Scenario

You are an entry-level CPA at Ernst & Old LLP. You were recently assigned to work on an engagement with three guys who desire to pool their resources and form an entity that will develop and manufacture state-of-the-art wearable biosensors suitable for comfortable, continuous, and noninvasive cardiovascular monitoring. The three organizers believe that this entity has the ability to go public and be the next great thing!

Role

They each bring something different to the table, and, although each of them trusts and respects the contributions of the others, they all want to know how this will affect each of them individually. Jan immediately jumps to a C corporation because that's all he knows, Franklin knows the benefits of flow-through entities for start-ups, and Terry doesn't really care as long as the endeavor makes money and he doesn't have to get involved. They will each own one third of whatever entity you recommend. It's your chance to make a good impression as an entry-level CPA. It's time for you to decide.

Players

• Jan Berkovitch - Clinical Transformation Innovator

Areas of Expertise:

• Cardiovascular Physiology and Related Devices
• Software/Systems Development Lifecycle
• Population Health Directed Wellness Programs
• Franklin Armando - Independent Consultant, Strategic Business Guidance

Areas of Expertise:

• Accomplished Corporate officer and Sr. Executive
• Corporate start-up/product launch expertise
• Industry experience in medical devices, pharmacy software
• Terry Cosinger - MD

Areas of Expertise:

• Physical Medicine & Rehab, Pain Management
• Avid bicyclist, fisherman and micro-brew beer enthusiast
• Independently wealthy, seeking investments

Deliverable

Given the scenario provided and having received an introduction to the players, it is your time to decide what Jan, Franklin, and Terry should do. Their initial questions include the following.

1. What entity should they choose to form for their new endeavor?
2. Jan doesn't have much money, but he does have a few existing patents on similar medical devices that he is willing to contribute to the new entity in exchange for stock. Jan worked on these patents for years and has $350,000 invested for patents that have a street value of $750,000. Will Jan's contribution of the patents be a taxable event? Please explain why or why not.
3. Franklin does not have any money or assets to contribute, but he does have a lot of connections and has successfully groomed start-up companies into thriving entities of which several have gone public. Franklin will contribute his expertise and forego a salary in exchange for stock. Franklin's salary for similar projects was $375,000 per year. That's how long he thinks it will need until he can attract venture capitalizes to invest and he can start taking a paycheck. Franklin expects no taxable income for his contribution because he is not receiving an actual paycheck.
4. Terry will contribute cash of $750,000. Terry hates taxes, so he wants to hear that this contribution not only is tax-free but that it also results in a deduction. Is he correct? Why, or why not?