Aristocrat , Baker , and Chef have formed Chez Guevara, Inc . ( Chez ) as a
Question:
Aristocrat, Baker, and Chef have formed Chez Guevara, Inc. (“Chez”) as a C corporation to operate a gourmet restaurant and bakery previously operated by Chef as a sole proprietorship. Aristocrat will contribute $80,000 cash, Baker will contribute a building with a fair market value of $80,000 and an adjusted basis of $20,000, and Chef will contribute $40,000 cash and the goodwill from his proprietorship with an agreed value of $40,000 and has a zero basis. In return, each of the parties will receive 100 shares of Chez common stock, the only class outstanding.
Chez requires at least $1,800,000 of additional capital in order to renovate the building, acquire new equipment, and provide working capital. It has negotiated a $900,000 loan from Friendly National Bank on the following terms: interest will be payable at two points above the prime rate, determined semi-annually, with principal due in ten years and the loan will be secured by a mortgage on the renovated restaurant building.
Instructions:
Evaluate the following alternative proposals for raising the additional $900,000 needed to commence business, focusing on the possibility that the Service will reclassify corporate debt instruments as equity.
- Aristocrat, Baker, and Chef each will loan Chez $300,000, and each will take back a $300,000 five-year corporate note with variable interest payable at one point below the prime rate, determined annually.
- Same as (a) above, except that each of the parties will take back $300,000 of 10% 20-year subordinated income debentures; interest will be payable only out of the net profits of the business.
- Same as (a) above, except that the $900,000 loan from Friendly National Bank will be unsecured but personally guaranteed by Aristocrat, Baker, and Chef, who will be jointly and severally liable.
- Aristocrat will loan the entire $900,000, taking back a $900,000 corporate note with terms identical to those described in (a) above.
- Same as (d) above, except that commencing two years after the incorporation, Chez ceases to pay interest on the notes because of severe cash flow problems.