Business Structures

LaShondra Dyer

BUS311: Business Law I

Instructor: Peter McCann

April 13, 2016

Selecting a business structure comes with a number of variables. Are you going into business alone? If so, how will you fund it and run it? Will you join forces with others to build a business? If so, what agreements need to be made, for the business to run effectively and efficiently? I have spent over a decade in the nightclub industry in various positions. I started as a waitress, became a bartender, moved up to management, and now I am a club owner. The decision to become an owner was not made overnight, but by having the dreams of becoming a successful entrepreneur by watching those who owned the clubs that I had previously worked. I did not have all of the funds necessary to go into business alone so; I teamed up with another individual that I worked with, and we created a business plan, and now we are in a partnership. Throughout this paper, I will discuss the following business structures: sole proprietorship, LLC, a corporation, and partnership as well as give an analysis of each. I will also discuss my partnership in the nightclub industry and explain why it was the best organizational option for me. Even though the liability of the partners for the debts of the business is unlimited, a partnership may benefit from the combination of complementary skills of two or more people because with more than one owner, the ability to raise funds may be increased and there is limited external regulation.

Sole proprietorship

A sole proprietorship is just what it is, solely your business. The successes and failures rest entirely on your shoulders. Forming a sole proprietorship is simple because there is no formal action that needs to be taken. According to Hopson and Hopson,” A sole proprietorship and a GP are the easiest entities to form and maintain, but they provide no protection against liabilities and tort claims” (2014, p. 47). Unlike corporations and LLC’s, there is no separate legal entity created by a sole proprietorship; however, the individual is responsible for any liabilities and debts. For example, when I decided to become a graphic designer to reduce costs for myself, I was also able to create a business to service others because of my skill. I alone create images for others and receive payment for the work that I do. I incurred all of the cost for buying products like Photoshop to create the images as well as a laptop and several other things necessary to complete the services I render to my customers. I had to register with my state, and I was ready to provide my services to others.

Taxation on a sole proprietorship, because it is indistinguishable from its owner, is as simple as its formation. Dissimilar to a corporation, which is its own tax entity, a sole proprietorship does not pay taxes as a business. According to www.sba.gov "Because you and your business are one and the same, the business itself is not taxed separately-the sole proprietorship income is your income” (n.d.). This tax advantage is a benefit to a sole proprietorship. As stated by www.sba.gov, “the tax rates are also the lowest of the business structures” (n.d.). The owner is only responsible for themselves or any employees they may have.

The personal liability for a sole proprietor is extensive. Anything that can or does go wrong, the owner is the only responsible party. Sole proprietors are personally liable for all debts. Any possible loans that the proprietor may have incurred in the event that the business closes, they are held responsible. An owner's personal possessions may be taken to repay any debts.

There appears to be a "balance beam" when speaking of the advantages and disadvantages of a sole proprietorship. An individual has the right to create a business for profit with ease; however they acquire and maintain all responsibility regarding any liabilities that may occur. According to S. Rogers, “it has the advantage of being very easy, with no formalities and no expense attached to creation. The disadvantage is that a sole proprietor has limited options for raising capital and no limits on liability for business debts” (2012). Taxation is simple and a huge advantage as far as responsibility is concerned. One must decide if the benefit of their business outweighs the risk.

LLC

An LLC is the least complex of business structures. As stated by S. Rogers, “the LLC represents an attempt to combine the best features of a partnership with the best features of a corporation” (2012). All LLC’s adhere to the same general principles when forming by, choosing a business name, filing the “articles of organization, creating an operating agreement, obtaining any licensing and permits required by their state, hiring employees and announcing their business.

The liability of an LLC is similar to that or a corporation. All those involved are protected from personal liability for business debts and claims. For example, if I merged my graphic design proprietorship with that of my partner in my nightclub business, any debts he and I incurred would not allow a supplier, a lender, or a landlord to come legally after my personal possessions if things were to go awry. Any assets of the LLC would be used to pay off our business debt.

