Dawn Taylor is currently employed by the state Chamber of Commerce

| August 14, 2017

Chapter
15, Comprehensive Problem 83

Dawn Taylor is currently employed by the state
Chamber of Commerce.
While she
enjoys the relatively short workweeks, she eventually would like to work for
herself rather than for an employer. In her current position, she deals with a
lot of successful entrepreneurs who have become role models for her. Dawn has
also developed an extensive list of contacts that should serve her well when
she starts her own business.

It has
taken a while but Dawn believes she has finally developed a viable
new
business idea. Her idea is to design and manufacture bed sheets that
have
various colored patterns and are made of unique fabric blends. The
sheets
look great and are extremely comfortable whether the bedroom is
warm or
cool. She has had several friends try out her prototype sheets and
they have
consistently given the sheets rave reviews. With this encouragement, Dawn
started giving serious thoughts to making “Color
Comfort
Sheets” a moneymaking enterprise. Dawn had enough business background to
realize that she is embarking on a risky path, but one, she hopes, with
significant potential rewards down the road. After creating some initial income
projections, Dawn realized that it will take a few years for the business to
become profitable. After that, she hopes the sky’s the limit. She would like to
grow her business and perhaps at some point “go public” or sell the business to
a large retailer. This could be her ticket to the rich and famous.

Dawn, who
is single, decided to quit her job with the state Chamber of
Commerce
so that she could focus all of her efforts on the new business.
Dawn had
some savings to support her for a while but she did not have any other source
of income. Dawn was able to recruit Linda and Mike to join her as initial
equity investors in CCS. Linda has an MBA and a law degree. She was employed as
a business consultant when she decided to leave that job and work with Dawn and
Mike. Linda’s husband earns around $300,000 a year as an engineer (employee).
Mike owns averyprofitable used car
business. Because buying and selling used cars takes all his time, he is
interested in becoming only a passive investor in CCS. He wanted to get in on
the ground floor because he really likes the product and believes CCS will be wildly
successful. While CCS originally has three investors, Dawn and Linda have plans
to grow the business and seek more owners and capital in the future.

The three
owners agreed that Dawn would contribute land and cash for a
30 percent
interest in CCS, Linda would contribute services (legal and business advisory)
for the first two years for a 30 percent interest, and Mike would contribute
cash for a 40 percent interest. The plan called for Dawn and Linda to be
actively involved in managing the business while Mike would not be. The three
equity owners’ contributions are summarized as follows:

Adjusted
Dawn
Contributed FMV Basis Ownership Interest

Land (held
as investment) $120,000 $70,000 30%
Cash $ 30,000

Linda
Contributed

Services $150,000 30%

Mike
Contributed

Cash $200,000 40%

Working
together, Dawn and Linda made the following five-year income
and loss
projections for CCS. They anticipate the business will be profitable and that
it will continue to grow after the first five years.

Color
Comfort Sheets 5-Year Income
and Loss Projections

Year Income (Loss)
1 ($200,000)
2 ($80,000)
3 ($20,000)
4 $60,000
5 $180,000

With plans
for Dawn and Linda to spend a considerable amount of their
time
working for and managing CCS, the owners would like to develop a
compensation
plan that works for all parties. Down the road, they plan to
have two
business locations (in different cities). Dawn would take
responsibility
for the activities of one location and Linda would take
responsibility
for the other. Finally, they would like to arrange for some
performance-based
financial incentives for each location.

To get the
business activities started, Dawn and Linda determined CCS
would need
to borrow $800,000 to purchase a building to house its
manufacturing
facilities and its administrative offices (at least for now). Also, in need of
additional cash, Dawn and Linda arranged to have CCS borrow $300,000 from a
local bank and to borrow $200,000 cash from Mike. CCS would pay Mike a market
rate of interest on the loan but there was no fixed date for principal
repayment.

Required:

a.
Identify significant tax and nontax issues or concerns that may differ
across
entity types.

b. Provide
your recommendation for forming CCS as a C corporation, S
corporation,
LLC, or partnership. Explain your reasoning for your choice
of
entity, identify any issues that you may still be concerned about, and
suggest
recommendations for dealing with the concerns.

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