Business for Sole Owners - Case Study Example

Forms of Business: A Comparison and Case Analysis John Smith XYZ Forms of Business: A Comparison and Case Analysis Sole proprietorship Under the sole proprietorship form of business, the owner is fully responsible for the company, and this includes responsibility for acts of negligence. If a worker were to get injured on the job due to machinery or other accidents, the sole proprietor could at the minimum have to defend him or herself in a court case for being negligent. . The sole proprietor is fully responsible for meeting unpaid bills and is personally liable to all creditors in the event of bankruptcy. It is difficult to raise capital in order to expand the business for sole owners. The only way the owner could expand would be to use his or her personal monies, or to apply for personal loans. The sole proprietorship form of business allows the owner to take on all profits or losses on an individual basis, and there is no sharing of the profits or losses. The sole proprietorship form has all profits taxed on the individual 1040 income tax form. Everything in the form of profits or losses flows through to the individual running the business and the business itself is not taxed (Willis, et.al, 2009). Under the sole proprietorship form of business, the business ends either when the person decides to go out of business, or if the person dies or somehow cannot operate the business. There is nothing formal that needs to be formally done to end the business. General partnership In the case of a general partnership, the same principles as with sole proprietorships apply in regards liability for injuries or accidents. The only real difference would be that the partners would share liability instead of all the liability resting with one person. In a bankruptcy case, the general partners would be personally liable for unpaid bills of the business. The legal rules apply differently from state to state, but being both jointly and separately liable is most common. This gives a third party the option to bring suit for unpaid bills either against one partner or against the partnership as a whole (Clarkson, et.al, 2006). The partners would find that it is easier to expand the company than for a sole proprietor. If there were two partners, they could combine their funds and resources for expansion. Banks would more quickly approve loans if more than one person was involved (Clarkson, et.al, 2006). The partners could invite more partners to join if more funds are needed. They could have a written agreement that the new partners provide funds or capital as part of the agreement to join the group (Clarkson, et.al, 2006). The general partnership would automatically divide the profits or losses equally unless the articles of partnership state differently (Willis, et.al, 2009). With a general partnership, the partnership itself is not taxed. Any income or losses flow through over to each individual’s income tax statements. The owners are taxed on their proportionate share of the business (Willis, et.al, 2009). Under general partnerships, the articles of the partnership determine how long the business operates. Those articles can state exactly the length of time that the partnership will continue. If nothing is stated in the articles, then any partner can end it by choice. If there is an agreement in place and a partner violates the agreement by leaving early, then the partner leaving early could be liable for losses (Clarkson, et.al, 2006). Limited partnership The limited partners would only be liable for accidents or injuries to their extent of their investment in the company. General partners on the other hand would face unlimited liability (Clarkson, et.al, 2006). If bankruptcy were to occur, general partners may be fully liable to creditors for unpaid bills, but any limited partners are only liable for the amount that they invested into the business (Clarkson, et.al, 2006). With limited partnerships, the ability to raise capital to expand would be the same as with general partnerships. The only difference with limited partnerships versus general partnerships is that the limited partners who join up do not help with any daily running of the business (Clarkson, et.al, 2006). The owner was concerned on how liability would be affected if changing from a sole proprietorship to a partnership. There is a great deal of liability exposure under both types of business. The major difference with partnerships is that the owner is not only responsible for his or her own actions, but any business actions that the other partners would take. As a result, a partnership is more risky as far as liability concerns even though it is easier to raise funds (Clarkson, et.al, 2006). Under the limited partnership, the same scenario is true as under the general partnership in regards profits and losses. Each partner would split them equally unless the articles of the partnership state otherwise. Losses cannot go beyond what the partner contributed into the business (Willis, et.al, 2009). In a limited partnership the tax treatment is the same as a general partnership where income and losses are taxed on the individual income statement and the partnership itself is not taxed (Willis, et.al, 2009). The length of a limited partnership is the same as the general partnership (Clarkson et.al, 2006). C-Corporation C-Corporation stockholders or owners are protected by state corporate law from losing any more than their original investment in the company (Willis, et. al, 2009). In the case of liability for injuries or accidents, S-Corporation owners are treated as C-Corporation owners in regards liability. In cases of bankruptcy, the owners or stockholders are only liable for the amount of their investment of stock in the company (Clarkson, et.al, 2006). By changing to a C-Corporation, the owner would find an easy way to generate funds to expand the company. All that would have to be done to raise additional money is to sell more company stock. A disadvantage with