Milestone 4 Case Study

Milestone Four: Conclusion

Conclusion: Advantages and Disadvantages of Different Business Entities

For Mr. Jones it was important to review all business types and ensure he had all the information to make a well-informed decision. He needed to understand different options offered for both him and his daughter since he is considering giving her a percentage of the business. Below is a breakdown of the distinct types of businesses.

Bob is looking for this business to help him and provide for a future for his daughter to carry on the business. A C Corporation provides growth potential and investment opportunities while keeping the business and personal finances separate. A C Corporation can have unlimited shareholders and potential investors

find a C Corporation more beneficial as there may be certain limitations with other business types.
For an S Corporation, there is a limit of 100 shareholders that are able to be in the corporation. If Bob was to form a sole proprietorship then only he would be the owner and could not provide his daughter with the possible 40% and he would also have to claim all the profit/loss on his form 1040 Schedule C when he filed his taxes. This could be problematic if his used car dealership does well because it could result in him paying more taxes due to him being put into a higher tax bracket.
Since Bob wants to have his daughter with part ownership a Partnership or S Corporation could be formed as they are pass through tax entities and the profits and losses are passed through to the owners to file with his or her taxes at year end. The Partnership or the S Corporation would give the partners or shareholders a K-1 at year end so that the individuals would report that information on his or her personal 1040 tax return for the tax year. Just as with the sole proprietorship if the profits are high the individuals could be placed into a higher tax bracket which would result in them paying more taxes.
Going with a C Corporation the business is a separate tax entity with its own tax identification number.

The corporation will file its own yearly taxes on form 1120. Bob and potentially his daughter will receive salaries and potential bonuses where the payroll taxes will be withheld and at year end they will receive a form W-2 to use when they file their taxes for the year. They will also have to report dividends on their individual tax returns if any dividends are paid out by the corporation. The owners are protected from any liabilities as long as they adhere to the rules of a corporation. I do recommend that they ensure they have a strong team made up of tax accountants and legal advisors to help ensure they are maximizing all tax deductions that are out there for them to use to help reduce the tax liability for the corporation as well as for themselves personally.

Below is a summary of the advantages and disadvantages of each type of business entity.

A sole proprietorship is an easy set up and comes with many tax advantages, but it is geared more towards a smaller business (Rodeck, n.d.). With Mr. Jones’s desire to be in business with his daughter and have her own a percentage of the company it does not seem to be the correct path. Even with this information and knowing it is not the way to go, below are some advantages and disadvantages for the sole proprietorship:

Advantages of a Sole

Proprietorship:
• The owner receives all profits
• Easier and inexpensive to start up
• The owner pays only personal income tax on his/her profits
o Everything is reported using Schedule C on the owner’s personal tax return (Form 1040)
• Avoidance of double taxation such as with the C Corp

Disadvantages of a Sole Proprietorship:
• The owner is sole responsible for the liabilities of the business and if there are not enough assets to pay the debt/liabilities the creditor could take personal assets of the owner,
• Owner is limited to how he/she can fund the business which would be through personal funds or loans from others – size of business is limited
• When the owner dies the business ends unless it is transferred however when or if it is transferred to heirs then a new sole proprietorship would be created

A partnership unlike a sole proprietorship is two or more people and they would all share in the gains and losses. Below are advantages and disadvantages of a Partnership:
Advantages of a Partnership:
• The business itself does not pay income tax
o Each partner will file his/her personal tax return and the profits loss that were passed thru to him or her on Form 1065 are filed with that personal return.
• A partnership is easy to establish (could be a handshake)
• Improved management/oversight with more than one owner

Disadvantages of a Partnership:
• The liability of the partners be an issue if one of the partners does something wrong or has a suit filed against him/her – this can be an issue with a general partnership and sometimes even a Limited Partnership
• A partner cannot transfer his or her interest in the company without unanimous consent
• If a partner chooses to leave the partnership or if a partner dies there is a potential that the business may have to be dissolved.

With an S Corporation, the business would not file or pay federal income taxes but just like a partnership the profit and loss would pass through to the shareholders. An S corporation is taxed under Subchapter S of Chapter 1 of the Internal Revenue Code (26 U.S. Code § 1361, 2016).
Advantages of an S Corporation:
• The corporation pays no income tax on profit. That profit is passed through to the shareholders.
• In an S Corporation there is a simple transfer of ownership
• Limited Liability for its shareholders and/or management

Disadvantages of an S Corporation:
• Setup costs can be costly.

The Corporation needs to file with the state the articles of incorporation and follow a more formal protocol for business than a sole proprietor or partnership. A partnership and sole proprietorship are each less expensive and no more complicated than a verbal agreement or handshake.

• Limited to one class of stock

• An owner/employee which has 2% or more of the shares cannot receive tax-free benefits

• Owners will sometimes pay taxes on the distributions they may not have received if said profit was reinvested in the company

Forming a C Corporation for Mr. Jones’s business is the recommendation. A C Corporation is a separate legal entity and has many advantages and disadvantages to do so. Making Mandy a 40% owner to start allows for a smoother transition of ownership should Mr. Jones decide to leave the business, or should he pass away. Doing so helps to avoid the ‘gift tax’ if she were not part owner when the business was established, and it would also help to avoid estate taxes if Mr. Jones passed away. With our recommendation the advantages far outweigh the disadvantages.

Advantages of a C Corporation

• Unlike an S Corporation there is no limit to the number of shareholders.

• Tax deductible business expenses

• If an owner leaves or passes away the C Corporation will still

exist

Disadvantages of a C Corporation
• Double taxation: the corporation pays taxes and when the profits are distributed to the shareholders, they must also pay taxes on that money.
• Expensive to start up – file with the secretary of state. File Articles of incorporation.
• “In order to maintain this limited liability, the corporation's owners must follow a number of legally required corporate formalities.” (Pros and Cons…,2017). The corporation must have annual shareholder meetings, regular director meetings with minutes taken, and maintain records of business activity to help show the corporation is indeed a separate entity.
• Unlike an S Corporation, owners cannot deduct the losses from a C Corporation on their personal taxes.

Conclusion: Liquidating the Business:
Liquidating a C Corporation due to closing the business or selling would require a closer evaluation by tax advisors a the time of the liquidation. This is because liquidating for whatever reason will cause tax implications for the corporation as well as the shareholders.
“A corporate liquidation should be considered at two levels, the shareholder level and the corporate level. On the shareholder level, a complete liquidation can be thought of as a sale of all outstanding corporate stock held by the shareholders in exchange for all of the assets in that corporation. Like any sale of stock, the shareholder receives capital gain treatment on the difference between the amount received by the shareholder in the distribution and the cost or other basis of the stock” (IRS, 2018). Selling the C Corporation produces tax implications. The liquidation of the corporation’s assets would result in taxes on the gains of the sale. If the stock is transferred this impact would be capital gains for any appreciated value for the corporation as well as the shareholders.
Conclusion: Transferring the Business Activity
Transferring the business activity with a C Corporation is an easier process than with some of the other business types. While corporate shares are transferrable it is important to be sure that there are no restrictions for a transfer set forth in the bylaws or articles of incorporation. If Mr. Jones wishes to transfer his share to his daughter, the stock certificates will need to be filled out to do so. A transfer is not affected until it becomes part of the stock records for the corporation. When the stocks are filled out or endorsed for transfer, the corporation will handle the transfer and cancel the old certificates and new stock certificates will be issued. This is an easier process then waiting and not having his daughter already a partial owner since the gift tax would become an issue.