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Our client, Pacific Leisure Corporation is a multistate retailer of outdoor apparel. It has

$25$ retail stores located in the western United States. It is a C corporation with a calendar

year$-$end. Pacific Leisure is very profitable. It has reported taxable income ranging from

$$10$ to $$12$ million in each of its five previous tax years. Its effective tax rate for

financial reporting purposes is $28\mathrm{.}5\%$ for its year ended December $31,20231.$ Pacific

Leisure$$s stock is publicly traded.

Larry Smith is the chief financial officer for Pacific Leisure. Larry has been actively

looking for business opportunities to increase the value and stock price of Pacific Leisure.

He is also concerned about the amount of federal and state income taxes paid by the

company. Larry has been investigating opportunities to reduce Pacific Leisure$$s income

tax liabilities.

Larry was recently contacted by one of Pacific Leisure$$s suppliers, Rugged Shoe & Boot,

Inc. Rugged has been in the business of manufacturing hiking boots since the early

$1960$s$.$ Its business has suffered greatly in recent years due to foreign competition.

Rugged cannot compete with its competitors$$ low$-$cost foreign labor. Rugged wants to

know if Pacific Leisure would be interested in acquiring Rugged.

$1$ The financial statements for the year ended December $31,2023,$ have not been finalized nor has the

financial statement audit been completed as of this date.

$2$

Rugged is a closely held C corporation. It is a January $31$ fiscal year$-$end taxpayer.

Rugged provided the following information to Larry pertaining to its estimated assets and

liabilities for its tax year ending January $31,20242$:

Fair Market Value Tax Basis

Cash $ $350,000$ $ $350,000$

Trade Receivables $500,000520,000$

Fixed Assets, Equipment $950,000950,000$

Land$/$Buildings $11,500,0002,300,000$

Misc. Assets $200,000250,000$

Trade Payables $(625,000)(625,000)$

Pension Liabilities $(1,800,000)(1,800,000)$

Long$-$term Notes $(7,500,000)(7,500,000)$

In addition, Rugged has a federal net operating loss $($NOL$)$ of $$15\mathrm{.}5$ million as of January

$31,20233.$

Rugged$$s initial asking price is $$4,200,000$ for its stock or $$15,500,000$ for its assets. No

liabilities would be assumed by Pacific Leisure if it the acquisition is structured as an

asset purchase.

Larry is interested in acquiring Rugged for two reasons:

$1.$ Acquiring Rugged$$s NOL to shield future taxable income of the combined Pacific

Leisure and Rugged businesses. Larry estimates that the combined businesses

$2$ The financial statements for the year ended January $31,2024,$ have not been finalized. The financial

statement audit for the year is scheduled to take place in March $2024.$

$3$ Per IRC Sec$\mathrm{.}172($b$)(1)($A$)($ii$)$ prior to the enactment of TCJA, none of the NOLs are set to expire

before its year ending January $31,2030.$

$3$

will generate taxable income in excess of $$75$ million over the next five years.

Could the NOL shelter the income?

$2.$ Acquire the real estate owned by Rugged. The real estate consists of its

manufacturing and warehouse locations. The properties are located in prime and

strategic locations in the states of Oregon and New York. There are already a few

commercial developers who have made inquiries to Rugged asking if they would

be willing to sell the real estate. Pacific Leisure may be interested in holding the

real estate as investment property or selling the properties to generate cash.

Larry stated that the Pacific Leisure board of directors is not very interested in continuing

the boot manufacturing business of Rugged. Thus, what the board would like to do is to

acquire Rugged, discontinue the boot manufacturing operations, sell the real estate within

the next several years, and use the NOL to shield future taxable income of the combined

operations.

Larry has several tax issues that he wants our firm to address. The questions are:

$1.$ What are the tax implications to Pacific Leisure if it purchases the assets of

Rugged?

$2.$ What are the tax implications to Pacific Leisure if it purchases the stock of

Rugged?

$3.$ How should the transaction be structured in order for the combined businesses to

utilized Rugged$$s NOL, if possible?

I am requesting that you provide me with a research memorandum addressing Larry$$s tax

issues. I need the memo no later than February $15,2024.$

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