Forms of Business Organization

Forms of Business Organization Free Online Research Papers For American business owners there are a variety of legal structures available to organize their businesses. These various legal structures make provisions for liability, income taxes, continuity of the business, control of the business, profit retention, and regulatory requirements. Each of these organizational structures is different and offers advantages and disadvantages. It is the responsibility of the business owner to choose an organizational structure that will maximize advantages and minimize disadvantages for their business. Some of the various legal structures and their specific characteristics include: SOLE PROPRIETORSHIP – A sole proprietorship is the most common business organization used today. It is an unincorporated business owned by a single person and is used most often by small businesses that do not have large capital needs. 1. Liability: The owner is personally liable for all of the business’s debts. This is a serious disadvantage of a sole proprietorship. 2. Income taxes: A sole proprietorship is not a taxable entity. Unlike a C corporation, profits from a sole proprietorship are not taxed twice. All profits and losses pass through to the owner and are taxed at the owner’s personal tax rate. 3. Continuity: A sole proprietorship will continue as long as there is one owner. If the owner brings someone on board to help manage or add capital to the business, then it will cease being a sole proprietorship and it will become a partnership. 4. Control: The business owner has total control of a sole proprietorship. However, a serious disadvantage of a sole proprietorship is the owner’s inability to raise capital since there is no stock to sell. Managing his debt and cash flow is the only way to increase capital. 5. Profit Retention: A sole proprietorship is not a taxable entity; consequently profits from a sole proprietorship are not taxed twice. All profits and losses pass through to the owner and are taxed once at the owner’s individual tax rate. Avoiding the double taxation of a corporation enables the sole proprietor to pay less in taxes and keep more of the profits earned. 6. Regulatory Requirements: A sole proprietorship is very easy to form. It does not have the reporting requirements of a corporation (board of director meetings, minutes, etc.). Its filing requirements are generally quarterly tax payment estimations to the IRS for the owner’s personal taxes, and if applicable, monthly state sales tax reports. GENERAL PARTNERSHIP – A general partnership is similar to a sole proprietorship in that it’s an unincorporated business with two or more co-owners. 1. Liability: Like a sole proprietorship, each partner in a general partnership is personally liable for any business debts, whether they are the fault of his actions, his partner(s), or his employees. This is a serious disadvantage of a general partnership. 2. Income taxes: A general partnership is not a taxable entity. Unlike a C corporation, the profit of a general partnership is not taxed twice. All profits and losses are passed through to the partners and taxed once at their personal tax rates. 3. Continuity: A general partnership has the right to choose its duration. It depends upon the partnership agreement. When a partner leaves a general partnership its called disassociation, and the remaining partners buy out the value of the departing partner, or they dissolve the partnership entirely. If it’s a large partnership the business generally continues to operate. 4. Control: A disadvantage of a general partnership is the management of the partnership, since all partners technically have a right to share in the management. This is especially true if there are many partners in the business, such as in a large law firm. As a rule many large general partnerships establish a management team to oversee their day to day operations. However, this does not negate the right of individual partners to address the management team if they deem it necessary. 5. Profit Retention: Unlike a C corporation, profits from a general partnership are not taxed twice. Since a general partnership is not a taxable entity, all profits and losses are passed through to the partners and are taxed at each partner’s individual tax rate. Avoiding the double taxation of a C corporation enables the partners in the general partnership to pay less in taxes and keep more of the profits earned. 6. Regulatory Requirements: A general partnership is easy to form and does not require the partners to file a formal partnership agreement with the government. LIMITED PARTNERSHIP – A limited partnership is similar to a general partnership except there are general partners and limited partners. 1. Liability: In a limited partnership the general partners are personally liable for the limited partnership’s debt. To protect themselves from this personal liability, many general partners are corporations so only the assets of the corporation are at risk, and not their personal assets. On the other hand, the limited partners are not personally liable for the partnership’s debt. Only their capital investment in the limited partnership is at risk. 2. Income taxes: A limited partnership is not a taxable entity. Unlike a C corporation, the profit of a limited partnership is not taxed twice. All profits and losses are passed through to the partners and are taxed once at their personal tax rates. 3. Continuity: The continuity of a limited partnership depends upon the partnership agreement. Generally a limited partnership has the right to choose its duration. When a partner leaves a limited partnership it’s called disassociation. When this happens the remaining partners either buy out the value of the departing partner, or they dissolve the partnership entirely. 4. Control: As a rule general partners run the limited partnership. The limited partners are primarily passive investors in the partnership. 