2 Forms of Business Organizations And Their Attributes Sole Proprietorship A sole proprietorship is the easiest business organization to form because ownership consist of a single individual. The sole proprietor has ultimate control over the focus and direction of the entire business. This feature sets the sole proprietorship apart from all other business organizations. The advantages of a sole proprietorship are that the only paperwork the sole proprietor needs to be concerned with, when forming the business, is state and local permits, licenses, and any special certificates that might be needed.
No other legal actions need to be taken for a sole proprietorship to be established, saving time and money. The disadvantages of a sole proprietorship are that the individual owner is personally liable for the activity of the business. The personal assets of the owner may be required to satisfy any outstanding debt. Credit can also be an issue, when it is time for the business to expand, because loans will be based solely on the credit worthiness of the owner. Lack of capital for sole proprietorships can actually limit the scope and opportunities for the business.
The attributes of a sole proprietorship are: • Liability-The owner of a sole proprietorship assumes total liability for the organization. He is responsible for the assets along with the liabilities that may accrue over the life of the business. Nothing distinguishes the owner from the business itself. Income Tax-There is no double taxation of a sole proprietorship, like there can be with other forms of businesses. Any income of the owner and profits of the business are taxed together. Form 1040 and the Schedule C are used to tax the owner and the business as a unit.
Good record keeping is a must to insure that personal income is separated from business income. Longevity or Continuity of the Organization-The greatest disadvantage of a sole proprietorship is its lack of continuity as an organization. Because a sole proprietorship is linked directly to the owner there is no perpetual existence. The sole proprietorship generally will cease upon the death the owner. Retirement and disability also can bring the sole proprietorship to an end. Control-The decisions of the organization are the responsibility of the owner alone.
The sole proprietorship insures that the owner has complete freedom of action. The owner can do whatever he thinks best at any moment without consulting anyone else. Profit Retention-All profits of the sole proprietorship belong to the owner. Just as the owner takes on all the risk of the business, he also reaps all the benefits. The owner determines how the profits are to be used. The owner may use profits for his own personal use or of for the benefit of the business for further expansion and growth. Location-Sole proprietorships have great mobility. A sole proprietorship can move freely from one state to another with the owner.
Since sole proprietorships are not incorporated no special paperwork is required besides that of state and local permits. Convenience or Burden-There are few regulatory requirements for sole proprietorships. The cost for start-up and reporting is the lowest of any business organization. Convenience of the sole proprietorship is the prominent reason why most entrepreneurs begin their business as sole proprietorships. • • • • • • 3 General Partnership A partnership is formed when two or more individuals (including corporate entities) combine their resources and abilities to form a single business.
In a general partnership, the partners all share in the responsibility of the business and its management. Each partner has a full voice in the activities of the partnership and speaks as an agent for each partner within it. If the partnership consist of more than two partners, the majority decision is usually followed. The agreement that establishes the general partnership can be oral or written. The advantages of a general partnership are that the labor, expertise and capital of the partners are pooled increasing the earning potential and stability of the general partnership. The profits from the partnership are shared among the partners.
General partnerships are generally inexpensive and easy to form. The disadvantages of a general partnership are that the partners are each personally liable for the actions of the partnership. If the debts of the partnership exceed the partnership assets, creditors can come after the personal assets of each partner. General partnerships may end with the death of one of the partners. The attributes of a general partnership are: • Liability-The partners of a general partnership assume total and full liability for the organization. Each partner can incur liabilities which all of the other partners become liable for.
Poor decision making on the part of one partner can adversely affect each partner. Income Tax-The partnership must file an information return with the Internal Revenue Service, but the income is passed through to each of the partners. This means there is no double taxation of the income received by the partnership. Any income of the partners and and each partners share of the profits of the business are taxed on each partners personal return. Longevity or Continuity of the Organization-The general partnership will cease upon the death or withdrawal of one of the partners, unless other arrangements are made within the partnership agreement.
If this occurs, the equity of the departed partner is purchased by the remaining partners. Control-The decisions of the partnership are the responsibility of each partner equally, unless the partnership agreement specifies differently. The actions of one partner commits all the partners. Profit Retention-All profits of the general partnership belong to the partners. The profits are divided among the partners according to the stipulations of the partnership agreement. The partners may remove profits from the partnership or let the profits remain within the business. All profits are taxed to the partners, whether dispersed or not.
Location-Partnerships are registered within the state of their creation. Partnerships may do business across state lines by filing a foreign qualification document with the state it intends to do business in. Convenience or Burden- The agreement that brings a general partnership into existence can be oral or written; however, the benefits of a written agreement are worth the time and expense. General partnerships are entities that need to register with the Secretary of State. Informational returns must be filed with the Internal Revenue Service for the general partnership, but profits are passed through to each partner.
