Question

Our client, Sven Jorgenson has worked for a large commercial bakery for several years. He would now like to start his own business baking his signature pastries. He will be working with his long time associate, Ingrid. Sven will be providing the majority of the cash and equipment for the business; Ingrid will be providing her services and the use of a building she owns where they can begin the bakery. They expect the business to generate modest income in the early years and more income later. Since they will be quitting their jobs to begin the business, Sven and Ingrid will need the profits generated by the business to replace their salaries but, as profits increase in later years they will use them to expand the business. Assume both Sven and Ingrid have an effective income tax rate of 25%. They have asked for your assistance in selecting the appropriate business entity type for their activity. Please explain to them which business entity they should choose and why and describe generally, the operation of their new business entity.

Answer 1

business will be owned and operated by several individuals, you'll want to take a look at structuring your business as a partnership. Partnerships come in two varieties: general partnerships and limited partnerships. In a general partnership, the partners manage the company and assume responsibility for the partnership's debts and other obligations. A limited partnership has both general and limited partners. The general partners own and operate the business and assume liability for the partnership, while the limited partners serve as investors only; they have no control over the company and are not subject to the same liabilities as the general partners.

Unless you expect to have many passive investors, limited partnerships are generally not the best choice for a new business because of all the required filings and administrative complexities. If you have two or more partners who want to be actively involved, a general partnership would be much easier to form.

One of the major advantages of a partnership is the tax treatment it enjoys. A partnership doesn't pay tax on its income but "passes through" any profits or losses to the individual partners. At tax time, each partner files a Schedule K-1 form, which indicates his or her share of partnership income, deductions and tax credits. In addition, each partner is required to report profits from the partnership on his or her individual tax return. Even though the partnership pays no income tax, it must compute its income and report it on a separate informational return, Form 1065. Personal liability is a major concern if you use a general partnership to structure your business. Similar to a sole proprietorship, general partners are personally liable for the partnership's obligations and debt.