Question

Parth and Brittany have been your best friends since grade school. You, Parth, and Brittany have decided to quit your respective jobs and start up a bakery together since you all love cupcakes. Parth insists he wants to start the business as a partnership. Brittany says that she wants to start the business as a corporation. You want to weigh in and give your opinion as to the best form of business.

1. What are the options for business form? Are there other options besides partnership and corporation?

2. What does it take to create each form of business? What are the positives and negatives as to each type of business form?

3. What happens if you start running the business without choosing or creating a business form?

4. After considering Parth and Brittany's opinions, and your own research, which business form would you recommend to them and why?

Answer 1

1.What are the options for business form? Are there other options besides partnership and corporation?

2. What does it take to create each form of business? What are the positives and negatives as to each type of business form?

Answer :

Forms of Business Organization:

One of the first decisions that you will have to make as a business owner is how the business should be structured. All businesses must adopt some legal configuration that defines the rights and liabilities of participants in the business’s ownership, control, personal liability, life span, and financial structure. This decision will have long-term implications, so you may want to consult with an accountant and attorney to help you select the form of ownership that is right for you.

In making a choice, you will want to take into account the following:

• Your vision regarding the size and nature of your business.
• The level of control you wish to have.
• The level of “structure” you are willing to deal with.
• The business’s vulnerability to lawsuits.
• Tax implications of the different organizational structures.
• Expected profit (or loss) of the business.
• Whether or not you need to re-invest earnings into the business.
• Your need for access to cash out of the business for yourself.

Sole Proprietorship

The vast majority of small businesses start out as sole proprietorships. These firms are owned by one person, usually the individual who has day-to-day responsibility for running the business. Sole proprietorships own all the assets of the business and the profits generated by it. They also assume complete responsibility for any of its liabilities or debts. In the eyes of the law and the public, you are one in the same with the business.

Advantages of a Sole Proprietorship

• Easiest and least expensive form of ownership to organize.
• Sole proprietors are in complete control, and within the parameters of the law, may make decisions as they see fit.
• Profits from the business flow-through directly to the owner’s personal tax return.
• The business is easy to dissolve, if desired.

Disadvantages of a Sole Proprietorship

• Sole proprietors have unlimited liability and are legally responsible for all debts against the business. Their business and personal assets are at risk.
• May be at a disadvantage in raising funds and are often limited to using funds from personal savings or consumer loans.
• May have a hard time attracting high-caliber employees, or those that are motivated by the opportunity to own a part of the business.
• Some employee benefits such as owner’s medical insurance premiums are not directly deductible from business income (only partially as an adjustment to income).

Partnerships

In a Partnership, two or more people share ownership of a single business. Like proprietorships, the law does not distinguish between the business and its owners. The Partners should have a legal agreement that sets forth how decisions will be made, profits will be shared, disputes will be resolved, how future partners will be admitted to the partnership, how partners can be bought out, or what steps will be taken to dissolve the partnership when needed; Yes, its hard to think about a “break-up” when the business is just getting started, but many partnerships split up at crisis times and unless there is a defined process, there will be even greater problems. They also must decide up front how much time and capital each will contribute, etc.

Advantages of a Partnership

• Partnerships are relatively easy to establish; however time should be invested in developing the partnership agreement.
• With more than one owner, the ability to raise funds may be increased.
• The profits from the business flow directly through to the partners’ personal tax return.
• Prospective employees may be attracted to the business if given the incentive to become a partner.
• The business usually will benefit from partners who have complementary skills.

• Disadvantages of a Partnership

• Partners are jointly and individually liable for the actions of the other partners.
• Profits must be shared with others.
• Since decisions are shared, disagreements can occur.
• Some employee benefits are not deductible from business income on tax returns.
• The partnership may have a limited life; it may end upon the withdrawal or death of a partner.

Types of Partnerships that should be considered:

1. General Partnership
Partners divide responsibility for management and liability, as well as the shares of profit or loss according to their internal agreement. Equal shares are assumed unless there is a written agreement that states differently.

2. Limited Partnership and Partnership with limited liability
“Limited” means that most of the partners have limited liability (to the extent of their investment) as well as limited input regarding management decision, which generally encourages investors for short term projects, or for investing in capital assets. This form of ownership is not often used for operating retail or service businesses. Forming a limited partnership is more complex and formal than that of a general partnership.

3. Joint Venture
Acts like a general partnership, but is clearly for a limited period of time or a single project. If the partners in a joint venture repeat the activity, they will be recognized as an ongoing partnership and will have to file as such, and distribute accumulated partnership assets upon dissolution of the entity.

Corporations:

A Corporation, chartered by the state in which it is headquartered, is considered by law to be a unique entity, separate and apart from those who own it. A Corporation can be taxed; it can be sued; it can enter into contractual agreements. The owners of a corporation are its shareholders. The shareholders elect a board of directors to oversee the major policies and decisions. The corporation has a life of its own and does not dissolve when ownership changes.

