While James Craig and his former classmate Paul Dolittle...

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1 While James Craig and his former classmate Paul Dolittle both studied accounting at school, they ended up pursuing careers in professional cake decorating. Their company, Good to Eat (GTE), specializes in custom sculpted cakes for weddings, birthdays, and other celebrations. James and Paul formed the business at the beginning of 2009 and each contributed $50,000 in exchange for a 50 percent ownership interest. GTE also borrowed $200,000 from a local bank. Both James and Paul had to personally guarantee the loan. Both owners provide significant services for the business. The following information pertains to GTE’s 2009 activities. GTE uses the cash method of accounting (for both book and tax purposes) and reports income on a calendar-year basis. GTE received $450,000 of sales revenue and reported $210,000 of cost of goods sold (it did not have any ending inventory). GTE paid $30,000 compensation to James, $30,000 compensation to Paul, and $40,000 of compensation to other employees (assume these amounts include applicable payroll taxes if any). GTE paid $15,000 of rent for a building and equipment, $20,000 for advertising, $14,000 in interest expense, $4,000 for utilities, and $2,000 for supplies. GTE contributed $5,000 to charity. GTE received a $1,000 qualifying dividend from a great stock investment (it owned 2 percent of the corporation distributing the dividend) and it recognized $1,500 in short- term capital gain when it sold some of the stock. On December 1, 2009, GTE distributed $30,000 to James and $30,000 to Paul. Required: a. Assume James and Paul formed GTE as an S corporation.
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