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Penelope, Mark, and John Entity Selection

After 20+ years of working for other firms, Penelope (Enrolled Agent, age 41), Mark (CPA, age 43) and John (CVA, age 65) want to leave the firms they are currently employed by and become their own bosses. Penelope specializes in Taxes, Mark is the Auditor and John is a Business Valuation expert.

There are so many options available to how they can structure the new business(s). The appropriate business entity for any individual(s) will depend on their particular facts and circumstances.

You are a valued colleague and friend of this three-some and they have come to you seeking advice as to how to structure their new business. They have the knowledge to figure it out themselves, but are looking for the advice of an unbiased 3rd party. Please consider the following tax and non-tax considerations as you recommend an entity choice to Penelope, Mark and John.

Prepare a tax memo (900 word minimum; 1,200 word maximum) to Penelope, Mark and John addressing the Entity Selection issue and discussing the following tax and non-tax considerations, point by point:

Part I: Discuss the various forms of organization that are available to Penelope, Mark and John.

Part II: Make your recommendation as to what form of organization you believe will be best and be sure to explain the reasoning for your choice.

Part III: Discuss the tax consequences of contributing cash, property and/or services to the new entity.

Part IV: Discuss, in detail, how this entity is taxed (if at all) and what filing requirements it has with the IRS.

Part V: Discuss how income and distributions may/will be allocated to Penelope, Mark and John.

Part VI: Discuss, in detail, how the individuals are taxed (if at all) with respect to the net profits from this entity and what filing requirements they will each have with the IRS.

Part VII: Discuss how Penelope, Mark and John will calculate their "basis" in the new entity. Be sure to include the impact that debt has on basis, if any.

Part VIII: Limited Liability - Discuss the exposure that Penelope Mark, and John's personal assets will have to the debts and lawsuits of the entity you have recommended.

You Decide: It's your turn as a tax professional to decide on the best course of action from a tax perspective on these issues as presented.

For this memo, begin by restating the issue and numbering the considerations as shown above [i.e., I, II, III, etc.]. Next, provide your recommendation and your explanation to each of the issues/considerations listed above; and discuss the tax rules that apply to the issue, which you gleaned from your tax research. Tax law includes IRC sections, regulations, court decisions, and other sources (if applicable). Be sure to conclude with a definitive answer what entity they should choose.

Present your answer concisely (i.e., to the point) following the KISS principle, in a professional, grammatically correct, and spelling error-free memo.

Solution Preview

Part I:
The most common forms would be a joint venture, a partnership, or a corporation. The corporation could elect S Corporation status to avoid double taxation. In this case, we're working with professions that naturally incur various liability issues (particularly in auditing and with the prevalence of fraud these days). Due to the circumstances, I would elect an LLC - a limited liability corporation. This would protect the partners to the greatest extent possible.

Part II:
See above. Basically, the LLC mimics both the corporation and the partnership and provides for greater protection for its members. The LLC itself is not a formal form of business entity, it is only what's called a classification. The LLC has to actually be a recognized business entity. I would elect to have the LLC treated as a corporation, and then choose S corporation status. By electing the LLC as a corporation, the three owners would be able to raise any needed capital easier than if they formed a partnership. Investors are more likely to invest in a corporation than a partnership because corporations ...

Solution Summary

This solution provides a comprehensive discussion regarding the business entity selection for Penelope, Mark, and John based on the scenario given. All parts and sections are thoroughly discussed and references are provided. Includes 3 references.