On January 1, 2006, the Branson Company (EIN 22-2222222) and Porto Engineering,Inc. (EIN 33-3333333), formed Branto, LLC (an equally owned joint venture). During its first four years, the LLC worked with the U.S. Department of Homeland Security and the National Transportation Safety Board to design and develop a specific device for airport passenger screening. Porto provides engineering expertise, and Branson provides high-tech manufacturing, selling, and distribution expertise. Early in 2011, the two governmental agencies recommended the product. In 2012, Branto’s screening device was being successfully marketed, sold, delivered, and installed in airports around the United States.
The LLC uses the accrual method of accounting and the calendar year for reporting purposes. Its current address is 3750 Airport Boulevard, Seattle, WA, 98124. The following information was taken from the trial balance supporting the LLC’s GAAP-basis (audited) financial statements for the 2012 calendar year:
Sales revenues $40,000,000
Interest income 50,000
Total revenues $40,050,000
Amounts related to cost of goods sold:
Beginning inventory $ 2,000,000
Materials purchases 8,000,000
Additional § 263A costs –0–
Other costs: Various items 2,700,000
Book depreciation 1,275,000
Less: Ending inventory (3,000,000)
Total amount of work in progress $19,975,000
Other costs not related to production:
Salaries and wages $ 1,000,000
Taxes and licenses 300,000
Charitable contributions 100,000
Interest expense 200,000
Meals and entertainment (subject to 50% disallowance) 1,200,000
Travel expenses 800,000
Employee benefit programs 300,000
Insurance (including key employee life insurance of $100,000) 300,000
Legal and professional fees 600,000
Office expenses 2,000,000
Sales and promotion expenses 2,500,000
Warranty expense (increase to reserves; not fixed and determinable) 300,000
Total other costs $10,400,000
Net income per books and GAAP-basis audited financial statements $ 9,675,000
The beginning and ending GAAP-basis balance sheets for the LLC were as follows at
December 31, 2012:
Cash $ 975,000 $ 1,825,000
Accounts receivable 620,000 2,600,000
Inventories 2,000,000 3,000,000
U.S. government obligations 1,000,000 1,000,000
Land 600,000 600,000
Buildings and equipment 12,000,000 15,000,000
Accumulated depreciation (6,375,000) (7,650,000)
Total assets $10,820,000 $16,375,000
Accounts payable $ 420,000 $ 800,000
Other current liabilities:
Operating line of credit (guaranteed by LLC members) 1,000,000 2,000,000
Warranty reserves (not guaranteed by members) 200,000 500,000
Mortgage notes on building 5,000,000 6,000,000
Capital, Branson Company 2,100,000 3,537,500
Capital, Porto Engineering, Inc. 2,100,000 3,537,500
Total liabilities and capital $10,820,000 $16,375,000
The LLC uses the lower of cost or market method for valuing inventory. Branto is subject to § 263A; for simplicity, assume that § 263A costs are reflected in the same manner for book and tax purposes. Branto did not change its inventory accounting method during the year. There were no write-downs of inventory items, and Branto does not use the LIFO method.
The LLC claimed $2,499,270 of depreciation expense for tax purposes (book depreciation is $1,275,000). All tax depreciation expense should be reported on Schedule A.
The LLC placed $3 million of assets in service during the current year; this exceeds the threshold for eligibility for a § 179 deduction. Tax depreciation amounts reflect bonus depreciation deductions (and these assets are not subject to AMT adjustments). Depreciation for assets placed in service in prior years creates an adjustment of ($276,900) for
AMT purposes. (This is a negative amount—book depreciation for these assets is greater than tax depreciation.)
All borrowings were used exclusively for business operations; consequently, none of the interest expense is considered investment interest expense. The LLC members were required to guarantee the debt related to the operating line of credit. The accounts payable, accrued warranty claim liabilities, and mortgage were not guaranteed by the members.
The mortgage relates to the real property and is considered qualified nonrecourse financing. The partners share equally in all LLC liabilities, because all initial contributions and all ongoing allocations and distributions are pro rata.
The LLC’s activities are eligible for the domestic production activities deduction (DPAD). For simplicity, assume that the LLC’s qualified production activities income (QPAI) is $9.5 million. The LLC’s production-related W–2 wages are $10 million.
No guaranteed payments were paid to either of the LLC members. Instead, the members each withdrew $3.4 million of cash during the year. The LLC has never made a distribution to the partners of noncash property. The LLC has not made a § 754 election and had no transactions during the current year that would warrant such an election. None of the members sold any portion of their interests in the LLC during the year.
Both LLC members are U.S. Subchapter C corporations. The LLC’s operations are entirely restricted to the United States, and all sales were to U.S. businesses. The LLC had no foreign operations, no foreign bank accounts, and no interest in any foreign trusts or other LLCs. None of the members contributed cash or other property to the
LLC during the year.
Both members are classified as “corporations” and “LLC member-managers” on
Schedule K–1. The capital account analysis on Schedule K–1 is prepared on a tax basis.
On the Analysis of Income (Loss), the IRS’s instructions indicate that the amounts for any LLC members should be reported on the line for limited partners.
The IRS’s business code for “Other specialty trade contractors” is 238900. The LLC files its tax return in Ogden, Utah. Branson Company is located at 3750 Airport Boulevard,
Seattle, WA 98124 (the same as the LLC’s address). Porto Engineering, Inc., is located at 42100 Highway 980 West, Tacoma, WA 98401. The LLC member corporations are each owned by several unrelated individual taxpayers. Branson Company is the tax matters partner.
The capital account reconciliation on the partners’ Schedules K–1 is prepared on a
GAAP basis, as is the LLC’s Schedule L. The LLC is required to file Schedule M–3, Form
8916–A (Supplemental Attachment to Schedule M–3), and Schedule C with its Form
a. Prepare pages 1–5 of Form 1065 for Branto, LLC. Do not prepare Form 4562. Leave any items blank where insufficient information has been provided. Prepare supporting schedules as necessary if adequate information is provided. You may assume that the answer to each “yes/no” question on page 3 is “no” unless discussed above.
b. Prepare Schedule M–3 and Form 8916–A (page 1). Do not prepare Schedule C.
Hint: You will find four book-tax differences (two temporary differences and two permanent differences).
c. Prepare Schedule K–1 for 50% LLC member Branson Company.