5. Profit Retention: Unlike a C corporation, profits from a limited partnership are not taxed twice. Since a limited partnership is not a taxable entity, all profits and losses are passed through to the partners and are taxed once at each partner’s individual tax rate. By avoiding the double taxation of a C corporation, the limited partnership enables the partners to pay less in taxes and keep more of the profits earned. 6. Regulatory Requirements: It is difficult to form a limited partnership. Unlike a general partnership, a limited partnership must file a certificate of limited partnership with their Secretary of State and annual reports. C CORPORATION – A C corporation is a legal entity that offers limited liability to its shareholders for corporate debts or liability while protecting the shareholder’s personal assets. Corporations can be â€Å"closed† corporations owned by a small group or family, or â€Å"open† corporations whose stock is sold or traded on the stock market. 1. Liability: A corporation offers limited liability to the shareholders for the corporation’s debts and liability. The shareholder’s personal assets are not at risk. The only possible exception would be if a shareholder injured someone using corporate property. The corporation would be corporately liable and the shareholder would be personally liable. 2. Income taxes: A disadvantage of a C corporation is its income is taxed twice. A corporation pays taxes and files tax returns on its income, and the shareholder’s also pay personal taxes on the dividend income received from the corporation. 3. Continuity: Once a C corporation is formed it can exist indefinitely, with or without the original stockholders. 4. Control: A C corporation is managed by a Board of Directors who are usually shareholders with a large stake in the corporation. 5. Profit Retention: This is a disadvantage of a C corporation. Profit retention for a C corporation is less than that of a general partnership, since a C corporation’s income is taxed twice. A C corporation pays taxes on its income and the shareholder’s also pay personal taxes on the dividend income received from the corporation. 6. Regulatory Requirements: This is a disadvantage of a C corporation. It is difficult to form a C corporation because regulatory requirements are many. A C corporation is required to file incorporation documents with the state, additional filings throughout the year, and keep Board of Directors reports, minutes of meetings, etc. S CORPORATION – An S corporation is a legal entity that offers the limited liability of a corporation, but the pass through tax advantages of a partnership. 1. Liability: An S corporation offers its shareholders limited liability for the corporation’s debt. 2. Income taxes: An S Corporation is not a taxable entity (unlike a C corporation) and it does not pay taxes on its income. In this respect it functions much like a partnership. Income passes through the S corporation to the shareholders, who then pay taxes on the income at their individual tax rates. This is a clear advantage of an S corporation. 3. Continuity: Once an S corporation is formed it can exist indefinitely, with or without the original stockholders. However, it should be noted there are restrictions on the transfer of stock in accordance with the regulatory requirements listed below. 4. Control: An S corporation is managed by a Board of Directors who generally are shareholders with a large stake in the corporation. 5. Profit Retention: Since an S Corporation is not a taxable entity; all profits and losses are passed through to the shareholders and are taxed once at each shareholders individual tax rate. By avoiding the double taxation of a C corporation, the S corporation enables its shareholders to pay less in taxes and keep more of the profits earned. 6. Regulatory Requirements: An S Corporation is difficult to form and has many regulatory requirements. Some of these requirements include one class of stock; a limit of 75 shareholders, shareholders must be U.S. citizens and cannot be corporations or partnerships. The regulatory requirements for an S corporation are disadvantageous. LIMITED LIABILITY COMPANY – An LLC is a legal entity similar to an S corporation in that it offers the limited liability of a corporation, but the tax advantages of a partnership. 1. Liability: An LLC offers its members limited liability of the company’s debt and protects the member’s personal assets. In an LLC only the capital investment of the members is at risk. 2. Income taxes: An LLC is not a taxable entity and it does not pay taxes on its income. In this respect it functions much like a partnership. Income passes through the LLC to its members, who then pay taxes once on the income at their individual tax rates. This is an advantage of an LLC. 3. Continuity: In a general sense once an LLC is formed it can exist indefinitely. However, this can vary depending on each state’s regulations regarding LLCs. If the operating agreement permits, an LLC member can transfer their interest in the LLC to anyone else without restriction. However, if the operating agreement does not address the transfer of interest, then the members of the LLC must unanimously agree to the transfer muck like in a partnership. 4. Control: A limited liability company is managed by a Board of Directors who are usually members with a large financial interest in the LLC. 5. Profit Retention: Since an LLC is not a taxable entity, all profits and losses are passed through to its members and are taxed once at each member’s individual tax rate. By avoiding double taxation the LLC enables its members to pay less in taxes and keep more of the profits earned. This is an advantage of an LLC. 6. Regulatory Requirements: A limited liability company is difficult to form and has many regulatory requirements. A charter must be filed with the Secretary of State and an operating agreement must be established outlining the obligations and rights of the LLC members. Since a limited liability company is a fairly new legal entity, perhaps the greatest difficulty is the varying requirements and restrictions for LLCs from state to state. REFERENCES Beatty, J., Samuelson, S. (2007). Business Law and the Legal Environment. 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