Question

1. When choosing a business form, what are they key difference between proprietorship, partnership and a corporation?
2. What are the seven (7) characteristics of a partnership?
3. What are the differences between a/an

a. Limited liability Partnership
b. Limited liability Corporation
c. S Corporation?

4. What factors are taken into consideration when choosing a business form?
5. What are the three (3) methods used to allocate income or loss? Explain each method.
6. What accounts are affected when recording the admission of a new partner when the new partner contributes cash?
7. What are the two ways a partner generally withdraws from a partnership?
8. What does capital deficiency mean? What happens if a partner cannot pay a deficiency?
9. When there is death of a partner, what happens to the partnership?
10. What are the steps taken when a partnership is liquidated?

Please answer all of the questions, if you can not answer all of the questions do not reply.

Answer 1

1.

Proprietorship:

Proprietorship is not a separate legal entity, therefore the liability is unlimited. It is the simplest form of business where the business assets and liabilities are assets and liabilities of the individual. There is no separate tax slab for proprietorship entity. They are advantageous becasuse of minimal cost for startup.

Partnership:

Partnership is entity where 2 or more individuals share profits and losses incurred in the business. It is suitable for people who plan to work together sharing their experiences and capital for the business. Although, pooled capital and knowledge keeps the partnership firm above proprietorship, there are some legal matters involved (eg, partnership deed). Partnership firms are of various types, general partnership (unlimited liability), limited liability partnership (LLPs), joint ventures etc.

Corporation:

These are separate legal entities that are owned by the shareholders. Corporations are much more complex and are typically used by larger businesses. They have more costly administrative fees and more complicated tax and legal requirements.

2. Characteristics of partnership:

i) Share of ownership - A partnership requires 2 or more members to be treated as partners.

ii) Agreement - There needs to be an oral or a written agreement known as the "Partnership Deed".

iii) Profit sharing - The partners shares profit and losses in the agreed ratio.

iv) Liability - The liability of partnership firm extends to the partners. Therefore, the partners are liable to pay for partnership firm liabilities.

v) Termination - A partnership can be terminated with the consent of the partners, death , retirement or insolvency of a partner.

vi) Business - Partnership is formed to carry on a business.

vii) Agency relationship - The partnership business may be carried on by all or any of them acting for all. Thus, the law of partnership is a branch of the law of Agency.

3. Difference between

LLP

Limited liability partnerships are businesses with more than one owner who all have limited personal liability for business debts. LLPs are primarily used by licensed professional groups, such as attorneys and doctors, and some states do not permit any sort of business apart from licensed professionals to form an LLP. A partner in an LLP is protected from personal liability in the case of debt or claims accrued by another partner, keeping personal assets from being used to pay for the mistakes of another. LLPs are easier to organize and manage than a corporation, making them preferable for professionals who just want protection for their personal assets.

LLC

A limited liability company is a flexible incorporating option, but the option is not available to all businesses nor are the regulations the same in all states. Generally, the IRS considers LLCs to have “pass-through” status, which allows all profits and losses from the business to pass to the owners and be reported on their personal tax returns. LLC owners are protected from personal liability for debts or claims attached to the business and stand to lose only what they invested in the business. LLCs essentially offer protection similar to that of corporation shareholders, but with simpler taxation and management.

S Corporation

S corporations are not legal business structures. The IRS grants S corp status to qualifying C corporations, and the change in status affects the taxation of the corporation’s profits. Intended for small- to medium-sized domestic businesses, S corporations cannot have more than 100 shareholders. Shareholders never have personal liability for business debt, but they pay personal income tax on any dividends or salaries drawn from the business. S corps are not required to pay corporate taxes; like LLCs, they are "pass-through entities" and all losses and profits go through to the corporation's owners. As a corporation, however, an S corp must perform a variety of bureaucratic duties to remain compliant, including issuing stock, passing bylaws and holding shareholder and director meetings with accurate minutes.