becoming a corporation is that there may be not as much opportunity to make decisions on how the company is run than the owner anticipates (Clarkson, et.al, 2006) It might be possible to sell shares to family members, but the company would be run by a board of directors that is voted on by the shareholders. As a result, by selling shares to form a corporation, it would be hard to maintain management control (Clarkson, et.al, 2006). Under a C-Corporation, the owners are the stockholders, and profit would be distributed in the form of dividend payments. (Willis, et.al, 2009) The C-Corporation has income or profits taxed two times. The first time is when the C-Corporation fills out its yearly income tax form. The second tax occurs when the owners receive dividend payments. These profits that are shared with the individual shareholders are taxed at the individual versus corporate tax form as well (Willis, et.al, 2009). C-Corporations have an indefinite life and take the form of shares of company stock. Those shares can be bought or sold and have multiple holders. As a result, corporations have long lives without any specific end date (Clarkson, et.al, 2006). S-Corporation The S-Corporation owners cannot lose more than their original investment (Clarkson, et.al, 2006). In the case of a bankruptcy, the owners are the stockholders and cannot lose more than whatever they originally invested into the company (Clarkson, et.al, 2006). If the owner decided to change to an S-Corporation instead of a C-Corporation, the major benefit would be potentially better tax benefits. The other concerns with raising funds to start the corporation would be similar to C-Corporations. Under an S-Corporation, the profit sharing would be the same as in a C-Corporation. (Willis, et.al, 2009). The S-Corporation normally will not have tax imposed at the corporation level with the higher corporate tax rates. The income or loss will pass through to the stockholders and will be a line item reported on the individual 1040 tax form. Even though S-Corporations do not have to pass on dividends to the shareholders, the shareholders normally are taxed on all the income whether or not it is distributed out to them (Clarkson, et.al, 2006). S-Corporations have the same unlimited duration characteristic as C-Corporations. Limited Liability Company Limited liability company owners as in the case of corporations do not have exposure to accident liability beyond their original investment (Clarkson, et.al, 2006). In the case of bankruptcy, the owners cannot lose more than their original investment into the company (Clarkson, et.al, 2006). There are not a large amount of liability concerns with an LLC, and the liability of the individuals are limited to the size of their original investments (Wiley, et.al, 2009) The ability to raise initial capital to form an LLC is somewhat more difficult than it is for corporations since more people tend to wish to invest in the more established form of the corporate form of organization (Wiley, et., al, 2009). It would be easier to keep family members in charge of operating the daily activities of the company since the LLC members can choose who performs the management role (Wiley, et.al, 2009). With a limited liability company, the profit sharing depends on what the operating agreement states (Clarkson, et.al, 2006). State laws apply if there is no operating agreement. Usually the state laws would indicate that profits or losses are equally shared if no agreement is in place (Clarkson, et.al, 2006). LLC’s can choose whether they want to be taxed like a partnership, or taxed as a corporation (Clarkson, et.al, 2006). The LLC is taxed as a partnership unless stated otherwise. This is where any profits or losses simply are shown on the individual tax form instead of being on a corporate tax form. If the LLC wants to keep the business expanding, sometimes they will elect to be taxed as corporations. This is to put profits back into the business versus giving dividend payments, and is because lower tax rates might apply to corporations (Clarkson, et.al, 2006). LLC’s look to the operating agreement as far as duration of the business is concerned. Most have limited life spans, but the length depends on the laws of the state in which it is formed (Clarkson, et.al, 2006). Based on the information given, I would recommend the limited liability company as a good alternative to the current sole proprietorship. Since the sole proprietor has to contract out much of his work given the high volume of work, it is important for him to limit his liability for injury or accidents. An LLC would provide this limited liability and any losses would not exceed the original investment of each owner. The size of the company would suit an LLC formation well. Trying to raise capital would be slightly more easy under a corporation form given that investors are more familiar with how the corporate form works, but this is still not a big enough business to be concerned about the LLC lacking ability to raise funds. An advantage of the LLC is that profit sharing can be formed at the start of the business, and can be agreed upon in advance on what percentage responsibility each person holds. LLC’s also have the advantage on choosing how they want to be taxed and can choose either the partnership form, or a corporate form of taxation. Since this business wants to expand, they may choose the corporate form of tax. Finally, lifespan is easily managed under the LLC and the length can be identified in the original terms of agreement. Overall, the advantages of an LLC would outweigh potential disadvantages. It is a less common form of business and less widely known, but the owner would be advised to investigate it as a good business choice in this case. References Clarkson, K., Miller, R., Jentz, G. & F. Cross (2006). West’s Business Law: Text and Cases 10th edition. Mason, OH: Thomson. Willis, E., Hoffman, W., Maloney, D., & Raabe, W. (2009). South-Western Federal Taxation: 2009 edition. Mason, OH: Thomson. Read More