Forms of Business Organization - Term Paper Example

Forms of Business Organization Sole Proprietorship Sole proprietorship is unincorporated form of business, which is owned and managed by a single entrepreneur. In other words a single person will own, operate, make critical decisions and carries out all business activities as well as transactions single handedly. Unlike most of business organizations, sole proprietorships are not considered separate entities legally. In fact sole proprietorship forms one of the most common business organizations in our society. Characteristics Liability: Sole proprietorships do not enjoy limited liability. This means that the business owner will be personally liable for all the business debs and risks and as their personal belongings will be confiscated to settle the claims of the creditors. Operating sole proprietorship form of business puts both the business as well as personal assets at risk owing to the fact that this form of business have unlimited liability(Cody, Hopkins & Perlman 202). Control: the business is owned and controlled by the owner. This means that the owner without consultation handles all the critical decisions of the business single handedly and as such, he/she has full authority to delegate tasks at will. Income taxes: Sole proprietorship income is taxed on the owner’s personal income. The Internal Revenue Service (IRS) treats income from sole proprietorship as personal income and thus taxes are charged on the owner’s income (Cody, Hopkins & Perlman 202). Continuity of the business: Sole proprietorship business is not a separate legal entity from its owners and as such, it does not enjoy perpetual existence as the death, or bankruptcy of the owner will lead to the end of business. Profit retention: The sole proprietor enjoys all the profits by himself and therefore he is the one to decide the amount to give up for plough back into the business. Location: Sole proprietorship is one of the easiest businesses to operate taking into consideration that it is not affected by change of location as most states operate similar laws and regulations relating to sole proprietorship. Advantages It is easily and less expensive to form compared to other forms of business organizations such as C-corporations and LLC. This form of business organization requires less capital to start as well as few legal formalities. Avoids double taxation as in the case of C corporations The sole proprietor enjoys all the profits alone taking into consideration that this form of a business is one-man show. Quick decision making as no one is consulted in case a decision has to be made like in the case of general partnership (Cody, Hopkins & Perlman 9). Disadvantages Sole proprietorship has unlimited liability and as poses a risk of loss to personal as well as business assets in case of credit default. Sole proprietors have limited capital owing to lack of a wide range of avenues of raising capital as in the case of C corporations. Lack of perpetual existence owing to the fact that illness, bankruptcy or death of the owner lead to termination of the business. General Partnership General partnership is an unincorporated for of business which involves two or more individuals (maximum of 20) coming together to form a business in order to make profits. Unlike in the case of sole proprietorship, partners in the partnership business share into the ownership, management, profits, loses and critical decisions affecting day-to-day operations of the business. Characteristics Liability: The General partnership does not enjoy limited liability as in the case LLC, C corp., or S corp. This means that all the partners are personally liable for all the debts and liabilities of the business. In fact, the partners risk losing, not only their investments in the business but also their personal property in case the business fails to honor its credit obligations (Cody, Hopkins & Perlman 9). Income tax: Income of the general partnership business does not attract taxes considering that partners will be taxed on the income of the partnership business. Control: Just like in the case of sole proprietorship, the control of the business is in the hands of the general partners and as such, they are responsible for management and deciding critical issues relating to the ordinary business operations. Continuity: General partnership has a limited life just like sole proprietorship taking into consideration that partnership has no independent legal life apart from that of its owners. In other words, the partnership will have to dissolve in case of retirement, withdrawal, death or bankruptcy of one partner (Cody, Hopkins & Perlman 9). Location: because limited legal compliance is required for general partnership in several states and therefore expanding or shifting business from one state to another cannot jeopardize partnership business. Profit retention: General partnerships tend to distribute all their profits and lose to the partners with little regard for profit retention. Advantages Partnership is less expensive and easy to start just like sole proprietorship Large financial resources compared to sole proprietorship owing to the increased number of owners. Diffusion of risk: Unlike the sole proprietor who bears all the business risks partners, share business risks thus reduced risk burden. Avoids double taxation considering that partners will be taxed on business income (Cody, Hopkins & Perlman 203). Disadvantages Unlimited liability: General partners do not enjoy limited liability like LLC or S corp. and as such, partners run the risk of losing personal property in case of debt default by the business. Joint and several liabilities: The liability of one partner becomes the burden of the entire business (Cody, Hopkins & Perlman 9). This means that a partner may end up being liable for a liability attributed to another partner. Limited lifespan: general partnership has no separate legal entity and as such death, withdrawal, bankruptcy, or retirement of one partner leads to dissolution of the business thus lack of perpetual existence. Limited capital: Apart from the capital contributed by the partners, partnership has limited avenues for capital compared to C corp. Limited Partnership Limited partnership is an unincorporated business setup with one or more (general) partner(s) with unlimited liability and one or more (Limited) partner(s) with limited liability. The Limited liability partners’ liability is only limited to the amount of money they have contributed towards organization capital (Cody, Hopkins & Perlman 