Accounting 625

Fall 2019

Client Memo Assignment

Irene Pesco is the owner of Delicious Alternatives, an unincorporated business that she operates as a

sole proprietorship. Delicious Alternatives produces a plant

-based formula that can be processed into

food products that taste, smell, and feel identical to meat products such as be

ef, poultry, and seafood.

The business then processes and sells the product to retailers and restaurants. For the past few years,

Irene has spent all her time

, money,

and energy in developing this formula and testing the end product

by offering it to vari

ous retailers and restaurants for free. Based on her research and feedback from her

customers, the formula has now been fully developed into a marketable product. Increasingly,

customers are now willing to pay for the end products and new customers are co

ntacting the company

and inquiring about the product. Irene believes that the companys products can be launched on large

scale with an adequate level of marketing and advertising. However, Irene has neither the funds nor the

expertise to engage in such marketing efforts.

Mark Norman, an investor, has offered to invest $100,000 in Irens company. In addition, Keystone

Promotions, LLC, a marketing firm owned solely by

William Drake, has agreed to perform the necessary

marketing and promotional activities to launch the products in exchange for a share in the company.

After the initial launch, the trio believe the company will be in a great position to go after larger

investors and obtain enough capital to rapidly rise to the level of a multinational supplie

r of food

products.

To accommodate its objectives, Iren, Mark, and William agreed to form a new corporation, Delicious

Alternatives, Inc. Irene, Mark, and Keystone Promotions, LLC will each contribute to the new

corporation as follows:

Irene will transfer

all assets and liabilities of the existing unincorporated business. The business

has assets with adjusted basis of $

500,000 and liabilities of $

400,000. The parties engaged a

business valuation consultant, who determined the total value of all of the businesss assets,

including the goodwill and going concern, to be $

1,000,000.

Mark will transfer $

200,000 cash to the new corporation, to fund some of the out

-of-pocket

costs incurred in marketing activities.

Keystone Promotions, LLC will perform the initia

l marketing and promotion

functions

necessary

to establish the needed market awareness and name recognition for the company. Over the

course of the next eight months, these services are estimated to be worth $

400,000.

In exchange for their contributions

, the parties will receive the following:

Irene: 6

00 shares in Delicious Alternatives, Inc.

Mark: 2

00 shares in Delicious Alternatives, Inc.

Keystone Promotions, LLC: 4

00 shares in Delicious Alternatives, Inc.

The corporation will have a single class of share. For the next round of investments, additional classes

with varying ownership and voting rights will be considered.

Irene has come to you for advice. Specifically, she is concerned about the tax consequences of the

transaction. Over the years, in a

ddition to the debt incurred to support the operations of her business,

she has invested every dollar she owned in the business and cannot afford a large tax liability. If the

transaction has adverse tax consequences, she would like to know whether there are things she can do

Accounting 625

Fall 2019

Client Memo Assignment

to mitigate them.

Irene would also like to know her basis and holding period in the stock of the newly

created corporation, and the corporations basis

in its assets under all alternatives considered.

Please proved your advice to Irene in the form of a client memo.