Galadriel Elvin, a wealthy entrepreneur, is returning home after taking the eldest of her three children to start college on the other side of the country when she notices that the person sitting next to her in the first-class cabin is absentmindedly fiddling with a pink substance. When she asks about it, Bill Halfacre explains that he has developed it because he is spending a small fortune on batteries for his young children’s toys. Simply dipping regular alkaline batteries in the substance for an hour has proven to more than double the effective life of the batteries.

When Galadriel mentions that this is a great idea, Bill replies that he is a bit depressed because he has been trying to connect with someone who can help him develop and market the product, but has been unsuccessful. Galadriel encourages him, and discovers that he has lived a varied and interesting life.

He had earned several degrees in chemistry, but had spent all of his time since graduating surfing throughout the world and tinkering with various inventions.

(He inherited enough money that he has not had to work since he finished school five years ago, but the money is running out.)

By the time the plane lands, Galadriel and Bill have set a time to meet with Galadriel’s lawyer, Elsa Treebeard, to discuss a venture to market Bill’s products.

They have also invited one of Galadriel’s colleagues, Jim Pippin, to attend the meeting. Jim has worked with Galadriel on several occasions; he makes a lot of money, but keeps very little of it. He is a marketing whiz who has strong connections to several distributors to large office supply outlets. Galadriel’s concern with Jim has always been that he plays things a bit fast and loose.

At the meeting with Elsa, the group develops projections of profits and losses for the first five years of the business. The expectation is that annual losses will range from \($100,000\) to \($200,000\) over these five years, with break-even occurring in about year five. The business will be capitalized with about \($200,000\) in cash, along with computers, equipment, furniture, and fixtures (fair market value of \($100,000\) and basis of \($25,000)\) contributed by Galadriel. Bill will contribute the patent at an agreed value of \($150,000\). Jim has nothing to contribute but time. He will receive a 25% interest for contributing all of his time for a year to get the business going. Thereafter, he will be compensated based on sales and profits. Elsa believes they will be able to borrow \($200,000\) initially and perhaps an additional \($100,000\) per year during the development period. The money will be used for working capital and manufacturing equipment. They feel that they may be able to attract new investors once some of the initial work has been completed.

Galadriel thinks Jim brings some needed talents to the venture, but she is very uneasy about being exposed to liabilities that he might create. Bill says he has nothing to lose, so the association with Jim does not concern him. Galadriel has about \($500,000\) in income each year. Bill’s income is about \($25,000\) a year, and Jim has earned anywhere from \($0\) to \($200,000\) annually over the last few years.

How should state and local taxes impact the major strategic decisions faced by the three entrepreneurs as they start up the business?