Transcript Types of Businesses Sole Proprietorship, Partnership, and

Businesses can be organized as any of the following: sole proprietorship,
partnership, C corporation, S corporation, franchise, or cooperative. In the
United States, most businesses are sole proprietorships; corporations generate
the most income. Each form of business includes both costs and benefits.
Costs and Benefits
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In business, retail, and accounting, a cost is the value of money that has been
used to produce something—afterward, this money is not available for use
anymore. Generally speaking, a benefit is something of value or usefulness. In
economics, a cost is an alternative that is given up as a result of a decision. In
economics, a benefit is a quantifiable amount of money, such as revenue, net
cash flow, or net income. Other benefits might be nonmonetary. A sole
proprietor, for example, might value the independence of making his or her
own decisions.
A sole proprietorship is an unincorporated business owned by a lone individual. The
sole proprietor pays taxes on the business through his or her personal tax returns.
Approximately 73% of all businesses in the United States are sole proprietorships.
Costs
Benefits
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Independence—the owner alone is
responsible for all aspects of the business.
Efficiency in decision-making (no board of
directors or stockholders involved).
Tax reporting to the IRS is relatively
simple and inexpensive.
Minor children of the sole proprietor may
be hired without paying payroll taxes,
and, if the child earns $5000 or less, he or
she pays no income taxes.
Healthcare reimbursement arrangements
(HRAs), also known as IRC Section 105(b)
plan, are available to the employees,
spouses, and families of sole proprietors.
This loophole in the tax laws allows an
employer plan to reimburse employees
for medical costs, including medical and
dental insurance, deductibles,
copayments, and other healthcare
expenses.
If a home office is used, a portion of office
expenses, property taxes, utilities, and
vehicle expenses may be tax deductible.
The owner keeps all the profits.
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The owner has limited ways to raise
capital. Potential investors in the business
cannot buy stock (there is no stock),
making investment difficult to define and
document.
The owner has unlimited liability and can
lose personal assets along with business
assets. If there are employees, their
mistakes may create liabilities for the
business. On the other hand, a small
unincorporated business has more
creditworthiness than an incorporated
business of similar size since the owner's
personal assets will be added to those of
the company for the purposes of assessing
credit. Lenders are aware, however, that
business owners can shift assets back and
forth between personal property and the
sole proprietorship. Therefore, lenders
may require the owner to guarantee the
loan personally, which means he or she
must put up personal property as loan
collateral.
There is greater difficulty in attracting
skilled employees to a smaller business.
The letters THE IHO could be the first letters of words
representing benefits of sole proprietorships:
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T
Taxes
H
Healthcare
E
Efficiency
Independe
nce
Home
office
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Partnerships
A partnership is a business owned jointly by two or more people.
Although not legally required, partnership agreements are strongly
recommended. Such an agreement documents how the business will be
run, how profits will be dispensed, etc. Some partnerships may offer
employees the possibility of becoming a partner as an incentive to be
productive in their work. In general, there are three basic types of
partnerships: 1) general partnerships, where everything is divided equally
(profits, liability, and management duties) unless an alternative is agreed
to and documented; 2) limited partnerships (also called partnerships with
limited liability), which allow partners to have limited roles and limited
liabilities and where partners often hire managers for short-term projects;
and 3) joint ventures, which are similar to general partnerships except they
usually exist only for a limited time period or to complete a specific
project. A joint venture can also file with the state as an ongoing
partnership.
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Taxation of a partnership "passes through" to the partners, meaning that
the business itself is not taxed, but, rather, all partners report their shares
of the partnership's income or loss on their personal tax returns.
Partnership taxes may include income taxes, employment taxes, excise
Benefits
• Partnerships are relatively easy and inexpensive
to form.
• Owners share commitment, decision-making,
profits, and responsibilities; however, each
partner can contribute a unique set of skills and
expertise to the success of the business.
• The incentive of becoming a partnership may
attract highly motivated and qualified
employees.
• The tax advantage of a partnership over a
corporation is that the owners are taxed only
once—on their personal tax returns.
• As with sole proprietorships, business decisions
can be made efficiently, without involving
shareholders, officers, and directors.
• Laws concerning partnerships vary among
states; however, the Uniform Partnership Act
has been adopted in every state except
Louisiana, which means partnership laws are
generally uniform across the country.
• Acquisition of capital can be easier in a
partnership than in a corporation since
individuals often receive better loan terms.
Banks perceive loans to individuals to be less
risky since personal assets can be used to secure
a loan. In addition, limited partnerships allow
investors to avoid the personal liabilities of
general partners.
Costs
• Owners face unlimited liabilities, not
only for their own actions but also for
the actions of their partners.
