Legal Issues For Business Organizations Law Company Business Partnership Essay

Published Date: 02 Nov 2017

Zack Custovic

Legal Issues for Business Organizations

REPORT – FORMS OF BUSINESS ORGANIZATIONS

Sole Proprietorship

This form of business organization is based on the fact that the business is owned by one person and it is also known as proprietorship or sole trader. One person is the founder, owner, and only decision maker when it comes to the business. Sole proprietorship, as any business, has its benefits and drawbacks.

Benefits of this type of business are simplicity, autonomy, sole gain, single tax and shelter income. Simplicity of this business means that it is relatively simple to start a sole proprietorship. This type of business has at least amount of government rules and regulations. That means that it only takes to acquire local permits and licenses. Owner also needs to fill out certificate about intent of the business owner if he/she wants to operate business under different name than their own. Owner makes all the managerial decisions including decision to stop the business. Autonomy of this type of business means that business owner has an infinite freedom of choice and action when it comes to business (within the legal boundaries). Owner gets to make all the decisions since he/she doesn’t have partners in the business. Sole gain relates to the fact that any profit made by the business belongs to the sole owner. Single Tax for the business owner means that the business owner and the business are being taxed as one entity (single unit). No matter what state business is in this rule applies. All profits of the business are personal income of the business owner. This is known as pass-through taxation. At the same time business owner gets a benefit of reducing taxable income by charging off costs of doing business as expenses.

Off course there are also disadvantages to the sole proprietorship business type of organization. Those are limited resources, unlimited and unshared liability and the fact that business dies with the business owner. Limited resources mean that the business owner is the only investor into the business. It is hard for the owner to raise capital because business has only one owner and who ever want to invest the money can never know what is happening with their investment or how secure investment is. Business is also limited in the intellectual resources since it has only one owner. This means that business will suffer financially and economically in one way or another any time business owner is sick or absent or if he/she lacks some technical or business abilities. Unlimited and Unshared Liability represents big drawback of the sole proprietorship; business owner is financially liable for any financial drawback of the business. If the business fails creditors can come after personal assets and business assets of the business owner, as they are, in this type of business organization the same. Business dies with the business owner’s death. This circumstance, without proper planning can leave owner’s family financial means cut off.

General Partnership

This type of business organization represents unincorporated company or association where each member (partner) is fully active part of the firm with a voice in its management. Each partner can represent business on behalf of other partners because each partner has a full authority to act for the firm and on behalf of the other partners. Also, each partner is personally liable for the debts of the business, taxes and each gets the same share of the profits. As co-owners the partners have same rights when it comes to possession of the company’s assets. Neither partner can make any actions with the assets of the other partners. If one of the partners dies or decides to leave a business partnership is broken. Usually these situations are regulated with the buy-sell agreement in which assets of the gone partner can be sold to the remaining partners in the business. General partnership as such is not subject to federal income tax although it is required to submit an information return that contains information about gross partnership income, business deductions, and net taxable income. Since a partnership is a pass-through entity no federal income tax is imposed on the partnership itself. Every partner is required to provide a copy of Schedule K of the form 1065. On the individual income tax form return each partner must include his or her share of the profits (no matter if these funds have been distributed during taxable year). Advantages of partnership are:

Profit retention – partners get to keep all the profits. Unlike some other business organizations there are no stockholders with whom to share the earnings of the business

Income Tax - Partnership itself is free from federal income tax and partnerships are not subject to accumulated earnings tax.

Losses or Profits advantages - of the partnership are directly imposed on partners as personal gain or loss for federal income tax purposes.

Talent and risk sharing – means that it is easier to attract partners with different skill set to run one aspect of the business while at the same time taking over same share of the risks.

Disadvantages of General Partnership can mostly be accounted for in the death of a partner which may automatically end the partnership if no agreement has been signed. Unlimited personal liability of the partners is the second disadvantage of this type of business organization. If the debts of the business cannot be paid from the business itself then personal assets of partners can become a way for creditors to gain their money back.

Limited Partnership

Limited partnership is similar to general partnership in that that it has at least one general partner(s), but at the same time it also has at least one limited partner. Limited partners do not have management decision rights and limited partner is liable for company’s debt in the amount invested by limited partner in the business. His/her liability in the firm is only measured by the investment made by that partner. In other words limited partner is the investor in the firm. Limited partner can only receive pre-determined share of the profits and in the case of partnership dissolution the limited partner’s share has priority over funds due the general partners. However, it is subordinate to claims of the firm’s creditors. In case of death of the limited partner his/hers personal representative is entitled to the deceased’s portion of assets and deferred profits in order to settle the estate. Death of the limited partner does not dissolve the partnership. However, death of general partner can end the business unless there is an agreement that states the otherwise. When it comes to taxation of limited partnership it is possible that partnership can be taxed as a corporation due to too many characteristics of the corporation. IRS uses four major characteristics to determine corporations and if limited partnership meets only two it will be taxed as corporation; freely transferable ownership interests, continuing of life, participation of limited partners in management of the partnership, and limited liability of the limited partners for debts of the partnership. Because of these characteristics limited partnership needs to be very careful in drawing agreement not to be taxed as corporation. There are also two versions of limited partnership:

Family partnership is a legal agreement that allows business owners and their children to address several business-succession and estate planning needs all at once. Primary benefit of this type of limited partnership is the ability to reduce the size of family partnership general partners’ estate tax thereby reducing the amount of federal estate tax at death.

