WriteRight, Inc. has engaged us to prepare its 2012 Federal (but not state) income tax return. Your responsibilities are as follows:
1. Prepare WriteRight, Inc.'s 2012 Federal income tax return, Form 1120, including any supporting information and forms that you feel are necessary. All necessary tax forms (e.g., Form 1120) and the related instructions may be obtained. Unless otherwise indicated in the attached information, you should reduce taxable income as much as possible.
2. Write a letter to Russ Engle, the Treasurer of WriteRight, Inc., that includes instructions on how to file the return (where, when, etc.) and summarizing how much is owed as well as brief explanations of our treatment of any items that might surprise Mr. Engle (he knows GAAP quite well but doesn't know much about tax rules and regulations...). Further, if estimated tax payments are necessary for 2013, instruct Mr. Engle on how and when to make them.
David Suroff is a graduate student in engineering at the University of Missouri at Columbia. David wrote so many papers as an undergraduate that he developed a new writing instrument to cut down on his writer's cramp. He found that his new pen, called Mr. Write, worked beautifully for him. He showed it to his friends, who tried it out and really liked it. One even remarked, "I would pay a lot of money for a pen like this!" That comment got David thinking about developing the product and marketing it to the general public. He immediately got a patent on his design. However, he was not a businessman; at times he could barely handle balancing his checkbook! But all was not lost. David had a friend, Russ Engle, who was a graduate student in accounting and a CPA. Russ liked the product and volunteered to help David set up the company and run its business affairs. All they needed now was some startup capital.
Russ had a friend, Josh Bonstead, an MBA student, who was independently wealthy and might be interested in investing in the idea. After trying out the product, Josh agreed to come aboard. Russ scheduled a meeting between the three of them to work out the details. At the meeting, the group discussed the possible formation of a new venture and developed projections of profits and losses for the first five years of operations. The business was to be capitalized with $342,000 of cash and buildings worth $360,000 contributed by Josh. In return, he received 65% ownership of the new venture. David contributed the patent for the new product, with an agreed value of $270,000 (David has no basis in the patent) in return for a 25% interest in the venture. It was agreed that Russ would receive a 10% interest in the venture in return for his contribution of office furniture worth $108,000. Additionally, all three of them are to receive salaries based in part on sales and profits. Finally, Josh helped arrange a loan for $400,000 to be used for working capital and manufacturing equipment. The feeling was that they would be able to attract more investors after some of the start-up work had been completed.
Josh was excited about the new venture and about the drive and abilities of his new business associates. However, neither of them had any appreciable assets to speak of, and Josh was concerned about possible exposure to liabilities that might be created by the new venture. Based on his concerns, Josh persuaded David and Russ to organize the new venture as a corporation under Missouri state law and under Subchapter C of the Internal Revenue Code of 1986.