Starting a business entity may be challenging and demanding because of the involved legal requirements. According to Blair and Tanya, the requirements for establishing any form of business is writing a business plan and deciding on the business structure (249). The legal structure of the business has effects on the taxes and income gained. Liability and risks, management, expense and formality, continuity and transferability and taxation influence the legal structure, which the owner should consider before starting the business (Besley 99). Common forms of business entities are the sole proprietorships, partnerships, limited liability companies and the corporations. More so, there are subdivisions within the above structures. Every type has its advantages and disadvantages on taxation, operating complexity, the liability protection, how easy is it to set up and the complexity (Besley 99). The paper aims to discuss the legal requirements to set up a given legal entity and the personal liabilities involved in each business structure. It will also explain taxation in the varied forms and compare the advantages and disadvantages involved in the various business structures.
Sole proprietorship
The sole proprietorship is less regulated, easy to set up, and it’s owned and run by one person hence it is the most common business entity because of its characteristics (Blair and Tanya 249). In the sole proprietorship business entity, the law does not differentiate the business entity and the owner. The form is popular because of the simplicity of the body, the nominal legal activities involved and the ease of setup (Besley 99). The essential requirements for the sole proprietor are registration of the name of the entrepreneur and secure the local licenses. Hence the business can start operating immediately. Legally and for taxation purposes, the owner is responsible for filing returns to the government through personal income tax (Besley 200). The owner exercises total control in the business entity. Therefore, the assets and the liabilities of the owner form the greatest risk to the running of the business.
In the sole proprietorship, the owner has unlimited personal liability for any risks and liabilities experienced by the business entity. Therefore, all the personal and business assets are at risk when the accidents occur in the industry. The unlimited liability of the sole proprietorship forms the most significant criticism against this business structure (Blair and Tanya 250). Consequently, the need to overcome this disadvantage calls for having well-written contracts and taking insurance covers to protect the business. More so, the sole proprietorship is readily flexible and can change to other forms of business structures especially when they result to lower taxes (Besley 201). The sole proprietorship should also consult on different kinds of taxes such as the federal and state taxes in the form of self- employment, and property taxes. Therefore, it is the responsibility of the entrepreneur to understand the different types of taxes and ensure they pay them to avoid collision with the law.
The sole proprietorship has the following advantages over the other legal entities; they are easy to establish because of the few legal formalities and the capital needed is minimal depending on the location of the business entity. The sole trader receives all the profits and can dissolve the business any time depending on the needs of the trader who exhibits maximum power over the business activities (Blair and Tanya 252). However, a sole trader has little ability to raise capital compared to the corporations who can borrow money from the public through the sale of shares. The inability to raise capital also inhibits the entities growth. Moreover, the sole trader does not experience the limited tax savings for the fringe benefits like in the corporations (Blair and Tanya 253). Hence, such disadvantages call for entrepreneur considerations before involving in any business ventures.
Partnerships
It is an agreement between two or more parties who agree to carry out business together. The Partnerships are like the sole proprietorships in these cases; the unlimited liabilities among its parties and the duration the legal entities can last before they terminate their services (Blair and Tanya 254). The partnerships differ from the sole proprietorships in sharing the financial strains among the partners, involvement in decision making, and sharing the responsibilities within the business structure. There are two types of partnerships; the general and limited, which are categorized depending on the management roles, financing the business and the liabilities of the partners (Blair and Tanya 254). In the general partnerships, they are obligated to file the state income and federal returns. According to the law and for taxation purposes a partnership is a legal entity separate from the parties involved.
The partnership agreement dictates the criteria for sharing the profits and losses in the general partnerships organizations (Besley 103). The general partnerships do not provide liability protection among its owners. Hence, all individuals’ assets are at risk even when the decisions made by only one-party lead to the fault in the business. Partnership structure is formed by signing an agreement in which the terms of the operation are written in the presence of a lawyer. The general partnership files the returns but does not pay the state income and federal taxes (Besley 103). It differs from the limited partnership in the case of the limited liability, in some partners and the duration of its existence.
