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 33% marginal tax bracket and Matt is in the 28% marginal tax bracket. Their marginal tax brackets will not change as a result of profit or loss from this business. What is Jerry's basis at the end of the second year if they organize the business as a partnership?
A) $0
B) $6,300
C) $27,950
D) $15,050
E) $15,400

Question

Quizplus · Accepted Answer

Jerry's basis at the end of the first year was zero [$4,200 invested + ($25,000 loan x 35%) - $12,950 deductible loss]. The excess $350 loss is carried forward to the second year. His basis at the beginning of the second year is zero but is increased for his $18,200 ($52,000 x 35%) share of profits. It is reduced for the $2,800 distribution to him and his $350 loss carried forward from the first year. His basis at the end of the second year is $15,050 (0 + $18,200 - $2,800 - $350).

Jerry and Matt Decide to Form a Business