• There is no "chain of command" in
decision-making, which creates the
potential for conflicts among partners.
• By law, a partnership is dissolved
whenever any partner retires, resigns
(known as withdrawing), or dies.
However, this situation can be
avoided by drawing up a partnership
agreement that stipulates how a
business can continue if a partner
retires, withdraws, or dies.
• According to the Uniform Partnership
Act, the existence of a partnership is
dependent upon the owners.
Ownership (partnership) cannot be
transferred unless all other owners
agree.
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Cooperatives
A cooperative (co-op) is an organization owned and operated by people
who use its services; they are designated as members, or user-owners.
Profits and earnings of the co-op are distributed among the members.
Members have voting rights to control the operation and direct the co-op
through an elected board of directors and officers. Formation of a co-op
begins when a group of people share a common need and develop a
strategy to meet that need collectively. A co-op may incorporate, but it is
not required to do so.
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The co-op is not taxed; rather, it receives a "pass-through" designation,
with the members reporting the profits and losses on their personal
income tax returns. Cooperatives are subject to the regulations of the IRS's
Subchapter T Cooperatives tax code. Members file taxes by submitting
Form 1099-PATR with their personal taxes.
Benefits (Advantages) versus Costs (Disadvantages) of
Cooperatives
Benefits
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Members receive reduced costs for
products and/or services due to the
economy of scale provided by the co-op. In
addition, if there is an excess of funds at
year's end, the money may be distributed
to the members.
The members cannot incur personal
liabilities from the actions of the co-op.
The democratic operation of the co-op
allows all members to have an equal vote
regarding how the business is run.
For certain types of co-ops, funding
opportunities may exist through
government-sponsored grants.
For an incorporated co-op, the taxation
status is similar to a limited liability
company (LLC) because surplus earnings
are not taxed. Members pay taxes on any
surplus distributions they receive.
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Costs
• Because of the democratic nature of
the co-op structure, everyone likely
will not be happy with all decisions
made by the group and the decisionmaking process may be slow.
• It can be difficult to attract large
investments since every member's
vote carries equal weight regardless
of the size of each member's
investment.
A franchise
A franchise is a relationship between the owner of a trademark, service mark,
trade name, or advertising symbol and an individual or group (the franchisee)
that wants to use this identity as part of a business. The franchise sells the right
to the franchisee to operate the business in a certain area. The franchise also
controls the business relationship.
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Benefits
Costs
• The franchise may provide the
resources (e.g., financing
assistance, training, marketing,
and management expertise)
necessary to assure the franchisee's
success.
• The franchisee has exclusive rights
to operate the business within a
defined area.
• The price of the franchise may
be very high.
• There is very limited flexibility
on how to run the business.
Limited Liability Company (LLC)
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The limited liability company (LLC) is a cross between
the limited liability feature of a corporation and the
taxation and operational features of a partnership. The
ownership of an LLC encompasses a broad range of
choices—from individuals, to corporations, to other
LLCs, and more options. LLC owners are "members,"
and profits and losses are "passed through" and
reported by individual members on their personal tax
returns—in a similar fashion to partnerships.
Taxation of an LLC
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The federal government does not tax LLCs, but some states do.
LLCs usually are not taxed, so LLC members pay federal taxes on
their personal income tax filings; however, the federal government
automatically categorizes certain LLCs as C corporations and taxes
them accordingly. If an LLC is not designated automatically as a
corporation, its members may choose to file with the IRS as either a
partnership or a sole proprietor. Visit IRS.gov for further
clarification on how to file as an LLC
Costs
Benefits
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Liability for business losses or actions
of the LLC do not apply to the personal
assets of individual members of the
LLC. Exceptions apply, such as tort
actions by employees due to accidents.
Tort is any wrongdoing not involving
breach of contract for which a legal
action for damages may be filed.
Perhaps the most significant benefit is
the minimal amount of start-up
expense and recordkeeping required.
There are few restrictions on profit
sharing in contrast to partnerships,
where profits must be evenly
distributed.
Taxation is "passed-through" to
individual members' returns, rather
than the double taxation of C
corporations, where both the
corporation and shareholders are
taxed.
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• The lifetime of an LLC may be
limited to the participation of the
original members. In many states,
this means the business disbands
when a member leaves the LLC;
however, it may be possible to
prevent dissolution by creating an
operating agreement that provides
for the departure of a member.
• The entire net income of an LLC is
subject to Medicare and Social
Security taxes.
S Corporation
An S corporation, or S corp, is designated based on Subchapter S of Chapter 1 of the Internal
Revenue Code. Filing as an S corp allows a business to avoid double taxation—once on the
corporation profits and again on the shareholders.
