Situation

You are a tax partner in a regional CPA firm. One of your fellow partners requests you to assist in a presentation to a new client, John Smith. John is a business executive with a scientific background and is about to form a new business. John is a married taxpayer with three children. He is currently in the 37% federal marginal tax bracket. John has approximately $200,000 to invest in the new business. John plans to start a pharmaceutical consulting company. He has developed a business plan and has obtained available financing of $ 1.2 M secured by his assets.

The business will be located in New Jersey or Pennsylvania with ten employees initially. John projects a loss in the first year of operation of approximately $60,000 due to startup costs, including marketing and business development. He is interested in protecting his personal assets from the creditors of the business venture. John anticipates making $140,000 of fixed asset purchases during the first year of operation. Three of Johns friends, Todd who is an attorney with a scientific background, Scott, who is an IT specialist, and Kate, who is a marketing/public relations and program manager, will join the business venture. Todds contributions to the business venture will his legal services, business advice, and cash of approximately $20,000. Scott will only contribute his services. Kate will contribute $50,000 and her services to the business. Since the business is projected to be profitable in year two, John may seek funding from outside investors for expansion in year three. He does not want a large number of investors.

When reviewing Johns prior year individual tax returns and supporting documents, you discovered an IRS notice regarding a math error on Johns 2018 Form 1040,Schedule D, which would result in a small payment of tax and interest.

Requirements

responding to the following questions in depth:

1. Outline and briefly discuss the advantages and disadvantages of the choices of entity for John in this situation- sole proprietorship, partnership, C Corporation, S corporation, and LLC.
2. What entity would you recommend for John?
3. Discuss the state tax implications and differences of operating in New Jersey or Pennsylvania?
4. What advice would you give John regarding the IRS notice?
5. Based on the above facts and current Federal and State developments , what tax and financial planning advice would you give John?