When Keith created a new corporation as the sole shareholder, he was advised by his accountant to consider 50 percent of the invested amount as the loan and 50 percent for the purchase of stock.
Discuss the advantages and disadvantages of this structure, as compared with treating the entire investment as the purchase of stock? Comment on how the approaches are different. Justify your answer with rationales.
Without knowing anything about the type of business or Keith's plans, following are general comments. These could be narrowed with more information:
1. The middle road of 50-50 allows flexibility in the future for Keith to withdraw cash from the business with no tax implications.
2. On the other hand, having an amount due to a sole shareholder requires more formality about the transaction: a real note with a stated interest rate, and regular payments of interest of principal and interest.
3. Having only half of the investment in stock may make it easier to bring in more investors ...
The solution presents seven different fact patterns to demonstrate the possibilities and consequences of stock versus notes in a new corporation. There is also a conclusion reached.