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C:11-67. One of your wealthy clients, Cecile, invests $100,000 for sole ownership of an electing S corporation’s stock. The corporation is in the process of developing a new food product. Cecile anticipates that the new business will need approximately $200,000 in capital (other than trade payables) during the first two years of its operations before it starts to earn sufficient profits to pay a return on the shareholder’s investment. The first $100,000 of this total is to come from Cecile’s contributed capital. The remaining $100,000 of the funds will come from one of the following three sources:
-Have the corporation borrow the $100,000 from a local bank. Cecile is required to act as a guarantor for the loan.
-Have the corporation borrow the $100,000 from the estate of Cecile’s late husband. Cecil is the sole beneficiary of the estate.
-Have Cecile lend the $100,000 to the corporation from her personal funds.
The S corporation will pay interest at a rate acceptable to the IRS. During the first two years of operations, the corporation anticipates losing $125,000 before it begins to earn a profit. Your tax manager has asked you to evaluate the tax ramifications of each of the three financing alternatives. Prepare a memorandum to the tax manager outlinging the information your found in your reserach.
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