64. {Planning} {Research} Daisy Taylor 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 family members and 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. She was employed as a business consultant when she decided to leave that job to work with Daisy and Aryan. 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 discuss how they are relevant to the choice of entity decision for CTC. Cool Touch Cookware (CTC) has been in business for about 10 years now. Daisy and Kesha are each 50 percent owners of the business. They initially established the business with cash contributions. CTC manufactures unique cookware that remains cool to the touch when in use. CTC has been fairly profitable over the years. Daisy and Kesha have both been actively involved in managing the business. They have developed very good personal relationships with many customers (both wholesale and retail) that, Daisy and Kesha believe, keep the customers coming back

When considering the choice of entity for Cool Touch Cookware (CTC), Daisy and Kesha should evaluate several tax and nontax issues that could impact their business. Here are some significant considerations: 1. **Taxation of Business Income**: The choice between a pass-through entity (like an S corporation or LLC) and a C corporation affects how business profits are taxed. Pass-through entities allow profits to be taxed only at the individual level, avoiding double taxation. C corporations are taxed at the corporate level, and dividends are taxed again at the shareholder level. 2. **Contributions of Property and Services**: Daisy's contribution of land could have tax implications, especially if CTC is structured as a C corporation, which could trigger gain recognition on the transfer. Kesha's contribution of services in exchange for equity could be taxable income to her. 3. **Allocation of Losses**: With projected initial losses, a pass-through entity would allow Daisy, Kesha, and Aryan to potentially deduct these losses on their individual tax returns, subject to passive activity and at-risk rules, especially relevant for Aryan as a passive investor. 4. **Self-Employment Taxes**: As active members of an LLC, Daisy and Kesha may be subject to self-employment taxes on their share of CTC's income. In an S corporation, only salaries (not dividend distributions) are subject to employment taxes, which could result in tax savings. 5. **Equity Compensation**: The plan to provide performance

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