Sole Proprietorship Essay Example
Sole Proprietorship Essay Example

Sole Proprietorship Essay Example

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  • Pages: 12 (3270 words)
  • Published: July 20, 2016
  • Type: Essay
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The most common form of business formation in the United States is a sole proprietorship, in which the person who starts it is personally responsible for any debts owed by the business and agrees to contract terms on behalf of the business. The main advantage of a sole proprietorship is its simplicity in formation, as the person creating it becomes fully accountable for all aspects of the business, including payments, collecting money from customers, and providing goods or services to clients. Another reason individuals choose to establish sole proprietorships is for the freedom and flexibility they offer; they can set their own hours, take vacations as desired, expand their business, and determine its direction without anyone to report to.

Despite the advantages of a sole proprietorship business, it also comes with several drawbacks. The owner bears full responsib

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ility for all financial obligations and must ensure timely and complete payments to creditors. If the owner faces financial difficulties, they are left vulnerable and solely accountable. Furthermore, a sole proprietorship cannot have multiple owners or be transferred to another individual. The owner's tax planning becomes complex since all income and debts of the company are intertwined with their personal finances. Consequently, operating as a sole proprietorship presents significant risks due to the owner's liability.

  1. Costs: Almost no creation cost since there is nothing to create.
  2. Longevity or Continuity of the Organization: A sole proprietorship business basically lasts as long as the owner decides to or dies.
  3. Raise Capital / expand business: It is very difficult to raise capital or expan
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the business with a sole proprietorship type of business. It is impossible to bring others into the business, and any capital that may be raised will come directly from the owner.

  • Control: Full control of a sole proprietorship is in the hands of the owner since they do not have any other members.
  • Expand ownership: Since a sole proprietorship can only have one owner, it is impossible to bring others into the business.
  • Taxes: Due to having no legal distinction between the owner and the business, all income that the business generates is treated as personal income to the owner.
  • Liability: The owner of a sole proprietorship has unlimited liability since the owner and the business are one in the same. The owner is personally liable for all the business debts and obligations.
  • General Partnership businesses are formed easily when individuals decide to conduct business together. These partnerships are usually formally created with an articles of partnership contract that includes the agreement details. General Partnerships share the business's profits and losses, and all members typically have a say in the business's direction. Once formed, both members of the General Partnership share in the profits and losses of the business together. In contrast to a Sole Proprietorship, where a sole individual is responsible for the business's profits and losses, General Partnerships share these responsibilities equally, resulting in shared profits between partners.

    General partnerships and sole proprietorships are both considered disregarded entities for tax purposes, resulting in them being taxed in the same way.

    As a result, each partner or sole proprietor is responsible for paying income tax based on their respective share of the business income. While general partnerships can be easily formed and dissolved, determining the value of a partner's share can pose challenges. To address this issue, buy/sell agreements are typically included in the articles of partnership contract to handle member withdrawals. Similar to sole proprietorships, general partnerships face unlimited liability which is a significant disadvantage. In situations where one partner engages in misconduct, the other partner can be held accountable for their actions without any protection against wrongdoing or poor financial decisions made by others.

    1. Costs: Relatively no cost involved in creating a partnership business. Any cost would be associated with forming the articles of partnership contract.
    2. Longevity or Continuity of the Organization: Once the agreement of the partnership ends, the partnership ends. Any remaining partners can keep the partnership going if they so wish to.
    3. Raise Capital / expand business: In raising capital a partnership has the same difficulties as a sole proprietorship has in that in raising any capital has to come from the partners.
    4. Control: The control of a partnership is between the partners.
    5. Expand ownership: It is nearly impossible to expand a partnership due to the agreement between the members.
    6. Taxes: The partnership is taxed the same as a sole proprietorship is.
    7. Liability: A general partnership is similar to a sole proprietorship in that each partner is jointly and

    severally liable for all financial liabilities.