The start-up documents are more cumbersome than with a sole proprietorship, but less than a corporation. • • • • • • 4 Limited Partnership A limited partnership is formed when general partners take on one or more limited partners. General partners still take on the full risk of the partnership, while the limited partners are only obligated up to the amount they have invested into the partnership. Limited partnerships allow people to infuse much needed capital into investment ventures, while minimizing their personal risk. The general partners manage the operations and are fully liable for the partnerships financial obligations.
The limited partners can not participate in the management or operations of the partnership. This keeps the limited partners from being entangled with the unlimited liability of the general partners. Because they are investors, limited partners usually receive a designated share of the profits. Limited partners have a priority over the general partners when it comes to the share of the funds of a limited partnership. The death of a general partner can cause a partnership to cease, where the death of a limited partner would not.
The advantages of a limited partnership are that the limited partners can provide additional capital that might not otherwise be available to the general partners. Taxation of the profits only occur once, because all partners declare their share of the profits on their own personal returns. The disadvantages of limited partnerships are that if a general partner dies the partnership will most likely come to an end. Also, if the limited partnership starts to take on the aspects of a corporation, it could possibly be taxed as a corporation.
The attributes of a limited partnership are: • Liability-The general partners of a limited partnership assume total and full liability for the organization. The limited partners only share in the liability of the organization to the extent of their investment. Income Tax-The partnership must file an information return with the Internal Revenue Service, but the income is passed through to each of the partners. This means there is no double taxation of the income received by the partnership. Any other income of the partners and each partner’s share of the profits are taxed on each partner’s personal return.
Longevity or Continuity of the Organization-The limited partnership will cease upon the death or withdrawal of one of the general partners. A limited partner’s death or withdrawal will not affect the continuity of the organization. However, depending on the size of the investment a limited partner takes with him, his departure a can adversely effect the financial stability of the partnership. Control-The management of the limited partnership is the responsibility of the general partners. Limited partners are not allowed to participate in the management of the organization.
Profit Retention-All profits of the limited partnership belong to the partners. The profits are divided among the partners according to the stipulations of the partnership agreement. However, the limited partners do have a priority if the partnership is liquidated. The partners may remove profits from the partnership or let the profits remain within the business. Location-Limited partnerships are registered within the state of their creation. Limited partnerships may do business across state lines by filing a foreign qualification document with the state it intends to do business in.
Convenience or Burden- The agreement that brings a limited partnership into existence should be written because of the distribution of the profits between the general partners and the limited partners. Informational returns must be filed with the Internal Revenue Service for the general partnership, but profits are passed through to each partner. • • • • • • 5 C Corporation A corporation must follow the specific guidelines of the state in which it is incorporated. Incorporation papers must be submitted and approved by the state for the corporation to become a legal entity.
A legal entity is an artificial person with a separate identity from it’s owners. The biggest advantage of a corporation is that the corporation is responsible for all liabilities it might incur. Therefore, a corporation gives the shareholders (owners) the greatest protection against liability of any business model. Corporations also have greater flexibility when it comes to raising capital. Additional stock shares may be sold to investors for the expansion of the corporation. These stock shares are easily transferred from one person to another without affecting the continuity of the corporation.
Also, owner-employees of the corporation can enjoy the additional advantage of tax-deductible fringe benefits. The disadvantages of a corporation are that some of its profit may be taxed at both the corporate level and the shareholder level. The easy transfer of stock shares from one person to another, when stockholders are few, can be disadvantageous to the other stockholders, as well. The paperwork required by the government to maintain a corporation can be overwhelming and people with specific knowledge in this area may have to be hired to deal with the additional “red tape”.
The attributes of a C corporation are: • Liability-The C corporation is a legal entity with the ability to form contracts, own property, and act on its own behalf. The corporation takes on all the liability of the business, shielding the stockholders from personal liability. If a creditor insist that financial obligations be signed not only by the officers but by the owners as well, the owners lose this privilege. Income Tax-The C corporation is required to file a corporation return and pay any applicable taxes. If dividends are issued to the stockholders, the stockholders must pay taxes on the dividends they receive.
This is known as double taxation. Longevity or Continuity of the Organization-The C corporation is established in perpetuity. The death or withdrawal of a stockholder does not disrupt the continuity of the corporation in anyway. Control-The stockholders of a corporation vote on the members of the board. Once the board is established, its members direct the business of the corporation and elect the corporation’s officers. The officers are then put in charge of the day to day operations of the corporation. Profit Retention-The board of directors determines the appropriate use for the profits of the corporation.
The profits can be retained to pay down debt, purchase new equipment, or used for research. The board can also vote to distribute profits in the form of a dividend. Dividends are distributed to the stockholders in proportion to the amount of stock they have acquired. If the profits are distributed to the stockholders, the stockholders must pay the appropriate taxes on the dividends. Location-Corporations are brought into existence through state regulations. The state in which a corporation is founded may be determined by which state’s rules and taxation policies most benefit the corporation.
