Reference no: EM133686149

Problem

I. Bob and Carl transfer property to Stone Corporation for 90% and 10% of Stone stock, respectively. Pursuant to a binding agreement concluded before the transfer, Bob sells half of his stock to Carl. Prepare a memorandum for your tax manager explaining why the exchange does or does not meet the Sec. 351 control requirement. Your manager has suggested that, at a minimum, you consult the following authorities:

1) IRC Sec. 351
2) Reg. Sec. 1.351-1

II. One of your wealthy clients, Cecile, invests $100,000 for sole ownership of an electing S corporation's stock. The corporation is in the process of developing a new food product. Cecile anticipates that the new business will need approximately $200,000 in capital (other than trade payables) during the first two years of its operations before it starts to earn sufficient profits to pay a return on the shareholder's investment. The first $100,000 of this total is to come from Cecile's contributed capital. The remaining $100,000 of funds will come from one of the following three sources:

1) Have the corporation borrow the $100,000 from a local bank. Cecile is required to act as a guarantor for the loan.
2) Have the corporation borrow $100,000 from the estate of Cecile's late husband. Cecile is the sole beneficiary of the estate.
3) Have Cecile lend $100,000 to the corporation from her personal funds.

The S corporation will pay interest at a rate acceptable to the IRS. During the first two years of operations, the corporation anticipates losing $125,000 before it begins to earn a profit. Your tax manager has asked you to evaluate the tax ramifications of each of the three financing alternatives. Prepare a memorandum to the tax manager outlining the information you found in your research.