Organizational Forms Advantages and Disadvantages - Essay Example

Organizational forms Organizational forms Various businesses can be organized into different forms. The form the owner of a business chooses affects their legal liability and the treatment they get from income tax. The different forms are sole proprietorship, Limited Liability Company, partnership and corporations (Bouchoux, 2010). Sole proprietorship The main aim of this form of a business is to become the sole propeller of the business. Thus, fewer forms are required to be filed compared to other organizational forms. This business is structured in a way that there is no need of legal documents to determine how profit in the company will be shared. This is an acceptable structure in the event that an individual is the sole owner of a business with no need of distinguishing the business from himself. It does not prevent one from choosing a business name that is different from one’s own name. All the profits, losses, assets, and even liabilities are the direct responsibility of this sole owner (Pride, Hughes, & Kapoor, 2012). He or she is also responsible for payment of self-employment tax from his or her income. Such forms of business are not recommended for a high-risk business due to the possibility of risking ones personal assets. It is important for such businesses to have a legal structure to protect their assets in case they are taking huge debts to start their business. Examples of high-risk businesses include manufacture or sale of perishable products, repairing valuable products or childcare businesses. In the event that the business risks are not that high, the sole proprietor can buy a good insurance policy to provide the required protection and give the business individual peace of mind during his daily business ventures. Advantages 1. Ease of formation- starting a sole proprietorship business is cheaper and less complicated considering that it does not require loads of paper work. In some states, such organizations can be formed without the need of double taxation that is applicable in corporations. The owner of a sole proprietor can name the business after his name or choose any name of his choice to enhance the marketing of the business. 2. Tax benefits- the business owner is not required to file a separate report on business tax. Instead, they only list their business information and figures within their own tax returns. As a result, they are able to save on accounting costs and tax filing costs. Their business is taxed according to their personal income and not the rate applied to corporate taxes. 3. Employment-since sole proprietors can hire employees of their choice, they create employment opportunities and get job creation benefits including tax breaks. The spouse of the business owner can be hired without a declaration as an employee of the company. married individuals can start a sole proprietorship business together though the liability is only assumed by one of them. 4. Decision-making-the owner has control over all processes of the business decision making. The owner can also transfer the ownership of the business at any time they feel like it. The business owner can also easily wind up the business at his or her own time. Disadvantages 1. Liability-the business owner is responsible for any possible losses, violations, or even debts that the company may face. The owner can also be sued for any violations made by the employees of the company. 2. Taxes- the owner must pay the self-employment tax. it is also impossible to deduct some tax benefits including health insurance premiums for the company’s employees. 3. Lack of continuity- the business may seize to exist in the event that the owner dies or becomes incapacitated. In case of death, the business is often liquidated and is distributed to the owner’s beneficiaries. 4. Raising capital is difficult-since the owner provides initial capital, it may be difficult to raise capital for the business. Such business does not allow any money generating investment including issue of stocks (Gitman & McDaniel, 2009). Limited Liability Company (LLC) This business structure is able to protect the personal assets of the owner from any financial liability and protects against personal liability. However, there are certain situations where such an owner can be held liable for instance if he intentionally conducts fraud, or failure to separate personal affairs from those of the LLC. The structure is often established under the state law thus the laws governing them varies depending on the location of LLC. According to IRS, most states do not allow banks, nongovernmental organizations, and also insurance companies to be LLCs. There are no federal taxes forms for LLC though they must decide whether they will be taxed as an individual, corporation, or partnership. The LLC need to name their company and file articles of organizations with the state of location. The company also has to create an agreement that spells out the percentages, responsibilities and each individual’s voting power. It is also crucial to publish a notice indicating the establishment and formation of the LLC. Advantages 1. Flexibility of taxes- IRS does not tax LLC directly at the initial stages. Members of the LLC determine how they want to be taxed. They do so by creating an operating agreement. 2. Less paperwork- they are governed by default rules in the state of location unless the company drafts an LLC operating agreement to create rules to govern the business. Thus, with less requirements and less paperwork, they are easy to form and keep in a better legal understanding. 3. Limited liability- members of LLC are limited from liability of the company. Thus, they are not personally liable for debts and violations made by LLC. Creditors are also prohibited from getting the personal assets of LLC members. 4. No restrictions on ownership- there are no restrictions made on the number of stockholders required in the formation of an LLC. Disadvantages 1. Limited life- if an individual member departs from the LLC, it ceases to exist. However, members of LLC can curb this by their operating agreement. 2. Roles confusion- due to the difficulty in allocating various roles to its members, it becomes difficult for the company and its investors to know the person in charge. 