11). General partners are the ones responsible for running organization affairs while the limited partners’ shares only in the profits and losses of the business without direct involvement in organization obligations. Characteristics Liability: limited partnerships have two types of partners (limited and general) with different liability positions. General partners have unlimited liability while the limited partners enjoy limited liability which is equivalent to amount contributed towards organization capital. Control: management and control of the limited partnership is under the jurisdiction of the general partners and the general partners will make as such critical organization decision about business affairs (Cody, Hopkins & Perlman 11). Location: various states operate similar laws and regulations regarding operations of the limited partners, and this means that there will be little implication if any on the business affairs in case the partner decides to move or expand their business in other states. For instance, most states only require Limited partnership business to file a Articles of Limited Partnership with the state after drafting a “Partnership Agreement”. Income tax: partners are taxed on the income earned by the limited partnership business considering that income earned by the business will be distributed to the partners based on the Partnership Agreement (Cody, Hopkins & Perlman 11). Burden: Unlike the C corps, the Limited partnership has no additional burden placed on them in relation to financial reporting, regulatory requirements, or organization meetings. For instance, are required to by law to publish their audited financial reports annually, and hold Annual General Meetings (AGM). Profit retention: just like general partnerships, limited partnership business distributes their income and losses with little regard for profit retention for future plough back. Continuity: The limited partnership just as general partnership does not enjoy perpetual existence as legal disability, death, withdrawal, or insolvency terminates the life of the business. Advantages Limited partners enjoy limited liability and as such, their liability is limited to the amount contributed towards company capital. Limited partnerships are easy to start and run unlike C corps, which are so robust and require large investments (Cody, Hopkins & Perlman 11). Avoids double taxation as in the case of C corps as the income of the partnership will be taxed on partners. Great access to financial resources compared to sole proprietorship as all the partners contribute some amount towards organization capital. Disadvantages Unlimited liability: the general partner(s) do not enjoy limited liability as their limited counterparts and as such they run the risk of losing their personal property incase organization capital cannot settle the claimed debt (Cody, Hopkins & Perlman 18). Limited financial sources: the limited partnership capital have few options for additional financial resource as their capital restricted to the amount contribute by partners unlike the case of C corp. or S corp. Personality and authority conflicts between the general and limited partners can spell doom on the effectiveness of the business owing to their liability status. Limited Liability Company Limited Liability Company (LLC) is flexible form of an unincorporated business that offers advantages of both the corporation and the general partnership in terms of management, limited liability, taxation, and formation (Cody, Hopkins & Perlman 104). LLC can be formed with as little as a single member however, this depends with the state. Characteristics Liability: The liability of the members in LLC is limited and members’ liability is limited to the amount invested in the company. Continuity: Just like corporations, LLC enjoys perpetual existence taking into considering that it is considered a separate entity from its owners. Income tax: LLC can choose to be taxed as a sole proprietor, general partnership, S corporation, or C corporation (Cody, Hopkins & Perlman 17). Control: Members of the LLC can participate in the management of the organization and as such they share in the control and deciding critical organizational issues. Burden: Unlike partnership and sole proprietorship, LLC is charged with several obligations in relation to reporting and regulatory requirements, which change from states to states. For instance, LLC are requiring by law to publish their financial states besides the need to prepare and maintain “Operating Agreement”. Location: It is noteworthy that moving or expanding the LLC business in other states can translate to varied implications on the operations of the business. It is noteworthy that various states operate different laws and regulations in relation to LLC businesses. For instance states such as New York, Alabama, Texas and Kentucky charge all LLC business franchise tax while other states do not. The same case applies with the form that needs to be filed by the state agencies, the minimum number of owners required to start LLC. States also charge different rates for filing documents and reports. Other states such as Washington DC do not recognize taxation of LLC income on its members and such a moves may jeopardize moving or shifting the LLC business to such states. Advantages Double taxation: LLC can avoid double taxation by choosing to be taxed as a partnership, sole proprietor, or S Corporation. If the LLC wants to be taxed as a partnership then it has to file the Internal Revenue Service (IRS) Form 1065. Limited liability: The LLC members enjoy limited liability unlike in general partnership or sole proprietorship (Cody, Hopkins & Perlman 101). Separate entity: Just like corporations, LLC enjoys independent legal ownership from its owners in several states. Disadvantages Limited financial resources: Various states have restricted the maximum number of shareholder in LLC businesses thus denying LLC businesses from raising additional capital. Additionally the fact that LLC businesses cannot trade its securities in the stock exchange denies it an opportunity to raise additional capital as in the case of corporations. Variation in regulations: Various states are practicing different regulations and policies regarding operations of LLCs. This aspect makes it hard for further expansion or moving of business from state to state. S Corporation S corporations are incorporated business that elects to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Service (IRS) and as such, they avoid paying Federal income tax. In other words, S