    A limited partnership is similar to a general partnership in that it involves multiple members and shared profits. However, unlike a general partnership, a limited partnership offers limited liability for one member. This means that the limited partner is only liable for the amount they choose to invest and are not financially responsible for the business as a whole. Limited partnerships must follow state laws and typically involve limited partners who do not participate in day-to-day management.

    In a limited partnership, the losses or gains of limited partners cannot exceed their contributions. The distribution of profits among partners is based on their partnership interest. Partners are individually taxed on the net income of the business, with gains and losses passing through to owners without separate taxation of the business itself. While owners cannot deduct their salaries from taxable net income, they can deduct group insurance costs and other employee fringe benefits. Since 2003, premiums for health insurance covering owners and dependents have been fully deductible.

    A limited partnership functions as a pass-through business where individual owners are taxed on their income.

    The establishment of a limited partnership is relatively affordable, and it's important to note that this type of business entity itself does not face taxation.

    1. Longevity or Continuity of the Organization: Basically the same as a general partnership, once the agreement of the partnership ends, the partnership ends. Any remaining partners can keep the partnership going if they so wish to. On dissolution of the partnership the limited partner’s share has priority over the funds due to the general partners of the business, but is

    subordinate to claims of the firm’s creditors. If a death occurs, the limited partner’s personal representative is entitled to the deceased’s portion of assets and deferred profits in order to settle the estate. However, death of a limited partner does not dissolve the partnership, but the death of a general partner can end the business unless the partnership agreement states otherwise.

  • Raise Capital / expand business: This is the basis of why Limited Partnerships are created. When a General Partnership is looking for additional capital to expand or grow the business they can bring in a Limited Partner. This Limited Partner can invest into the business on a limited liability basis and only lose the amount of their investment. The General Partners will remain as so.
  • Control: The control of a limited partnership lies with the general partners.
  • Expand ownership: Since the partnership was formed with an agreement is it nearly impossible to bring in additional ownership. However, they can bring in additional Limited Partners.
  • Taxes: A General Partnership is considered a disregarded entity for its tax purposes. So basically the income flows through the business to the partners. The partners then pay ordinary income tax on the business income. The partnership may also file an information return that reports total income and losses for the partnership and how those profits and losses are allocated among the general partners. Tax planning opportunities are limited for general partners.
  • Liability: The liability of a limited partnership lies with the general partners and

  • not the limited partners. Every partner in the partnership is jointly and severally liable for the partnership’s debts and obligations.

    A C Corporation is an autonomous legal entity that is distinct from its owners, able to exist for a limited or indefinite period. The separation between owners and the corporation enables seamless operation in spite of ownership changes, allowing many corporations to outlive their founders and maintain independent existence. Nevertheless, this separation also entails certain legal and constitutional obligations for corporations. In most cases, companies are incorporated in the state where they are located; however, there can be exceptions. Once incorporated in a specific state, adherence to local state laws becomes mandatory. To establish a corporation, founders must submit articles of incorporation to the relevant local state agency.

    When establishing a company, the founders must provide its name and indicate whether it is for-profit or nonprofit. It is vital to choose an exclusive name that includes terms like Incorporated, Company, Corporation, or Limited. Creating a corporation is more complex compared to other types of businesses. Typically, founders seek assistance from lawyers and accountants to ensure compliance with corporate law. Additionally, corporations have various financial obligations such as annual license fees, franchise fees, taxes, and attorney fees. Shareholders are the owners of the corporation and enjoy limited liability by risking only their invested amount. However, one disadvantage of a C Corporation is double taxation. Tax authorities treat corporations as separate entities which can result in taxation issues. To identify the company, it is assigned an Employer Identification Number (EIN). The extensive legal requirements make managing a C Corporation extremely challenging and costly.

    Costs: There are substantial more costs associated with creating a corporation than compared to a partnership or sole proprietorship. There are many fees when creating a corporation.