Corporations must register with the secretary of state in any state they wish to do business in. Convenience or Burden-Documents of incorporation can be tedious to fill out. Assistance from outside sources may be needed to help insure that all the documentation is correctly completed and submitted. States also require careful recorded keeping. Financial and business records, such as minutes of shareholder or board meetings, must be meticulously kept. Shares must be • • • • • • 6 issued by the corporation to its shareholders, as well.
Capital is easier to acquire for a corporation than it is with a sole proprietorship or partnership; however, the start up cost for a corporation is much higher. S Corporation A C corporation can elect to become an S corporation if all the shareholders agree to do so. S corporations have characteristics of a C corporation and also of a partnership. Like a C corporation, the board of directors is in charge of the management of the S corporation. The advantage of an S Corporation is that the liability of the business is only passed on to the stockholders to the extent of their investment.
Like a partnership, the profits and losses are passed through to the owners, so there is no corporate taxation on the profits of the business. Each shareholder in an S corporation must be issued the same class of stock, but not necessarily the same number of shares. The disadvantage is that although shares in a S corporation are transferable, the number of shareholders is capped at 100. This can have a negative effect on the sell of stocks by a shareholder. Many new businesses elect to become S corporations primarily for the tax benefits.
The attributes of a S corporation are: • Liability-The S corporation is a legal entity with the ability to form contracts, own property, and act on its own behalf. The corporation takes on all the liability of the business, shielding the stockholders from personal liability. If a creditor insist that financial obligations be signed not only by the officers but by the owners as well, the owners lose this privilege. Income Tax-The S corporation is required to file a corporation return but the profits are passed through to the owners as dividends. These dividends are only taxed on the owners tax return.
Dividends may not be used in leu of a salary for shareholder-employees. Longevity or Continuity of the Organization-The S corporation is established in perpetuity. The death or withdrawal of a stockholder does not disrupt the continuity of the corporation in anyway. However; once the tax benefits cease for an S corporation, the owners generally revert it to a C corporation. Control-The stockholders of a corporation vote on the members of the board. Once the board is established, its members direct the business of the corporation and elect the corporation’s officers.
The officers are then put in charge of the day to day operations of the corporation. Profit Retention-Any earnings retained by the S corporation are still taxable to the shareholders in proportion the the shares they hold. Dividends are also distributed proportionally to the shareholders. Location-Corporations are brought into existence through state regulations. The state in which a corporation is founded may be determined by which states’ rules and taxation policies most benefit the corporation. Corporations must register with the secretary of state in any state they wish to do business in.
Convenience or Burden-Documents of incorporation can be tedious to fill out. Assistance from outside sources may be needed to help insure that all the documentation is correctly completed and submitted. States also require careful recorded keeping. Financial and business records, such as minutes of shareholder or board meetings, must be meticulously kept. The same class of stock must be issued to all shareholders. The number of shareholders of an S corporation is limited to 100. Because of the limited amount of shareholders a S corporation may have, the ability • • • • • •
7 to raise capital may be minimized as the number of shareholders increase. Also, nonresident aliens are not allowed to be shareholders. Having more than 100 shareholders or allowing a nonresident to own shares will terminate an S-corporation. Limited Liability Company The “new kid on the block,” when it comes to business formation, is the Limited Liability Company or LLC’s. LLC’s blend aspects of partnerships, C corporations, and S corporations while being more adaptable and minimizing paperwork. The advantages are that the members (owners) of an LLC are shielded from liability, like in a corporation, but do not suffer double taxation.
Members can also participate in management of the business, unlike limited partners. While S corporations are limited to 100 shareholders, there is no set limit on the number of members a LLC may have. LLC’s may also have varying classes of ownership. LLC’s are a great option for family business that want to stay that way, because one member can not transfer their interest without the approval of all the members. The disadvantage is that the death of a member can end the LLC, but the majority of states let the remaining members decide whether to end the LLC or continue with it.
The attributes of a limited liability company are: • Liability- Just as the name implies the LLC limits the liability of its members. Members are only liable to the extent of their investment. Personal property of the members is protected when another member does not act with due care. Income Tax-The LLC can be taxed like a sole proprietorship, a partnership, or a corporation. The tax status of an LLC will determine how the advantages and disadvantages add up for the company. Longevity or Continuity of the Organization-The LLC is not established in perpetuity.
The death or withdrawal of a member may disrupt the continuity of the company. Generally, the remaining members can decide the fate of the company. Control-The members of a LLC are usually active in the management of the company. Profit Retention-Members determine how profits are distributed. The distribution is based upon the increment of each members investment. Much of the profit retention is determined by the way the LLC is organized, as far as tax status is concerned. Location-LLC’s are brought into existence through state regulations.
All 50 states now have regulations for the establishment of an LLC. The state in which a LLC is founded determines the requirements for the LLC articles of organization and how it is to be ended. Convenience or Burden-Documents of organization must be filed with the state where the LLC is to be located. The flexibility of an LLC is that members can determine how the LLC will be treated by the Internal Revenue Service. This determination will set the perimeters for the amount of paperwork needed to be filed by the LLC. •