Mimi’s CupcakesTax Research Memorandum
Mimi Charpentier, operates a successful sole proprietorship which sells cupcakes to retail customers at fourlocations in Las Vegas. Mimi’s Cupcakesdoes not carry any inventories, because of the nature of its products. Mimi owns the four small buildings in which the shops exist. One of the stores is slightly larger than the others; it is Mimi’s original location, and it still is the site of the kitchen and the loading dock where the Cupcakes trucks daily pick up and deliver merchandise and supplies. The workforce of each store is the equivalent of 2.5 employees; the employees are paid reasonably well, and the low-pressure atmosphere of the typical workday results in a very low turnover rate. Mimi’s offers only one fringe benefit to the employees –it encourages the employees to use Health Savings Accounts for their medical costs, and Mimi’s reimburses the employee for the out-of-pocket deductible amounts, to a $2,500 maximum per employee per calendar year.Mimi’s attorney, Gloria Willis, has urged Mimi to incorporate the business, primarily because of the limited shareholder liability associated with corporate status, and to facilitate a business succession plan for the operation. After several years of discussions, Mimi has agreed to go ahead with this idea. She plans to take a sixty percent ownership interest in the common stock of the new entity; twenty percent interests will be made available to Mimi’s daughter Nancy, and to Joan Price, the chief operating officer of the business, who is not related to the other two shareholders.Mimi has operated the business as a cash basis sole proprietorship since 2009, and she anticipates incorporating the business on January 1 of next year. A summarized projected balance sheet for the business as of December 31of this years attached. Willis’ practice consists of general work with small business clients. She is not by any means conversant with the federal income tax rules as they apply to individuals and C corporations. In this process, Willis is concentrating on the establishment of the new corporate entity, the retitling of assets as they are transferred from the proprietorship to the corporation, and the mechanics of creating and issuing shares to the new shareholders. Nancy recently graduated from community college in restaurant and hospitality management, with an emphasis in financial recordkeeping. Joan is about fifty years old, in good health, and planning to remain in charge of operating decisions for the three stores for the foreseeable future. Neither Mimi nor Joan projects that the corporation would add a fifth store, nor would it expand outside of Las Vegas, but the parties review these issues at least once a year.
The proprietorship does not carry any debt; its trade payables and receivables are disposed of in a timely fashion. Its website allows for remote ordering, scheduled pickups, and deliveries of larger orders to customer locations. Mimi’s is active on Twitter and Facebook, where the company has about five thousand friends/followers. This presence allows Mimi’s to plan and carry out “spontaneous” outdoor events on the stores’ patios, where high-markup products are made available in plentiful quantities, this really made a difference in 2020.As Mimi has told you several times, “this is a simple business, and we know how to keep our customers happy and coming back on a regular basis. I do not want the legal etc. aspects of an incorporation to disrupt the good thing that we have here.” But, in your dealings with Mimi over the years concerning her Forms 1040 and employment tax obligations, you know that she expects you to give her suggestions about how her tax liabilities would be affected by decisions that she makes, and that she expects to “get it right the first time” when she makes her choices.At Mimi’s latest appointment with her hairdresser, Cathy Duvall mentioned that her own salon was about to incorporate, but that Duvall would retain her individual ownership of the land and building. Duvall was certain that there were tax and legal advantages to structuring the corporation that way, but she could not really explain to Mimi what those advantages were
.Required:You will be meeting shortly with Mimi, Nancy, and Joan to discuss the tax aspects of the incorporation.Be sure to review the following items:
•Review the various options available for operating the business and the tax consequences of these options.
•Mimi certainly will ask you to cover the issue of which assets to contribute to the new corporation, with the explanations that Duvall could not provide. Concentrate on those issues for this meeting, offering at least two alternative plans for the asset transfers be sure to include computation of tax effect of the alternative plans.
•At the meeting, Nancy will look to you for information on issues of asset basis, as well as any effects that the incorporation might have on sales/use and self-employment tax obligations. •Ignore any exposure to the individual alternative minimum tax.