4. Factors taken into consideration when choosing a business form:

i) Control

An important factor to consider when selecting your legal structure is the level of control you wish to have over your business. For example, if you wish to own and operate the enterprise completely alone then being a sole trader would be the most appropriate structure. Your choice of legal structure will affect what aspects of the business you will control and what aspects you will legally own.

ii) Limitation of liability

Your choice of legal structure will have important implications on your potential legal liability. Considering the extent you need to be protected from personal legal liability is important before choosing a business structure, as a considerable advantage of a complex legal structure such as a company, is the protection from your personal assets becoming liable from any debts and losses incurred.

iii) Cost and complexity of formation and legal structure

The different legal structures each have differing set up procedures, cost and complexities involved. For example, while a sole trader is simple to set up and requires few reporting requirements, a more complex structure like a trust involves strict reporting requirements and must be set up by a solicitor or an accountant.

iv) Flexibility and future needs

It is important when considering a legal structure to also reflect on where you envision your business going in the future. For example, the expansion of a trust is subject to legal penalties so is not an appropriate structure to choose should expansion be a goal in mind for your business.

v) Tax implications

The legal structure of your business will have significant effects on the amount of tax you pay and the kinds of tax that you must pay. For example, a sole trader enjoys tax benefits from being able to claim on a personal tax return and those in a trust do not pay income tax on profits.

vi) Ongoing administration

Whilst a sole trader legal structure has few reporting and administrative requirements, the complex legal structures such as a company have strict and difficult record keeping and paperwork requirements. In fact, an important consideration before setting up a complex legal structure is ensuring that you have the time, people and ability to abide by the strict recordkeeping requirements that are legally enforceable.

vii) Continuity of existence

It is important to consider how you see the business coming to a conclusion. If you wish for the business to be terminated when you personally wish for it to end, then becoming a sole trader is the most appropriate option. However, if you wish to secure your family’s financial future, it is more appropriate to select a legal structure that does not come to an end if you are incapacitated.

5. Methods used to allocate income or loss:

i) Profit ratio: In this method each partner receives predecided ratio of the profit, say 70:30 or 50:50. The rato is mentioned in the partnership deed, in absence of the same, equal partnership is assumed.

ii) Capital balances: The profit is shared in the ratio of partners capital in the partnership firm. Eg, if A and B have contributed 40,000 and 60,000 to the partnership, the profit will be shared in the ratio of 4:6

iii) Salaries, interest etc.: The partners are paid salaries for the time contributed in the partnership and interest on the capital invested. The remaining amount is distributed in the ratio predecided.

6. Accounts affected when recording admission of new partner are:

Cash A/c Dr.

To Partner Capital A/c

7. Ways a partner generally withdraws from a partnership:

i) Dissolution - When a partner retires, the partnership is dissoved and all the assets, liabilities and incomes are distributed as per the partnership agreement.

ii) Purchase of partner share - The retiring partner sell his share to the existing partner and the partnership firm continues. For this to work, the partnership firm must have atleast 2 members after the partner has retired.

8. Capital deficiency means that one or more partner has a debit balance in his/their capital account at the point of final cash distribution. The capital deficiency may arise from liquidation losses, excessive withdrawals before liquidation or recurring losses in prior periods.

When a partner is unable to pay a capital deficiency: The deficiency is absorbed by the remaining partners.

9. Death of a partner:

When a partner dies, partnership is dissolved. However, in cases where the terms of the partnership deed provide, the nominee or legal representative of the deceased partner can take the place of deceased partner and business of the firm can be continued with the presumption that the partnership was never dissolved on the death of that partner.

10. Partnership Liquidation:

A liquidating partner typically starts liquidation proceedings by deciding which business assets will be sold for cash and which will be set in reserve. Assets that are placed in reserve can be given to a partner as part of his share of his final distribution of the partnership assets that remain after the payment of obligations. The cash is used to pay off all partnership debts and claims. If the partnership succeeds in paying off its bills from the sale of its assets, any remaining cash or assets must be distributed to the partners in proportion to their ownership interests. In case, there is shortfall, partners contibute personally to settle the shortfall.