Taxation on a LLC gives the owners the option of taxing their LLC like a sole proprietorship, a partnership or a corporation depending on filing the appropriate forms with the IRS. According to Witner and Simons. “the state tax treatment of LLCs is varied. Some states follow the Federal example and treat them as partnerships for state tax purposes. Other states impose a corporate income tax” (1993). The IRS determines how a LLC will be taxed depending on the amount of owners or members. If there is one member, the business will be taxed as a sole proprietorship, and if there are re more than one, then the business will be taxed as a partnership.

Creating an LLC is an alluring opportunity; however, it does not come without its disadvantages. An LLC can have a limited life. According to www.sb.gov, “in many states, when a member leaves an LLC, the business is dissolved and the members must fulfill all remaining legal and business obligations to close the business,” (n.d) or the remaining partners can create a new LLC or walk away. The members may be protected from personal liability, but taxation is the responsibly of each member.

Corporations

A corporation “is a form of business organization that owes its existence to statutes in all states that provide guidelines for its creation and management” (Rogers, 2012). It is an independent legal entity owned by shareholders that is is more complicated and expensive than most other business structures. Corporations have certain rights, privileges, and liabilities beyond those of a sole proprietorship, LLC and partnerships. According to P. Paroo “in addition to tax complexity, the major drawbacks to forming a corporation—either a C or an S-type—are time and expense” (2016, p. 24). Forming a corporation can be a rather daunting task. It must be filed under the laws of the state where it is registered, all licensing ad permits must be obtained, the corporation must adhere to the federal and state regulations involving employees, as well as it requires a massive amount of money or capital. In addition, to filing correctly, corporate bylaws must be created, and stock certificates must be issued to the initial shareholders as well as recording who owns stock in the business.

Like an LLC, the owners of a corporation are protected from personal liability. According to S. Rogers, “in order for a corporation to offer its shareholders the protection of limited liability, it must be run in accordance with the requirements under a state's business corporation law” (2012). Protection of the limited personal liability requires "maintaining records of various meetings of directors and shareholders, and keeping records and transactions of the business separate from those of the owners” (Pakroo, 2016, p. 25). Corporations are liable for the contracts and obligations that directors, managers, and employees enter into on its behalf. On average, the personal liability shield a corporation provides is significantly greater than the tax benefits they receive.

A corporation is the only type of business structure that is required to pay income taxes on its profits. Corporations can range from small businesses or S corporations like A Kurrent Event, an event planning service in new York, to C corporations like Apple or Samsung. Owners of the corporation pay a double tax on the business's earnings. According to s. Rogers, "Double taxation is also one of the disadvantages of the corporate form” (2012). Not only are corporations subject to corporate income tax, but any earnings remitted to shareholders are taxed at individual tax rates on their personal income tax returns.

Taxation, time, and money are the major disadvantages of a corporation. As stated by www.sba.gov "In some cases, corporations are taxed twice - first, when the company makes a profit, and again when dividends are paid to shareholders” (n.d.). On the other hand, a benefit to corporation's is that shareholders are not liable for any debts incurred; the shareholders only risk their equity in the corporation. Another advantage is that unlike LLS’s a corporation can last forever whether a member leaves the situation or not. Filing can be challenging and complicated, but if you want to raise capital by selling shares, incorporation is the way to go.

Partnerships

When building a business structure partnerships are far from last on the list. Partnerships fall between sole proprietorships and LLCs. I am describing it last because that is the type of business structure that my nightclub falls underneath. There are two of us who put or money together to build, finance and promote the club. As stated by S. Rogers, "A partnership can be defined as an association of two or more competent persons to carry on a business as co-owners for profit” (2012). The individuals involved are an adept combination that blends integral skills, monetary resources, customers and connections for the success of the business. Partnership requires the association of the persons to be competent individuals; they must carry on business activities, be co-owners, and the business must be for profit. Our nightclub is most certainly for profit, and the two of us brought skills and connections the other did not have. Similar to LLC’s and corporations, partnerships must register the business, establish a business name, obtain any licensing and permits required and follow federal and state regulations for employees.