3. Few fringe benefits- employees of LLC receiving fringe benefits must recognize them as taxable income (Miller & Cross, 2013). Corporations The corporate structure distinguishes the business from its owner and it is able to reduce the resulting liability. However, running a corporation is more complicated due to accounting on tax, record keeping, and various paper work requirements seen. It is not advisable to start a business as a corporation from the start unless the business owner is willing to have various shareholders or the potential clients of the business are only willing to conduct business with a corporation. In establishing corporations, it is required that the business owners choose a business name, appoint directors of the company, file incorporation articles, pay the required fee, and follow any other set requirements (Johnson, OBrien, Campbell, Grange, & Johnson, 2008). There are two types- the C corporations and the S corporations. The C-corps are separate entities in payment of tax. They file their returns on income tax and remains on income earned until it is paid in form of a salary or wage to the officers or employees of the corporation. In S-corps, income, losses and any deductions and credits have to pass through the company and become the company’s shareholders direct responsibility. Advantages 1. Limited liability- the members of a corporation are not personally liable for debts incurred by the business. It protects the personal assets of owners from debt collection, lawsuit, and any other emerging business issue. 2. Tax treatment- the corporation separates tax liabilities from the owners’ personal tax liabilities. As the owner of the business, one is only required to pay tax on the money one is paid by the corporation in form of either a salary, dividends and or a commission. The corporate taxes incurred are the responsibility of the liability to pay. 3. Long-lasting- since it does not die when the owners of the corporation passes on. This is because a corporation is its own entity. It lives on even after the shareholders decide to dissolve it or if it merges with another company. It is much easier to merge a corporation since it will only require new shareholders as compared to forming an entirely new business. 4. Easy ownership transfer- this is because the number of certificate of shares that a person holds represents the ownership. 5. Easy to raise the required capital through various cash generating procedures including stock exchange and many other means. Disadvantages 1. It is a complex process undergone to establish a corporation. The reason is it requires registration with the central regulatory authority. It also requires enlisting in a stock exchange, which requires fulfillment of various requirements in relation to capital, and the number of directors. 2. Corporations have many shareholders who appoint the board of directors. In turn, the directors hire managers who govern the daily activities of the corporations. In some instances, the management may act under their own interest and not following the interests of the corporation owners resulting into agency problem. 3. Corporations suffer from double taxation. The corporate income is taxed and the dividends paid to shareholders are also taxed. Partnership Partnership is similar to sole proprietorship except that there are two or even more partners who co-own the business all the partners share the profits and losses of the company and have an unlimited liability for all their liability debts. The way they share the profits and losses in the business is determined by the agreements on the partnership agreement, which can be either informal or formal written agreement. In limited partnership, one or more partners will run the business with an unlimited liability but there will be another partner or more who will not be actively involved in the business. It is important for partners to have a written agreement since a partner in a general partnership is capable of being held accountable for all the debts incurred in the partnership. It is also important for limited partners to avoid too much involvement in the business decisions unless he or she is willing to assume the obligations held by the general partner. If things go the way they were not intended, the limited partner might be held as the general one though they say that they are the limited partner (Sutherland, 2008). Advantages 1. Capital- the nature of the business allows the partners to fund the initial startup capital of the business. Thus, the more partners there are the more startup capital the business will have. This will allow the business to be more flexible and to grow steadily. It also allows the partners to have more profit, which they are able to share equally. 2. Flexibility- it is easier to form and manage a partnership. They are regulated less strictly in terms of the laws that regulate its formation. The partners have the only required say in how the business should be run thus increasing the flexibility of the business. 3. Shared responsibility- they share the responsibility of running the business thus allowing them to maximize on their abilities. 4. Decision making- they share the aspect of decision-making and can help each other out where need arises. They are able to come up with creative means of solving problems arising in their business. Disadvantages 1. The partners have to pay taxation on self-employment just like the sole proprietors do. 2. Their liability on the debts of the company is unlimited 3. Partners may disagree on various decisions of the company creating a conflict of interests. This may destabilize the business and it might suffer losses in the end. 4. Each partner is liable for the mistakes of each of the other partner. 5. If one partner decides to leave the company, the organization will have to value all the assets of the partnership, which might be costly (Liuzzo, 2013). This also applies when a partner joins. References Bouchoux, D. E. (2010). Fundamentals of business organizations for paralegals. Austin: Wolters Kluwer Law & Business. Gitman, L. J., & McDaniel, C. D. (2009). The future of business : the essentials. Mason-OH: South-Western Cengage Learning. Johnson, L. M., OBrien, L., Campbell, A. D., Grange, J., & Johnson. (2008). Federal Tax Course 2009. New York: Cch Inc. Liuzzo, A. (2013). Essentials of business law. New York: McGraw-Hill. Miller, R. L., & Cross, F. B. (2013). The legal environment today. Mason,Ohio: Southern Cengage Learning. Pride, W. M., Hughes, R. J., & Kapoor, J. R. (2012). Business. Mason-OH: South-Western Cengage Learning. Sutherland, J. (2008). Essential Business Studies for Aqa As Le. Chichester: Folens ltd. Read More