Advantages of a Corporation

• Shareholders have limited liability for the corporation’s debts or judgments against the corporation.
• Generally, shareholders can only be held accountable for their investment in stock of the company. (Note however, that officers can be held personally liable for their actions, such as the failure to withhold and pay employment taxes.
• Corporations can raise additional funds through the sale of stock.
• A Corporation may deduct the cost of benefits it provides to officers and employees.
• Can elect S Corporation status if certain requirements are met. This election enables company to be taxed similar to a partnership.

Disadvantages of a Corporation

• The process of incorporation requires more time and money than other forms of organization.
• Corporations are monitored by federal, state and some local agencies, and as a result may have more paperwork to comply with regulations.
• Incorporating may result in higher overall taxes. Dividends paid to shareholders are not deductible from business income; thus this income can be taxed twice.

Subchapter S Corporation

A tax election only; this election enables the shareholder to treat the earnings and profits as distributions, and have them pass through directly to their personal tax return. The catch here is that the shareholder, if working for the company, and if there is a profit, must pay his/herself wages, and it must meet standards of “reasonable compensation”. This can vary by geographical region as well as occupation, but the basic rule is to pay yourself what you would have to pay someone to do your job, as long as there is enough profit. If you do not do this, the IRS can reclassify all of the earnings and profit as wages, and you will be liable for all of the payroll taxes on the total amount.

Limited Liability Company (LLC)

The LLC is a relatively new type of hybrid business structure that is now permissible in most states. It is designed to provide limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. Formation is more complex and formal than that of a general partnership.

The owners are members, and the duration of the LLC is usually determined when the organization papers are filed. The time limit can be continued if desired by a vote of the members at the time of expiration. LLC’s must not have more than two of the four characteristics that define corporations: Limited liability to the extent of assets; continuity of life; centralization of management; and free transferability of ownership interests.

Federal Tax Forms for LLC

Taxed as a partnership in most cases; corporation forms must be used if there are more than 2 of the 4 corporate characteristics, as described above.

Part 4. After considering Parth and Brittany's opinions, and your own research, which business form would you recommend to them and why

Solution : After considering Parth and Brittany's opinions, and our own research, we would recommend them to go for Limited Liability Company (LLC) business form because It is designed to provide limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. Therefore, this form of business organization would best suit them.

Part 3 :What happens if you start running the business without choosing or creating a business form

Solution :If you start a company without registering it, you will be regarded as a sole trader, even if you do not intend to be one. Basically, an unregistered business is a sole proprietorship, a legal structure that requires you to use your Social Security Number (SSN) in place of an Employer Identification Number (EIN) and your legal name as the name of your company. You are allowed to operate a sole proprietorship without registering, but you are required to register with your local government to collect and file state taxes.

There is nothing wrong with running an unregistered business as long as your business is legal and meets all licensing and tax requirements. In most states, businesses are required to register or obtain a business license before they can operate legally, but this procedure is different from organizing or incorporating a company.

Unless your business is registered as a limited liability company or corporation, which offers protection against personal liability, you may be held liable for any loss or damage that is related to your business. For example, if someone suffers from food poisoning after consuming a food product, he or she can sue for damages and go after the business owner's personal assets.

Possible Consequences of Starting a Business Without a License

Forced to Close

When a business is caught operating without the appropriate license, it may be forced to close down. After it is closed, one of the following three things may happen:

• You may be able to start operating your business again after you obtain the necessary license.
• Your business may have to undergo probation for a certain amount of time before it can open for business again.
• Your application for a business license may be rejected by the local government.

Fines and Fees

It is illegal to run a business without a license, but the extent of the legal infraction varies depending on the location, industry, and licensing requirements. For instance, a home-based bookkeeper working without the necessary license or permit is regarded as a minor offense compared to an over-the-road trucking company operating without a license. The bookkeeper may only face local fines and fees, and possibly, back taxes, while the trucking company may face fines, fees, and charges from local, state, and federal authorities.

Possibility of Lawsuits

If you operate an unregistered business, you will be personally liable for your business. If someone files a lawsuit against your business, he or she is suing you. By not setting up a limited company, you will assume personal liability for any debt incurred by your business. This means that if you form a limited company, all business debts will be attached to the company, not you.

Also, if you conduct business without the appropriate license, a customer can sue you in a small claims court if he or she is dissatisfied with one of your products, using fraud as the reason for the lawsuit. In actuality, conducting business without a license is regarded as a fraudulent act. In the event that the customer wins the lawsuit and you are found liable, you will be responsible for the amount he or she paid for the product and possibly, damages in relation to the fraudulent activity.

Loss of Reputation

If your business is caught operating without the required license, it can cause your customers to doubt your ability to do business in a competent or ethical manner. They may come to the conclusion that your business may not follow customer directives since it has failed to follow the necessary procedures to operate legally.