Personal liability in the case of a partnership involves the possibility of a partner being liable for another partner’s misconduct or negligence depending on the type of agreement that the partners enter. According to www.sba.gov “similar to sole proprietorships, partnerships retain full, shared liability among the owners. Partners are not only liable for their actions but also for the business debts and decisions made by other partners“ (n.d.). This means that the partners personal assets can be used to pay the debts of one or the other and both.

Taxation of a partnership includes the annual report of income, employment taxes, excise taxes, incomes taxes, self-employment tax as well as estimated taxes. According to Hopson and Hopson,” The tax advantage of partnerships—is that there is no entity tax” (2014, p. 46). This means that partnerships are not doubled taxed like corporations. It is necessary for a partnership to file an annual information return that reports the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. In my nightclub, my partner and I use an accountant to ensure that our bookkeeping and payments are correct. The partners pay taxes on their share of the profits or deduct their share of the losses on their individual income tax returns.

Partnership is a relatively inexpensive business structure to get involved with because it is comparatively inexpensive, the financial commitment is shared between the partners, the partners complement one another by bringing their skills and connections to the table, and there are possible incentives for employees to join the partnership. For example, in my nightclub, if one of my head bartenders buys into the club, not only do they bring bar skills, but they can use their bar skills to drive cost down and bring revenue up as well as bring in other experienced bartenders to make the club more successful. The advantages of a partnership are extensive; however, there are some disadvantages to think about, if my partner and I have a disagreement that we cannot amicably resolve can result in a split of assets that have been described in their formal agreement. "The downside of a partnership is liability. Because each partner is an agent of the partnership and the other partners, he or she has the power to bind the partnership and the other partner to transactions within the scope of the partnership business” Rogers, 2012). Entering into a partnership not alone will you be held legally responsible for yourself but, for your partner as well.

My partnership in the nightclub business was the best organizational for me. It was necessary to have the finances, skill and connections of another individual. I am not from Atlanta, so I needed a partner who had the contacts required to achieve my goal. A club primarily doesn’t fall under a corporate umbrella although to could be considered as a small business. I did not have all of the funds to go into business alone to have a sole proprietorship, so it was best that I joined forces with another person. Collectively we had everything that we needed to form an agreement for a partnership. All of the liability falls on my partner and me so we could not be an LLC. We did not need any other shareholders or investors to go into business, and we have held firm for the last five years.

Conclusion

Starting a business brings about a variety of choices and decisions that will be made. Ultimately one of the most important decisions will be choosing your business structure. Personally, a partnership was the best decision for me. I needed the assistance of other individual to effectively and efficiently run a nightclub. Your choice in business structure will determine the amount you pay in taxes and what types of taxes you will pay. There is required paperwork for each structure to have a legitimate business, and some are more complex than others. Personal liability is also a paramount part of the process. One must decide on letting it rest on their shoulders or that of the companies assets. Each structure has its pros and cons. The decision an entrepreneur makes will be whether their advantages outweigh the disadvantages for heir decided business structure. My decided business structure of a partnership made us take on all of the liability; however, we have both benefited from the combination of our complementary skills.

References

Hopson, J. F., & Hopson, P. D. (2014). Making the Right Choice of Business Entity. CPA Journal, 84(10), 42-47.

Pakroo, P. H. (2016). CHAPTER 1: Choosing a Legal Structure. Small Business Start-Up Kit For California, 7-28.

Rogers, S. (2012). Essentials of Business Law [Electronic version]. Retrieved from https://content.ashford.edu/

U.S. Small Business Administration | The U.S. Small Business Administration | SBA.gov. (n.d.). Retrieved April 13, 2016, from https://www.sba.gov/

Witner, L., & Simons, K. (1993). Tax aspects of limited liability companies. (cover story). CPA Journal, 63(8), 22.