In the limited partnership, there is some protection against liabilities to the limited partner (Besley 103). Hence, in that case, the partners are regulated by their actions within the partnership and are protected from the risks within the entity. The general partner is responsible for their actions in the business, and they do not have the limited liabilities. Therefore, the limited liability partnership attracts big investors who are not ready to be involved with the daily routines in the business running. There is no formal registration engaged in the limited liability though they need a certificate of limited liability partnerships (Besley 104).
Taxation in the limited partnership is like the general partnership whereby they file an information return. However, the limited partnerships do not pay the federal or income tax (Besley 104). Revenue and profits are shared according to the limited partnership agreement. These organizations are inexpensive and comparatively easy to start. They require fewer formalities and meetings compared to the limited liability companies (Besley 105). The partnerships have favorable taxation obligations compared to other small businesses, and they do not pay the minimum taxes like the limited liability companies and corporations. The partnerships are more advantaged than the sole traders for example they have a growth potential because banks prefer partnerships instead sole proprietorships when offering financial helps (Blair and Tanya 153). They are able to reap from the managerial strengths of all the partners. They are also free from the government controls and get special taxation. However, the partnerships have unlimited liabilities. Entrepreneurs involved in the partnerships are responsible for the faulty actions of one of the partners. More so, they are bound to disputes especially where they lack the partnership agreement.
Limited liability companies
The limited liability companies have become very popular since the 1990’s because of the liability protection among its members and the tax simplicity (Cooper 93). For example, the limited liability company can have the pass-through taxation method similar to the partnership structure. Moreover, the limited liability company can have one member under taxation identical to the sole trader and corporations. Limited liability to the risks involved in the company hence the risks only affects the assets contributed to the company similar to the corporations (Cooper 94). Greater care is needed because of the flexibility of this type of company hence the need to have a certificate filed with the secretary of the states and the internal organization agreement (Besley 104). The limited liability company agreement defines the relationship of the members forming them.
According to the agreement, members have equal rights to determine how the company will operate (Cooper 98). Cases where the relationships are not well elaborated, the use of default helps to control the companies' activities (Besley 111). Therefore, the limited liability company tends to combine all the best characteristics of the partnerships and the corporations. The limited liabilities companies offer membership to everybody without any restrictions like in the S-corporations and it formation guarantees special allocation among the members and the pass-through mode of taxation (Besley 111). More so, it is specific to individuals' profits and liabilities compared to the individual contribution to the business. People in the limited liability company are referred to as members, and they have interest in the company. The members are involved in the management process by selecting a board of governors to manage the company (Besley 111). Either a single individual or many people make the limited liability company.
Limited liability companies formed by one-person, taxation mode can be adopted similar to the sole proprietorship. The LLCs are flexible enough to adapt the method of taxation in the partnership entity or the means in s-corporation (Cooper 94). However, using only one mode of taxation has consequences to the company. The dissolution process in the limited liability company can only take place according to the state laws only (Cooper 94). The advantages of the limited liability include; easy access to capital, little record keeping compared to the corporations, limited liabilities to its members and lack of corporate tax. However, regardless of the many advantages, the disadvantage cannot be overlooked. The limited liability company is obligated to pay the self-employment taxes among its members for Medicare and social security. More so, setting a limited liability company in a state where the entity is not acceptable primarily due to regional operations laws the members are unprotected from the risks and liabilities involved thus a significant risk in its activities (Blair and Tanya 257).
Corporations
The corporations are the long-lived operating business entities, which have managed to maintain their traits over the centuries. The corporations have the participatory ownership to the members through offering the stock certificates (Blair and Tanya 257). Many people have participated in the corporations without any information on the risks and liabilities involved by purchasing shares from the stock exchange markets. Corporations have an advantage of raising capital from the public through the sale of shares (Blair and Tanya 258). In the formation process, the corporations need to have the articles of incorporation, written with the secretary of the state comparable to the limited liability companies (Besley 115). The report of integration has the name of the corporation and the incorporators though it does not include the names of the shareholders. It also highlights the specific aim of the corporation. The corporation has a hierarchical order of management and officers who are chosen by its directors run it (Besley 115).
