HYPOTHETICAL BUSINESS 1
Many companiesare formed without consideration of organization structure. Suchgroups automatically assume the classification of soleproprietorships and general partnerships. However, these entitieslack legal separation between the business and its owner. Businessmodels determine the characteristics and privileges enjoyed by anindividual venture. The major classifications are corporations andlimited liability companies (LLCs) (Piper, 2012). Coca-Cola Companycan be identified as a corporation while Koch Industries is awell-known LLC.
There are twodistinct types of corporations, C and S corporations. C corporationsare the regular corporations subject to double taxation. This impliesthat the organization incurs corporate tax in addition to theindividual tax levied on the shareholders. The dividends due to theshareholders are obtained after corporate tax deductions are made onbusiness profits. On the other hand, S corporations enjoy a specialtax status with the Internal Revenue Service (IRS). They acquire sucha status after lodging applications and fulfilling certainrequirements as stipulated by the IRS (Mancuso, 2005). As such, Scorporations are legally registered under the Subchapter S of the IRSregulations.
There existseveral similarities between an LLC and a corporation. Both Coca-ColaCompany and Koch Industries provide limited liability protection totheir members and owners. This implies that liabilities and debtswould never be charged to the personal assets of the members andowners. Sole proprietorships and general partnerships notable fail tooffer this protection. Additionally, both corporations and LLCs allowthe organization to exist as separate entities from the owners(Piper, 2012). This legal separation allows the firm to conductbusiness independent from the personal failures of the owners.
As discussed, aregular corporation is subject to double taxation of its profits.However, an S corporation enjoys the same tax status as an LLC sinceit circumvents corporate tax. Both entities experience pass-throughtaxation in that profits and losses are directly applied to theowners. In this instance, individual tax takes precedence. Moreover,the filing of tax returns is mandatory for both entities especiallywhere the LLC has multiple owners. Both Koch Industries and Coca-ColaCompany must abide by state requirements such as paying registrationfees and filing annual reports (Mancuso, 2005). An LLC and a Ccorporation would both lack restriction on the number of owners andalso reduce the tax bill.
Nevertheless,there are glaring differences between corporations and LLCs. Thefirst difference concerns ownership. An LLC can have an unlimitednumber of members as owners. On the other hand, an S corporation ispermitted less than 100 shareholders. An LLC can have members fromdifferent nationalities while an S corporation should have onlyAmerican citizens as its shareholders. This restriction isimplemented due to the special tax status accorded by the IRS. An Scorporation would never be owned by other corporations while an LLCis unbounded regarding ownership (Beach & Seidler, 2010).Additionally, LLCs can have multiple subsidiaries while an Scorporation exists as a sole entity.
The ongoing formalities imposed on an S corporation far outweighthose of an LLC. Granted, the documents associated with an LLCpresent more difficulty in their preparation. Moreover, an LLC hashigher startup costs compared to an S corporation. Therefore, thedifficulty of preparation is offset by the relatively fewer documentsrequired for continued compliance. An LLC has a flexible managementstructure compared to a corporation (Piper, 2012). The owners of anLLC can choose to have either members or designated managers to serveas management. The former situation would make the LLC act as apartnership while the latter renders it a corporation. Where managersare appointed to provide oversight, the members relinquish controlover daily operations of the business. On the other hand, acorporation has a rigid corporate structure. The shareholders havethe mandate to appoint a board of directors which makes majordecisions and handles other corporate affairs. The board alsoappoints managers to oversee the daily operations of the business(Minnesota Continuing Legal Education, 2012). Therefore, acorporation encompasses several aspects of principal-agentrelationship. The shareholders act as the principals whereas theappointed managers serve as the agents.
A corporation hasperpetual existence whereas an LLC features a dissolution clausewithin its paperwork. An LLC risks closure in case one of the membersdies, withdraws, or suffers bankruptcy. In a corporation, the stockis easily transferable as per the ownership restrictions. Theconverse is true for an LLC. In fact, approval from the rest of themembers is needed before interest in the LLC is sold to an externalparty. An S corporation enjoys certain privileges due to consideratetaxation procedures. Owners of a corporation could choose to beconsidered as employees paying self-employment taxes. Therefore, theywould retain some of the business proceeds and award themselvesreasonable salaries with favorable taxation (Piper, 2012). Thecorporate income accrued after payment of salaries is exempt fromself-employment taxes.
