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Juan and Desi, two unrelated individuals, decide to form SB Enterprises Inc. as a C corporation. Juan will transfer tangible assets and intellectual property with an aggregate basis of $500,000 and an agreed fair market value of $2,000,000. Desi will contribute $1.5 million cash. Juan wants to keep effective control of the business since it was his idea to form the company. Desi is interested in a guaranteed preferred return on his investment but also wants to share in the growth of SB Enterprises. They hire Mocosa, an unrelated individual, to serve as the Chief Operating Officer of the corporation. Mocosa wants to be fairly compensated (she believes her services are worth $800,000 per year) and receive stock in the company, but she cannot afford to invest any cash. Juan, Desi and Mocosa all want to avoid negative tax consequences. Consider the following alternative scenarios and evaluate whether they meet the tax and non-tax objectives of Juan, Desi and Mocosa:

a) In exchange for their respective contributions, Juan will receive 2,000 shares and Desi will receive 1,500 shares of SB Enterprises stock. Mocosa will agree to a salary of $400,000 per year for five years per her employment contract with the company. Mocosa will also receive 1,500 shares of SB Enterprises common stock upon the incorporation. Assume that the value of the stock is $1,000 per share.

b) Same as (a) except that Mocosa will receive compensation of $800,000 per year and will pay $1.5 million for her SB Enterprises stock.

c) Same as (b) except that Mocosa will borrow the $1.5 million from the corporation instead of paying the money. The loan reflects interest at the market rate and is payable in five equal annual installments.

d) Same as (a) except Mocosa will pay $1 million for her 1,500 shares and the incorporation documents specify that she is receiving those shares in exchange for her cash contribution rather than for future services.

e) Same as (d) except Mocosa will pay $200,000 cash rather than $1 million.

f) In general, is there another approach to structuring the formation of SB Enterprises that would make be a winwin-win for Juan, Desi and Mocosa from a tax standpoint? Consider the use of a more complex capital structure, with two classes of stock.

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