1. Problem 4-B: Lucy’s C Corp Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 4-25 C Corp Lucy Jim Sue Dave 100k ARs 100k Cash Signing Bonus 500k Bldg, 250k basis Basis 0 400k NR Debt 351 flunked because 80% test not satisfied - Lucy has 100k gain on ARs - Sue has 100k compensation income - Dave has 250k capital gain on building - All have 100k basis in stock with new holding periods - C Corp has 100k basis in ARs, 500k basis in building, 100k deduction for Sue, and new holding periods. ARs for 100 shrs Bldg for 100 shrs

2. Problem 4-B: Lucy’s 351 Fix Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 4-26 C Corp Lucy Jim Sue Dave 100k ARs 100k Cash Signing Bonus 500k Bldg, 250k basis Basis 0 400k NR Debt ARs for 100 shrs Bldg for 100 shrs Twist: Sue puts in 15k cash; bonus 85k. 351 now satisfied - Lucy has no gain; zero basis in stock - Sue has 85k compensation income; 100k basis in stock - Dave has 150k capital gain – liability in excess of basis; zero stock basis - Dave gets tacked holding period - C Corp has 0 basis in ARs, 400k basis in building, 85k deduction for Sue; tacked holding period for building.

3. 4-27 Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 1. Section 83 restrictions - Why would partners want? - Tax deferral to Sue – but what are future tax impacts? 2. The 83(b) election: Pain now for future upside 3. The Gross-Up Negotiation Problem 4-B: Sue Compensation Options

4. 4-28 Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com Compensation “Gross-Up” Game Assume: 1. Stock for services equal 150k 2. Corporation tax rate 34% 3. Executive tax rate 33% Straight recognition transaction: - Executive pays taxes of 50k - 33% of 150k. - Corporation saves taxes of 51k – 34% of 150k Gross up amount formula: [Stock value / (1 - Executive tax rate)] – Stock Value = Gross-Up Bonus [ 150k / (1 -.33 =.67)] – 150k = 74k - Corp tax savings: (150k + 74k) x 34% = 76k (More than Gross-up) - Employee tax bill: (150k + 74k) x 33% = 74k (Paid by Gross-up)

5. 4-29 Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com Problem 4-B: Shareholder Debt Gambit Advantages of shareholder debt in C corp: Deductible interest payments vs. after-tax dividends Return of principle with no double taxes Potential reasonable business need for 531 Factors to determine if real debt or disguised equity Proportional to all shareholders: Hurts but not killer Inside debt to equity: Here 9-to-2, far beyond 3-to-1. Total debt to equity: Here ? Preferably, not over 10-to-1. Commercially normal terms: Some oddities here. Debt intent trapping: Need more facts here. Subordination: Not killer if all else works. Lenders demand. Equity hybrid characteristics: Killer. None here.

6. Problem 4-C: Lucy’s LLC Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 4-34 LLC Lucy Jim Sue Dave 100k ARs 100k Cash Signing Bonus 500k Bldg, 250k basis Basis 0 400k NR Debt ARs for 100 units Bldg for 100 units Tax impacts of Lucy’s contribution - Lucy has no gain per 721; zero basis in units - Partnership’s basis in receivables zero; no gain or loss to partnership - Collection of ARs ordinary income, allocated to Lucy Tax impacts of Jim contribution - No gain or loss to Jim or partnership - Jim’s basis is units 100k

7. Problem 4-C: Lucy’s LLC Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 4-35 LLC Lucy Jim Sue Dave 100k ARs 100k Cash Signing Bonus 500k Bldg, 250k basis Basis 0 400k NR Debt ARs for 100 units Bldg for 100 units Tax impacts of Sue’s contribution - Sue recognizes ordinary income of 100k – possible deferral under 83. - Partnership has 100k 162 deduction, allocable to other partners. - Potential deemed sale by other partners. Would trigger proportional gain on ARs (allocable to Lucy) and Bldg (allocable to Dave). No deemed sale under Proposed Regs.

8. Problem 4-C: Lucy’s LLC Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 4-36 LLC Lucy Jim Sue Dave 100k ARs 100k Cash Signing Bonus 500k Bldg, 250k basis Basis 0 400k NR Debt ARs for 100 units Bldg for 100 units Tax impacts of Dave’s contribution First 150k nonrecourse debt allocable to Dave – excess of nonrecourse debt over basis. Options for remaining nonrecourse debt. Here assume allocated ¼ or remaining to each partner. Thus Dave’s total allocation is 212.5k, and each of other partners allocated 62.5k. Dave relieved of 187.5k debt, which is less than basis. Thus, no gain recognized by Dave.

9. Problem 4-C: Lucy’s LLC Copyright 2005 Dwight Drake. All Rights Reserved. Business Planning: Closely Held Enterprises www. drake-business-planning.com 4-37 LLC Lucy Jim Sue Dave 100k ARs 100k Cash Signing Bonus 500k Bldg, 250k basis Basis 0 400k NR Debt ARs for 100 units Bldg for 100 units Tax impacts of Dave’s contribution (cont’d) - Dave’s basis in his partnership interest is transferred basis (250k) less deemed cash distribution (187.5k) = 62.5k. - Basis of each other partner’s interest increased 62.5k (NR debt share). - Partnership’s basis in Bldg is 250k, with tacking.