  • Longevity or Continuity of the Organization: Corporations can be created for a limited duration or they can have perpetual existences.
  • Raise Capital / expand business: With a corporation the owners can raise capital by selling shares or stock in the company. This capital can be used to expand the business.
  • Control: Owners of corporations are referred to as shareholders. Corporations can have as few as one shareholder or millions of shareholders.
  • The number of shares held by shareholders can vary, ranging from one to a larger amount. The total number of shareholders depends on whether the company is closely held or publicly traded. However, not all shareholders have equal rights. United States corporate law allows for different kinds or categories of shareholders. For example, a special class of stock may be set aside exclusively for the creators of the company, giving them preemptive rights. Ford Motor Company illustrates this concept with its multiple shareholders and two types of stock: Class A for the general public and Class B for the Ford family. Despite there being more Class A stock than Class B stock in terms of quantity, the latter holds 40 percent voting rights in any shareholder meeting. As a result, owners of Class B stock (the Ford family) have the power to veto any shareholder resolution that requires two-thirds approval. By establishing distinct classes or types of stock, they

    exert significant influence over the future direction of the company.

    1. Expand ownership: In a corporation they can expand ownership by simply selling shares or stock in the company.
    2. Taxes: A C Corporation is held to double taxation.
    3. Liability: Shareholders of a corporation enjoy limited liability and can only lose what they invest into the corporation. Personal assets of those shareholders are unreachable by creditors.

    The text discusses the option for an S Corporation, also called a C Corporation, to be taxed as a partnership or sole proprietorship. The "S" designation differentiates it from a C Corporation, which can face double taxation. Instead, an S Corporation only incurs taxes at the shareholder level when dividends are declared, rather than at the corporate level. Shareholders then have to pay personal income tax on their share of profits. Despite having separate legal and constitutional rights from owners, corporations must still comply with corporate law regulations.

    Most companies incorporate in the states where they operate; however, there are exceptions to this rule. Incorporation involves filing articles of incorporation with the appropriate state agency in the chosen location. These articles should indicate if the company is for-profit or nonprofit and include its name using terms like "Incorporated," "Company," "Corporation," or "Limited." Creating a corporation is more complex compared to other business forms.

    When starting a corporation, founders often seek assistance from attorneys and accountants to ensure compliance with corporate law. The corporation is responsible for various fees such as annual license fees, franchise fees, taxes, and attorney fees. S Corporations offer limited

    liability benefits found in corporations but also enjoy single-level taxation like sole proprietorships by not paying corporate taxes. However, there are important restrictions on S corporations. They cannot have more than one hundred shareholders, all of whom must be U.S. citizens or resident aliens. Additionally, they can only have one class of stock and cannot be part of an affiliated group of companies.

    S corporations are commonly used for small businesses and resemble partnerships in terms of passing business activity through to owners who are then taxed based on their proportionate share of earnings. Whether the earnings are distributed or remain within the corporation as undistributed earnings does not matter; owners must personally report these earnings. Expenses and losses are directly passed through to shareholders. An S-Corporation is formed and treated similarly to any other corporation except for tax treatment.

    1. Costs: There is substantial more costs associated with creating a corporation than compared to a partnership or sole proprietorship. There are many fees when creating a corporation.
    2. Longevity or Continuity of the Organization: Corporations can be created for a limited duration or they can have perpetual existences.
    3. Raise Capital / expand business: With a corporation the owners can raise capital by selling shares or stock in the company. This capital can be used to expand the business.
    4. Control: Owners of corporations are referred to as shareholders.

    The number of shareholders in a corporation can vary, ranging from one to millions. Each shareholder may own one or multiple shares. The quantity of shareholders depends

    on whether the corporation is closely held or publicly traded. However, U.S. corporate law allows for different types or classes of shareholders and does not treat them all equally.

    Founders, for example, may reserve a special class of stock with preemptive rights for themselves. Ford Motor Company is an example of this, as it has numerous shareholders but issues two types of stock: Class A for the public and Class B for the Ford family. Despite there being more Class A stocks than Class B stocks, the latter holds 40 percent voting rights during any shareholder meeting.

    This means that members of the Ford family holding Class B stocks can impede any resolution requiring two-thirds approval to pass as they exert significant influence through having separate classes/types of stock.