Professional partnerships are consisted of commercial (business) partnerships and professional (personal services) partnerships. Important difference between two lies in the character of assets; most commercial partnerships are capital intensive (substantial part of the value of the firm is represented by its physical assets such as real estate, machinery, fixtures, etc). However, with professional partnerships they are not capital intensive. The real value of the typical personal service partnership lies in the training, knowledge, skills, experience, character, and reputation of the individual members of the firm. Key difference between two professional partnerships is that partners must be qualified members of a given profession. A deceased partner’s heirs cannot come into the business as partners unless they too are qualified professionals in the same field.

In conclusion benefits of limited partnership are:

Limited liability – limited partner is only responsible for the money he/she vested into the business. If business goes under creditor’s will not come after limited partner’s personal assets.

Profits – although risk is significantly less compared to general partner limited partner still has the right on the profit from the business

Disadvantages of limited partnership can only be seen through taxation where if limited partnership has characteristic of corporation it can be taxed as corporation which would decrease profit for limited partner

C-corporation

C-corporations (also known as closed corporations) are type of corporation that are seldom owned by more than a handful people of whom is engaged actively in the day-to-day management of the business. One major characteristic is that c-corporation’s stock is not listed on the stock exchanges and rarely changes hands except at death, retirement or a major realignment within the firm. In a closely held corporation (c-corporation) each stakeholder has threefold role; director, an officer and an employee. Owners are the managers. Death of an owner means death of a key employee of the corporation. Also, with c-corporations there is a limited liability of running business. However, many creditors require signature form the owners of the corporation as well signature from corporate office. In this case if corporation can’t pay the debt then owner will have to pay debt out of their own pockets. This means that liability of the c-corporation falls on shoulders of the owners. In mostly all c-corporations owner are salaried employees of the corporation. However, in theory and practice owners can set their own salaries at whatever levels they wish. It would be unwise for owners to pay themselves dividends over salaries since salaries are tax deductible. As like with any other corporation so c-corporation can go indefinitely. Owner’s death, withdrawal, mental incompetence, or bankruptcy does not in itself interrupt the corporation’s continued existence. Changes in the c-corporation are hard to make as we said before since stocks are not publicly available for trade. Like with any other corporations, c-corporations pay little or no income tax. Benefits of the c-corporation are that owners keep all the profits (salaries, dividends, and stocks), limited liability of owners in theory where creditors can’t go after owners’ personal values. Disadvantages would be that most creditors in practice want a signature from owner making them liable for money borrowed.

S Corporations

S corporations are common type of corporations. S corporations have some similarities with C-corporations they are taxed in part like partnerships and in part like corporations. This means that same as with partnerships there is generally no federal income tax for S corporations and S corporations are pass-through forms of business. Owner of S corporations are taxed on their proportionate share of the earnings of the corporation. Decision to incorporate as a C or S corporation will often vary based on the relative income levels; owners would rather have income taxed to a C corporation, rather than have it passed through to their individual taxes via S corporation’s structure. S-corporations, same as C-corporations, have continuity of life; death of the shareholder doesn’t mean business will stop. Liability of the stakeholders is limited to the amount of his or her investments. S corporations cannot have more than 100 shareholders due to the fact that their shares lack marketability. Also, some states might impose corporate taxes on S corporations. For a corporation to become an S-corporation all shareholders must vote in favor of it. To revoke the status of an S-corporation requires consent of one or more shareholder who owns 50 percent or more of the voting stock. Also, corporation must be domestic and there can only be a single class of stock. Major benefit of S corporation is that the owners can take advantage of corporate expenses and losses to reduce and offset their other personal income at tax time each year. Also, there is a benefit of having an option for stockholders to vote to go back into a regular corporate form. The intent is to do this once the major tax losses and high early expenses are used up.

Limited Liability Companies

Limited Liability Companies (LLC) are another form of business organization. They are innovation in forms of business organizations. LLC combines some basic concepts of partnerships, C and S corporations. LLCs combine the personal liability protection of a corporation with the tax benefits and simplicity of the partnership. Basically, LLC is being taxed once on their profits and the owners are not personally liable for debts and liabilities. LLCs do not have limit on the number of members (individual or entities). For tax purposes LLC may be treated as a sole proprietorship, partnership or corporation. Tax regulations determine how a business entity is classified for tax purposes. Basically, if business have characteristics of a regular corporation it will be treated for tax purposes as corporation. If business has only one owner it will be treated for tax purposes as a sole-proprietorship and business with two or more owners can elect partnership or corporate tax status. Major benefits of LLCs are recognized by new businesses or partnerships that want to become LLCs. Also, existing partnerships or S corporations can convert to LLC tax-free; there will be no gain or loss recognized on the transfer of assets and liabilities so long as each partner’s or owner’s percentage of profits, losses and capital remains the same after the conversion. Dissolution of LLC is a disadvantage because it can be started by owner’s death. However, most states allow the remaining members of the LLC to vote to continue the LLC (all members or stipulated percentage of them).