The owners of anLLC are obligated to remit taxes on their profit share. Such taxesare paid regardless of whether the profits are retained in thebusiness or sent to personal accounts. However, owners of acorporation only pay individual taxes on the amount they earn asdividends. In contrast to a corporation, members of an LLC are notclassified as employees. Therefore, their share of profits is exemptfrom Medicare tax and social security. Only active workers remitself-employment taxes from both salaries and profits. In acorporation, Medicare tax and social security are levied solely onsalaries. Active workers of an LLC are allowed to deduct lossesincurred by the business from their tax returns (Fontana, 2010). Thishelps to offset their obligation by reducing their tax liability.However, a corporation’s shareholders do not exercise this right.Granted, the same restriction does not apply to S corporationshareholders.
The shareholdersof corporations enjoy plenty of benefits that are tax-allowable. Suchbenefits include employee stock purchase plans, stock options, andsome retirement plans. Both an LLC and an S corporation remit taxeson some employee benefits such as life insurance and health benefits.In an LLC, all members receive an equal share of the dividendregardless of their individual capital contribution. A standardcorporation can also set up a unique class structure of stock thatguarantees equal distribution of dividends among shareholders.Nevertheless, an S corporation can only maintain a single classstructure of stock (Minnesota Continuing Legal Education, 2012).Under this arrangement, it can issue dividends to shareholders inproportion to their relative investment into the firm.
Setting up ahypothetical business as either an LLC or an S corporation presentsparticular benefits and drawbacks for either case. An LLC affords themost flexibility and autonomy to a business owner. It also involvesless paperwork by avoiding mandatory meeting requirements establishedby the state. An LLC is ideal where equal distribution of dividendsis preferred as opposed to the comparative method (Fontana, 2010).However, setting up an S corporation would make the most sense for ahypothetical business.
An S corporationoffers the most reliable protection to a business entity. Itsafeguards the liability of the owner from the losses of thebusiness. An S corporation also provides the best chance forattracting investments. Investors usually prefer to pool theirresources into businesses that offer tax incentives. This alsoguarantees them to receive dividends commensurate with theirinvestment in the company. The corporate structure of leadership in acorporation provides adequate checks and balances against fraudulentactivities. The principal-agent relationship between the managers andthe shareholders ensures the objective of wealth maximization isrealized. The irreproachable board of directors makes sober corporatedecisions on behalf of the firm. The board also appoints qualifiedmanagers after intense vetting and deliberation (Fontana, 2010). Theboard charter also lays the groundwork for quorum and corporategovernance.
An S corporationwould also enable the hypothetical business to flourish due to thetax haven. An owner would stand to earn a salary instead ofself-employment salary. This serves to reduce the tax liability.Additionally, an S corporation makes it easy to sell and transferstock. This highlights the high potential for growth within an Scorporation (Fontana, 2010). Attracting investors and acquiringequity would accord the business endless opportunity for exponentialgrowth.
As discussed, abusiness needs to adopt a structure so as to enjoy certain privilegesdue to legal separateness. Limited liability companies andcorporations are two of the most common business models. Both modelshave striking similarities. For example, they offer limited liabilityprotection to the owners of the business. They also allow thebusiness to exist as a separate legal entity from the owner.
Beach, R. B. & Seidler, W. E. (2010). LLC or Inc.?: Entityselection for a small to medium sized business. Eau Claire, Wis.:National Business Institute.
Fontana, P. K. (2010). Choosing the right legal form of business:The complete guide to becoming a sole proprietor, partnership, LLC,or corporation. Ocala, Fla.: Atlantic Pub. Group.
Mancuso, A. (2005). LLC or corporation?: How to choose the rightform for your business. Berkeley, CA: Nolo.
Minnesota Continuing Legal Education. (2012). LLC vs. Corporation:The cage fight battle of the entities. St. Paul, MN: MinnesotaContinuing Legal Education.
Piper, M. (2012). LLC vs. S-corp vs. C-corp. St. Louis, Mo.:Cengage Learning.