YOU DECIDE PAPER 2 Part I: Discuss the various forms of organization that are available to Penelope, Mark and John The various forms of organization available to Penelope, Mark and John are: GENERAL PARTNERSHIPS: A general partnership is a business organization formed when 2 or more individuals or entities form a business for profit. All partners share in the management and in the profits and decide on matters of ordinary business operations by majority of the partners or by percentage ownership of each partner. Each partner is liable for all business debts and bears responsibility for the actions of the other partners.
Each partner reports partnership income on their individual tax return. A partnership dissolves on the death or withdrawal of a partner unless the partnership agreement provides otherwise. Partnerships are relatively easy and inexpensive to form and require few ongoing formalities. LIMITED LIABILITY COMPANY: A limited liability company is a new and flexible business organization of one or more owners that offers the advantages of liability protection with the simplicity of a partnership, i. e. partners are not liable for business debts.
Each partner reports business income on their individual tax return. LLCs may dissolve on the death or withdrawal of an owner depending on state law. An LLC is not appropriate for businesses seeking to become public or raise capital. LLCs require few ongoing formalities but usually require periodic filings with the state and also require annual fees. LLCs are more expensive to form than partnerships. CORPORATIONS: A corporation is a legal entity that has most of the rights and duties of a natural person but with perpetual life and limited liability.
Shareholders of a corporation appoint a board of directors and the board of directors appoints the officers for the corporation, who have the authority to manage the day-to-day operations of the corporation. Shareholders are generally liable for the amount of their investment in corporate stock. A corporation pays its own taxes and shareholders pay tax on their dividends. However, in a subchapter S corporation, shareholders report their share of corporate profit or loss in their individual tax return. The corporation is its own legal entity and can survive the death of owners, partners and shareholders.
A corporation is the best entity for eventual public companies. Corporations can raise capital through the sale of securities and can transfer ownership through the transfer of securities. Corporations require annual meetings and require owners and directors to observe certain formalities. Corporations are more expensive to form than partnerships and sole proprietorships. Corporations require periodic filings with the state and also require annual fees. (COMMON FORMS OF BUSINESS ORGANIZATION – http://www. tulsascore. org/organization. tml) PARTNERSHIPS: Partnerships are unincorporated businesses. Like corporations, partnerships are separate entities from the shareholders. Unlike corporations, partnerships must have at least one General Partner who assumes unlimited liability for the business. Partnerships must have at least two shareholders. Partnerships distribute all profits and losses to their shareholders without regard for any profits retained by the business for cash flow purposes. (LLCs are taxed as partnerships, unless they choose to be taxed as corporations. of organization you believe will be best and be sure to explain the reasoning for your choice. In my opinion, a Limited Liability Company would be the best choice for them to form as it provides easy management and “pass-through” taxation (profits and losses are added to the owner(s) personal tax returns) like a Sole Proprietorship/Partnership, with the liability protection of a Corporation. Like a corporation, it is a separate legal entity; unlike a corporation, there is no stock and there are fewer formalities.
The owners of an LLC are called “Members” instead of “Shareholders”. So in essence, it’s a like a corporation, with less complicated taxation and stock formalities. The heart of a Limited Liability Company is known as the “Operating Agreement”. This document sets the rules for operating the company and can be modified as the business grows and changes. Operating an LLC is less formal than a corporation, usually only requiring an Annual Members’ Meeting and Members’ agreeing to changes of the Operating Agreement and other major company decisions.
Provides the liability protection of a corporation without the corporate formalities (Board meetings, Shareholder meetings, minutes, etc. ) and extra levels of management (Shareholders, Directors, Officers). Taxed the same as a sole proprietorship (1 Member LLC) or partnership (2 or more Members). (Which Type of Business Entity to Choose? http://www. mynewcompany. com/entity. htm) Part III: Discuss the tax consequences of contributing cash, property and/or services to the new entity. Contributions of appreciated property to an LLC, however, are generally tax free and there is no ownership or control requirement.
There are ordinarily no federal income tax consequences when a person contributes property or services to an LLC, but there are some exceptions to this rule that you should keep in mind when planning for contributions by new or existing members of LLCs. Under IRC §721(a), a contribution of property to an LLC is generally tax free to both the contributor and the LLC. There is no 80 percent control requirement to obtain tax-free treatment for a contribution to an entity taxed as a partnership as there is for a contribution to a corporation under IRC §351.
Therefore, a contribution of property to an LLC will be tax free even if the contributor obtains only a relatively small interest in the LLC in exchange. Part IV: Discuss, in detail, how this entity is taxed (if at all) and what filing requirements it has with the IRS Limited liability companies that are subject to the partnership tax rules are not responsible for actually paying the tax on business earnings, but are responsible for preparing annual partnership tax returns on IRS Form 1065.
This return is for informational purposes only; all income, deductions and credits are reported by each individual owner. The LLC reports each owner’s share of these amounts on a Schedule K-1 at the end of the year. In this situation, if Penelope, Mark and John earn $120,000 and have $60,000 of deductible business expenses, then each of them will receive a Schedule K-1 with $40,000 of earnings and $20,000 of deductions. Each of them must then report these figures on their personal income tax returns.
Essentially, the business will increase their personal taxable income by $20,000. (LLC Tax Filing Rules – Tax Basis in LLC Interest: In general, the initial tax basis of a member who acquires an LLC interest from the LLC will be equal to the amount of money and the tax basis of any property that the member contributes to the LLC in exchange for such interest. The tax basis thus determined will be increased by such member’s share of the LLC’s liabilities, by its share of the LLC’s income, and by any subsequent capital contributions.
The member’s tax basis will be reduced (but not below zero) by the member’s share of LLC distributions and losses and also by any decrease in such member’s share of the LLC’s liabilities. IRC § 752 embodies the statutory rules for sharing LLC liabilities. That Section provides that any increase in a partner’s share of a partnership’s liabilities, or any increase in a partner’s individual liabilities by reason of assuming a partnership’s liabilities, will be considered a contribution of money by such partner to the partnership.
Conversely, any decrease in a partner’s share of a partnership’s liabilities, or any decrease in a partner’s individual liabilities by reason of a partnership assuming such liabilities, will be considered a distribution of money to the partner by the partnership. Unfortunately, the statute does not provide for the manner in which a partner’s share of liabilities will be determined. Instead, one must look to the Regulations. (Federal Income Taxation of LLC Members – http://www. mmmlaw. com/media-room/publications/articles/federal-income-taxation-of-llc-members)
This last exception is the most important. In some circumstances, a court might say that the LLC doesn’t really exist and find that its owners are really doing business as individuals, who are personally liable for their acts (LLC Business Basics – http://articles. bplans. com/small-business-legal-issues/llc-basics/186) Cited Sources: COMMON FORMS OF BUSINESS ORGANIZATION – http://www. tulsascore. org/organization. html Types of Business Organizations: 6 Forms of Business for IRS Purposes http://taxes. about. com/od/taxplanning/a/incorporating_2. tm Which Type of Business Entity to Choose? http://www. mynewcompany. com/entity. htm Contributions to LLCs – http://www. alberty. com/newsletter_summer01. html How LLC Members Are Taxed – http://www. nolo. com/legal-encyclopedia/how-llcs-are-taxed-29675. html Tax Implications: LLC Versus S Corporations – http://www. hutchlaw. com/library/tax-implications-llc-versus-s-corporations LLC & Asset Protection – http://www. ehow. com/about_6563015_llc-asset-protection. html LLC Business Basics – http://articles. bplans. com/small-business-legal-issues/llc-basics/186
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