corporations are created with the intention of minimizing tax burden as the income of the business is passed through to the shareholders for taxation purposes (Cody, Hopkins & Perlman 207). S corporation share several similar features as those of the C Corporation. However, significant differences are only evident in the restricted number of shareholders and the fact that S corporations cannot float their shares in the stock exchange. Characteristics Control: The management and control of S corporation is in the hand of the Corporation’s Board of Directors and as such, owners are relieved from the management and control of company affairs including decision-making. Income tax: Shareholders are taxed on the income of the business considering that the I come of the corporation will be passed through to the shareholders to be taxed at personal level while the company incurs no Corporate Income Tax on the reported profits. Liability: The shareholders enjoy limited liability as in the case of LLC or C corporations. Continuity: The Shareholders are assured of perpetual existence of the company taking into consideration that S corporations have a separate independent life from that of its owners. Burden: S corporation are faced with a wide range of additional burden placed on them in relation to financial reporting, regulatory requirements or organization meetings. For instance, the business has to file IRS Form 2553, Articles of Incorporation and maintain minutes of meetings and By-laws. Location: It is noteworthy that various states apply different regulations with respect to operations of the S corporations and as transferring or expanding the business into other states will lead to varied implications on the performance. Advantages Taxation: S corporation enjoys an advantage of avoiding double taxation as it can elect to be taxed as general partnership thus avoiding Corporate Income Tax on reported profits (Cody, Hopkins & Perlman 207). Liability: Shareholders of the S corporation enjoys limited liability Continuity: Unlike general partnership and sole proprietorship shareholders of S corporations enjoys perpetual existence of the company. Disadvantages S corporation is facing a wide range of government requirements and regulations in terms of the type and number of shareholders. The number of shareholders is restricted to 100 persons who must be local citizens thus locking out foreigners. S corporations suffer limited financial resources owing to the fact that they cannot float their securities in the stock exchange, beside the fact that the number of shareholders is restricted to 100 persons. C Corporation C corporations are incorporated businesses taxed under Subchapter C of the Internal Revenue Code with a separate independent life comprised of three categories of persons namely the shareholders, officers, and directors. Unlike other forms of business such as S corporation, Partnership and LLC that elect to pass through business income to shareholders and members, C Corporation is only organization that pays Corporate Income Tax on their income (Cody, Hopkins & Perlman 204). Characteristics Liability: The shareholders of C corporations enjoy limited liability and their liability to company debts is restricted to the amount they have invested in the company assets. Continuity: C corporations enjoy perpetual existence as death, bankruptcy or withdrawal of one shareholder cannot terminate life of the business. Income tax: The C corporations pay Corporate Income Tax on their income. Location: Most of states practice similar laws, regulation, and requirements regarding operations of C Corporations and as such, there will no considerable implications in transferring and expanding the company into other states. Burden: There are several additional burdens placed on C corporations in relation to financial reporting, regulatory requirements, or organization meetings. For instance, C corporations are legally required to publish audited financial states annually, document minutes of the board meetings, and shareholder participation. Advantages Liability: Shareholders of C corporations enjoys limited liability, which is equivalent to the amount of money they have invested in the company. C corporations enjoy perpetual existence considering that it is separate independent entity from its owners. C corporations boast of wide sources of financial resources owing to the fact that they can float their securities in the stock market to raise additional capital (Cody, Hopkins & Perlman 204). Disadvantages Profits earn by C corporations are subjected to double taxation at the company level in terms of Corporate Income Tax and at individual level for all earnings distributed to the shareholders inform of dividends. Bureaucracy and expensive: Setting up C corporation calls for compliance with many requirements mostly legal besides high cost of startup. Control of C Corporation is relieved from actual owners and vested in other persons with limited interest in the company. Recommendation The manufacturing business owner should convert his business into a Limited Liability Company (LLC). The main reasons for this move include The business owner will enjoy limited liability restricted to the amount he will invest in the company and as such, he will be relived from the damage claims associated with injuries and losses suffered during business operations such delivery trucks or forklifts causing accidents as well as those that may be caused by loosely fitted cabinet. The business owners will have an opportunity to increase investments in the company by selling stocks to other private interested investors. Several states are practicing similar laws, regulations, and requirement associated with operations of LLC and as such, he will be in position to expand the business without any worries. The Business owner will enjoy the flexibility of operating a business with features of corporations but being taxed as a general partner or sole proprietor. Limited Liability Company will give the business owner flexible management option of participating in the management and control of the business unlike in corporations (C and S corps). The business owner should not be worried about the continuity of business in case he dies taking into consideration that LLC has perpetual existence unlike sole proprietorship and general or limited partnership business whose lives are terminated once the owner dies, becomes bankrupt, or incapacitated. Work cited Cody, T., Hopkins, D & Perlman, L. Guide to Limited Liability Companies. Chicago: CCH Group.   Read More