To qualify as an S corp, the business must:
• be a domestic corporation
• have only allowable shareholders
• include individuals, certain trusts, and estates
• not include partnerships, corporations, or nonresident alien shareholders
• have no more than 100 shareholders
• have one class of stock (all shares must have same dividends and voting rights per share)
• not be an ineligible corporation (e.g., certain financial institutions, insurance companies,
and domestic international sales corporations)
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To receive S corp designation, a corporation must first register as a C corporation in the state
where it plans to become an S corporation. S corporations are "considered by law to be a
unique entity, separate and apart from those who own it" (IRS code). Thus, as with C
corporations, there is a limit on the financial liability of each shareholder.
The main difference from a C corporation is that with S corporations, profits and losses "pass
through" to the shareholders' personal tax returns, and the business itself is not taxed. To
prevent abuse of the lower corporate tax rate, individuals who work for the company must
receive fair market value for their services. Otherwise, if a shareholder receives corporate
earnings in lieu of wages, the IRS has the option to reclassify the corporate earnings as wages
and tax those earnings at the higher personal income tax rate.
As is the case with C corporations, states vary in their recognition and regulations of S
corporations.
Benefits
• Lower taxation of the business
owner is a significant feature of the
S Corporation. The shareholder,
who also is an employee, pays taxes
on wages but also receives a
dividend from the corporation for
his stock, which is usually taxed at a
lower rate. The corporation itself is
not taxed because they "pass
through" to the owners' income
taxes.
• The shareholders/employees can
write off business expenses.
• The shareholders are protected from
liabilities incurred by the
corporation.
• Since up to 100 shareholders are
permitted, there are more
opportunities to raise capital.
• Accounting rules can be simpler,
compared to C corporations.
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Costs
• S corps are required to operate
under strict processes, such as
holding board of directors' and
shareholders' meetings and
keeping detailed records—similar
to the demands on C corporations.
• Compensation requirements
include a careful accounting for
the wages and distributions of
shareholder employees. A
shareholder is required to receive
reasonable compensation for
services rendered to the
corporation, even if the
corporation is not making a profit.
• Shareholders will be taxed for
income the corporation makes,
even if they do not receive any of
that income. Also, an S corporation
can issue only one class of stock.
Corporations
According to the IRS, there are four characteristics that define a corporation: limited liability
in terms of personal assets, continuity of life, centralization of management, and the ability
to transfer ownership interests. If you wish to have more than two of these characteristics,
you will have to incorporate your business and operate as a corporation.
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C Corporations
Regular corporations are called C corporations after Subchapter C in chapter 1 of
the Internal Revenue Code.
The identity of a corporation is separate from that of the shareholders who own it.
This means that corporations, and not shareholders, are legally liable for any
indebtedness and/or actions of the corporation. This does not mean, though, that
individuals representing the corporation are immune from the consequences of
illegal behavior. A corporation is formed in accordance with the laws of the state
in which it is registered, and these laws vary from state to state. Since C
corporations are the most complex (with costly administrative fees and complex
tax and legal requirements) of the business entities, they tend to be large,
established companies with many employees and with a relatively large flow of
cash.
Benefits
• C corporations can raise capital by selling shares of the business to prospective
shareholders in exchange for money, property, or both. The initial sale of stock is
often done when the business "goes public" through an initial public offering,
known as an IPO. To justify the expense of setting up and registering a
corporation, the business should have enough income or potential income to reap
the benefits of a large entity. Such benefits could include the following: 1) capital to
make large-scale investments; 2) qualifying for bank loans and lines of credit; and
3) achieving economies of scale through large purchases.
• Limited liability. Corporations have limited liability, in that individual employees
(including management) or shareholders are not personally liable for the actions or
indebtedness of the corporation.
• Corporate tax treatment. Corporations usually pay lower taxes, and only on the
profits of the corporation. In addition, these taxes are completely separate from the
taxes paid by individual owners of the corporation. Individuals would, however,
pay personal taxes on bonuses, salaries, and dividends received from the
corporation.
• Not only is partial ownership attractive to employees, it also motivates employees
to make the company successful. Another attraction—though not necessarily
unique to C corporations—is employee benefits, such as health insurance and
retirement plans, which are tax-deductible expenses for the corporation while
adding to the employees' compensation.
• The corporation has a "perpetual existence," compared with employees or
shareholders who may leave the corporation.
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Costs
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• Corporations are double-taxed; profits are taxed at the corporate level and
again when distributed to shareholders as dividends.
• Corporations are more expensive to establish and operate.
• Complex regulations consume many resources in terms of business
accounting, environmental regulations, taxation, employer-employee
relations, etc.
• The corporation is accountable to stockholders. Annual meetings are required,
and major changes in the corporate structure or dividend policies require
stockholder approval by vote.