A corporation needs annual meeting opportunities to air their views and vote in the new managers. Therefore, the shareholders do not have the direct control of the corporate management and control of the business activities (Besley 118). The members vote in a board of directors who control other corporate events such as signing contracts on behalf of the stockholders. The corporations are authorized business entities separate from the parties forming them and regulated according to the federal and states statutes (Cooper 113). The charter states the authority and the inhibitions of the specific business. The federal laws differ in many nations. Thus the corporations ought to follow them, mainly when operating in more than one state. The corporations offer limited liabilities to its stockholders (Besley 116). The only risked assets are those already invested in the corporation. However, they are liable in the cases of fraud against the public. Therefore, the personal assets of the entrepreneurs are safe even when the corporation suffers losses beyond it available assets.
Corporations only pay the state and federal taxes separate from the stockholders (Cooper 113). The corporations differ from the sole traders and partnerships, in the cases of separation as legal structures from the individual owners. Hence, the corporations pay taxes twice in the form of corporate taxes and money distributed to the owners in the form of dividends (Cooper 113). Therefore, to evade the present and future returns, losses incurred in operation should be used to show the lack of profits in the services. Consequently, corporations can avoid paying taxes in its formation by incorporating newly formed corporation (Besley 112). More so, the contributions made to the corporations in the form of shares are not tax-free. The disadvantages of the c corporation decreased with the introduction of the s corporations whose taxation are similar to the partnership entities (Blair and Tanya 258). However, there are restrictions on the number of the stockholders and sharing of profits and income among the members. The s-corporations also lack the flexibility on the individual allocations and distributions on it members.
Converting a C-corporation to an s-corporation have adverse effects primarily on the taxes (Besley 124). The corporations offer limited liabilities to its members like in the limited liability companies. The s corporation helps to avoid double taxation hence only the shareholders pay taxes. They can assess a lot of capital from the public through the sale of shares. People prefer buying shares from the corporations instead of establishing the sole proprietorships business (Blair and Tanya 258). However, there are limitations in corporations, which impacts on their choice. They tend to execute more administrative procedures compared to other forms of businesses; an example is the annual shareholder meeting. The minority shareholders are subject to exploitation in corporations hence the government may demand a refund of their profits when complaints arise (Besley 119). The corporations experience double taxation both on the dividends and on the corporation as a legal entity.
Conclusion
In summary, the business structure influences the taxation process. For example, the sole proprietorship, the partnership, the limited liability company and the S-corporations entities do not pay taxes directly. However, the business profits and losses passed on to the owners are subject to taxation in the form of the personal tax returns. The Corporation is the only legal entity paying taxes directly. The partnerships are easy to form because they require few legal formalities and they can raise capital quickly because of the parties involved in the formation compared to the sole proprietorships. However, the corporations raise more capital from the public through the sale of shares. The most significant criticism of corporations is the double taxation. The limited liability companies combine the strengths of partnerships and corporations hence forming the ideal legal entity for many investors.
The legal entities dictate the responsibility of the parties involved in case of risk and liability for condemnation when there is a lawsuit against the business. For example, in some cases, the business owner is responsible for all damages, which may lead to loss of personal property when the risk occurs mainly because of the unlimited liabilities of the members. Business entities with universal responsibilities include; sole proprietorships and the partnerships unless for the individual cases of the limited partners. Hence, insurance covers and well-written contracts help to avoid risks and liabilities. The business ability to continue its operations depend on the type of the legal entity and terms of agreement according to the law.
Works cited
Blair, Eden S., and Tanya M. Marcum. "Heed Our Advice: Exploring How Professionals Guide Small Business Owners in Start‐Up Entity Choice." Journal of Small Business Management 53.1, 2015, pp. 249-265.
Besley, Timothy. "Law, regulation, and the business climate: The nature and influence of the World Bank Doing Business project." Journal of Economic Perspectives 29.3, 2015, pp. 99-120.
Cooper, Michael, et al. "Business in the United States: Who Owns It, and How Much Tax Do They Pay?" Tax Policy and the Economy 30.1, 2016, pp. 91-128.