    In terms of management structure, S corporations have a board of directors elected by shareholders with specific authorities who then appoint corporate officers to oversee the company.

    1. Expand ownership: In a corporation they can expand ownership by simply selling shares or stock in the company.
    2. Taxes: One way for corporations, mostly closely held corporations, to avoid the double taxation of a C-Corporation is to elect to be treated as an S-Corporation. The S comes from the subsection of the tax law that can choose to be taxed like a partnership or sole proprietorship. So basically it is only taxed once, which is at the shareholder level when a dividend is declared, and not at the corporate level. Each shareholder then pays personal income tax when they receive their share of the corporate profits.
  • Liability: Shareholders of a corporation enjoy limited liability and can only lose what they invest into the corporation. Personal assets of those shareholders are unreachable by creditors.
  • An LLC, which stands for limited liability company, is a business entity that combines the advantages of corporations and partnerships. Members of an LLC have limited liability and enjoy tax benefits similar to partnerships. Unlike limited partnerships, members of an LLC can actively participate in daily business activities. One major advantage of an LLC is its flexibility in taxation – members can choose to be taxed as a corporation or a partnership each year.

    Starting an LLC is generally easier than starting a corporation. It only requires a name and legal contact information. Unlike corporations, LLCs are not obligated to issue stock certificates, hold annual filings or meetings, appoint officers, or engage in regular entity maintenance. An interesting aspect of LLCs is that they can be established with just one member, similar to a sole proprietorship.

    The distribution of profits within an LLC can vary depending on the operating agreement and the source of cash investment. Additionally, an LLC has the ability to allocate distributions proportionately based on each member's initial investment in the company.

    An LLC provides numerous benefits for its members; however, there are also some drawbacks associated with it. One disadvantage is the challenge of raising capital since lenders typically require members to personally guarantee any loans obtained by the LLC.

    1. Costs: Relatively low cost in creating a LLC.
    2. Longevity or Continuity of the Organization: A LLC usually can last as long as the business

    is sustainable.

  • Raise Capital / expand business: Raising capital for an LLC is quite difficult especially in the early stages. Most lenders require the LLC members to personally guarantee any loans the LLC may take out.
  • Control: The control of the business is with the members of the LLC.
  • Expand ownership: A LLC can add expand ownership like a partnership, but these members can participate in the day-to-day activities.
  • Taxes: Taxation in a LLC is very flexible. Essentially, the LLC can determine how it chooses to be taxed each year.
  • Liability: A LLC has limited liability similar to that of a corporation. Part B (The Memorandum)
    • A recommendation of a specific form of organization that should be used in the given situation
    • A justification or rationale as to why that is the best business organization form for this situation

    Date: August 24, 2012 From: Joshua Jensen Attention of: Business Owner

    Subject: Business Recommendation
    I recommend establishing your own business as a limited liability company (LLC) if you want to be a manufacturer's representative for industrial-type equipment and start as the sole owner. This business structure offers several advantages.
    One major benefit is that it safeguards your personal assets, which makes LLCs a popular choice for forming businesses nowadays. In contrast, if you were to form a sole proprietorship, you would personally assume all debts and financial obligations.
    Furthermore, I suggest an LLC because it provides flexibility in terms of taxation.

    Each year, you can decide how the LLC will be taxed. You have the option to pay corporate income tax on net income by being subject to taxation like a corporation. Alternatively, you can choose for the income to pass through the business to yourself and then pay personal income tax.

    The advantage of choosing to establish a business as an LLC is the elimination of stock certificates, annual filings, a board of directors, shareholder meetings, and regular maintenance. It's important to maintain an arm's length relationship with the LLC to avoid piercing the veil and be aware of potential risks early on. The owner has full control and can bring in additional owners as desired, giving them influence over day-to-day activities. However, selecting an LLC may disrupt business continuity in case of death, retirement, or resignation depending on state laws. Profit sharing among members corresponds to their interest in the business and transferring interest beyond a specified number may require compliance with the operating agreement. In summary, establishing your business as an LLC is the best choice considering your specific circumstances.

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