During 2020, an individual sells his incorporated business for its fair market value. At the time of the sale the business has accounts receivable of $123,000. The vendor of the business and the purchaser agree on a fair market value for these receivables of $118,500. In 2019, the vendor had deducted a reserve for estimated bad debts of $6,800. Which of the following statements is correct?

Question

Quizplus · Accepted Answer

The correct answer is B because the vendor had previously deducted a reserve for bad debts of $6,800, but sold the receivables for $118,500, which is $4,500 less than the original accounts receivable amount of $123,000. However, for tax purposes, the difference between the original accounts receivable and the fair market value at which they were sold ($123,000 - $118,500 = $4,500) needs to be adjusted by the previously deducted reserve for bad debts. Since the reserve was $6,800, the net addition to income for tax purposes is the difference minus the reserve, which is incorrect as stated. The correct calculation should consider the sale price and the reserve's impact on the original value, leading to the conclusion that the vendor will have an addition to net business income for tax purposes, but the precise calculation provided in the options is misleading. The principle behind option B is that the vendor needs to reconcile the difference between the book value and the sale price, adjusted for any reserves previously taken.

During 2020, an Individual Sells His Incorporated Business for Its