Daisy has developed a viable new business idea. Her idea is to design and manufacture cookware

that remains cool to the touch when in use. She has had several friends try out her prototype

cookware and they have consistently given the cookware rave reviews. With this encouragement,

Daisy started giving serious thought to starting up a business called Cool Touch Cookware

(CTC).

Daisy understands that it will take a few years for the business to become profitable. She would

like to grow her business and perhaps at some point go public or sell the business to a large

retailer.

Daisy, who is single, decided to quit her full-time job so that she could focus all of her efforts on

the new business. Daisy had some savings to support her for a while but she did not have any

other source of income. She was able to recruit Kesha and Aryan to join her as initial equity

investors in CTC. Kesha has an MBA and a law degree. Kesha was employed as a business

consultant when she decided to leave that job and work with Daisy and Aryan. Keshas husband

earns close to $300,000 a year as an engineer (employee). Aryan owns a

very

profitable used car

business. Because buying and selling used cars takes all his time, he is interested in becoming

only a passive investor in CTC. He wanted to get in on the ground floor because he really likes

the product and believes CTC will be wildly successful. While CTC originally has three

investors, Daisy and Kesha have plans to grow the business and seek more owners and capital in

the future.

The three owners agreed that Daisy would contribute land and cash for a 30 percent interest in

CTC, Kesha would contribute services (legal and business advisory) for the first two years for a

30 percent interest, and Aryan would contribute cash for a 40 percent interest. The plan called for

Daisy and Kesha to be actively involved in managing the business while Aryan would not be.

The three equity owners contributions are summarized as follows:

Daisy Contributed

FMV

Adjusted

Basis

Ownership

Interest

Land (held as investment)

$120,000

$70,000

30%

Cash

$30,000

Kesha Contributed

Services

$150,000

30%

Aryan Contributed

Cash

$200,000

40%

Working together, Daisy and Kesha made the following five-year income and loss

projections for CTC. They anticipate the business will be profitable and that it will continue

to grow after the first five years.

Cool Touch Cookware

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 Daisy and Kesha to spend a considerable amount of their time working for

and managing CTC, 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). Daisy

would take responsibility for the activities of one location and Kesha 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, Daisy and Kesha determined CTC 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, Daisy and Kesha

arranged to have CTC borrow $300,000 from a local bank and to borrow $200,000 cash from

Aryan. CTC would pay Aryan a market rate of interest on the loan but there was no fixed

date for principal repayment.

Required:

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

recommend the appropriate entity.