two years, and Mr. Jones will need to determine as to if he is willing to accept this responsibility on his personal taxes.