Mitch McDonald is a wealthy Kentucky entrepreneur in the bridge construction business. He and his close friend, Nancy Pelusi from California, decided to start a new business. Nancy is a wealthy retiree, having made a fortune selling frozen ice cream bars from her sub-zero freezer in her California home.

Based on Mitch’s experience, and Nancy’s political connections, they believe that they can use robotics to build bridges and get lucrative government bridge contracts once Congress funds large infrastructure projects.

Neither Mitch nor Nancy is an expert in robotics, but they know a young very bright recent graduate of Carnegie Mellon University who has a PhD in robotics, who can help them develop robotic equipment that can build bridges quickly and at a much lower cost than conventional bridge builders. This youngster, Alfie Newman, is interested in joining Mitch and Nancy in this venture, but Alfie has no money or property of value to contribute to the project.

So Mitch, Nancy, and Alfie agree to form a joint venture where Mitch will contribute bridge construction assets having a value of $5 million, with a tax basis of $3 million, Nancy will contribute $5 million of cash, and Alfie will contribute his robotics development skills to the newly formed entity, which they will name Bridges R Us. Mitch and Nancy will own 35% each for their contributions to the business, and Alfie will own 30% of Bridges R Us in exchange for his robotics development efforts. All three joint venturers will be active in the business.

The three principals know that they will need financing to develop the business, so Bridges R Us intends to borrow $50 million. Nancy will guarantee $30 million of debt and Mitch will guarantee $10 million of debt. Nancy does not want to stay in the business for more than 5 years. She believes that within 5 years Bridges R Us will develop successful robotics products that will make the company very valuable. She believes that in 5 years she can sell her joint venture investment to a private equity investor and make a sizeable profit. Mitch and Alfie are in the business for the long run. Nancy, however, would like to maximize her tax benefits over a 5-Year period. Mitch and Alfie are open to ideas to give Nancy as much tax benefit as possible.

Bridges R Us is expected to incur large tax losses over the first 5 years, as the assets to be acquired by the borrowed funds will be depreciated over a 5-year period for tax purposes. The bridge construction assets to be contributed by Mitch will be depreciated over a 5-year period as well.After 5 years when the assets are fully depreciated, the joint venture is expected to generate large amounts of taxable income. Nancy has a large personal tax liability, and she would like to use early year tax losses to reduce her personal taxable income.

Alfie understands that he will receive his joint venture interest in exchange for services, but he would like to minimize his 2020 tax liability as much as possible. The private equity firm would like to maximize its tax benefits,if and when it purchases Nancy’s joint venture interest in 5 years.In 5 years, the value of Bridges R Us assets is expected to greatly exceed the tax basis of its assets. The private equity principal heard someone talk about a Sec 754 election oncebut doesn’t know what that means.

The three principals of Bridges R Us know that you are about to finish your tax course, maybe the best ever, no one has ever seen anything like it, focusing on choices of entity, and they can’t think of a better person than you to advise them on which type of entity they should choose to conduct their business. They asked you for a memo that discusses your recommendation for an entity that best fits their needs. You should focus on the tax consequences of forming the entity, operating the entity, and leaving the entity given these specific facts. Your choices should be limited to a C Corporation or a partnership/LLC structure. Your memo should address issues that you identify, and how each issue would be treated under corporation tax law, versus partnership tax law. Consider also the impact on the 3 principals. You should be able to identify and discuss at least four issues.