Question

In: Accounting

Ann and Jack have been partners for several years. Their? firm, A? & J Tax? Preparation,...

Ann and Jack have been partners for several years. Their? firm, A? & J Tax? Preparation, has been very? successful, as the pair agree on most? business-related questions. One? disagreement, however, concerns the legal form of their business. Ann has tried for the past 2 years to get Jack to agree to incorporate. She believes that there is no downside to incorporating and sees only benefits. Jack strongly? disagrees; he thinks that the business should remain a partnership forever. ? First, take? Ann's side, and explain the positive side to incorporating the business. ? Next, take?Jack's side, and state the advantages to remaining a partnership. ? Lastly, what information would you want if you were asked to make the decision for Ann and? Jack?

What information would you want if you were asked to make the decision for Ann and Jack? (Choose all that apply.)

A.Marital status and tax situation of each partner.

B.Growth prospects of the firm.

C.Risk tolerance of the owners.

D.Age of the current owners.

E.Capital needs of the firm

Solutions

Expert Solution

While Jack and Ann disagree over whether or not their firm should incorporate or remain as a partnership, each form of business organization has its advantages and disadvantages. One advantage of a partnership is that income is taxed at each partner’s individual tax rate that includes 10%, 15%, 25%, and higher rates up to a top rate of 35% while corporate rates are 15%, 25%, and 34% with a top rate of 39%. The corporation is allowed to retain accumulated taxable income, but for a personal service corporation such as Jack and Ann’s tax preparation service, there is an additional tax, called an accumulated earnings tax, of 15% for accumulated taxable income in excess of $150,000. If corporate earnings are paid out as salary, Jack and Ann will pay their individual rates as they do on their partnership earnings. If some of the income is paid out in the form of dividends it will be taxed twice, first as corporate income and then as dividend income (generally 5% or 15% depending upon the individual’s tax bracket).While taxation of income is a key factor in deciding which form of business organization to select, two other factors are also important. In a partnership, each partner has unlimited liabilityand may have to cover debts of other partners, while corporate owners have limited liability that guarantees that they cannot lose more than they have invested in the corporation. The third major consideration is ease of transfer of the business. Partnerships are harder to transfer and are technically dissolved when a partner dies, while a corporation can have a very long life with ownership readily transferred through the sale of stock.

If a third party was asked to decide which legal form of business A&J Tax Preparation should take, it would be useful to have the following information:

• Marital status and tax situation of each partner

•Expectation of the longevity of the firm

•Age of the current owners

•Current plan of succession

•Risk tolerance of the owners

•Expectation of future tax law changes

•Capital needs of the firm

•Growth prospects of the firm

•Reasons for each partner’s view of thepreferred form of ownership.


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