Hi, today we discuss different forms of business organizational structure.One of the decisions that a business owner has to make is what type of organizational structure their business is going to use because each structure has different tax, income and liability implications for businesses owners and their companies.
Different Forms of Business Organizational Structure
Different Forms of Business Organizational Structure
- Sole proprietorships.
- Limited liability companies.
- Sole proprietorships
The sole proprietorship is the oldest form of business organization. As the title suggests, a single person owns the business, holds title to all its assets, and is personally responsible for all of its debts. A proprietorship pays no separate income taxes. The owner merely adds any profits or subtracts any losses from the business when determining personal taxable income.
Its principal shortcoming is that the owner is personally liable for all business obligations. If the organization issued, the proprietor as an individual issued and has unlimited liability, which means that much of his or her personal property, as well as the assets of the business, may be seized to settle claims. Another problem with a sole proprietorship is the difficulty in raising capital. Because the life and success of the business is so dependent on a single
Individual, a sole proprietorship may not be as attractive to lenders as another form of organization. Moreover, the proprietorship has certain tax disadvantages. Fringe benefits, such as medical coverage and group insurance, are not regarded by the Internal Revenue Service as expenses of the firm and therefore are not fully deductible for tax purposes. A corporation often deducts these benefits, but the proprietor must pay for a major portion of them from income left over after paying taxes. In addition to these drawbacks, the proprietorship form makes the transfer of ownership more difficult than does the corporate form. In estate planning, no portion of the enterprise can be transferred to members of the family during the proprietor’s lifetime. For these reasons, this form of organization does not afford the flexibility that other forms do.
A partnership is similar to a proprietorship, except there is more than one owner.
A Partnership, like a proprietorship, pays no income taxes. Instead, individual partners include their share of profits or losses from the business as part of their personal taxable income. One potential advantage of this business form is that, relative to a proprietorship, a greater amount of capital can often be raised. More than one owner may now be providing personal capital, and lenders may be more agreeable to providing funds given a larger owner investment base. In a general partnership, all partners have unlimited liability; they are jointly liable for the obligations of the partnership. Because each partner can bind the partnership with obligations, general partners should be selected with care. In most cases, a formal arrangement, or partnership agreement, sets forth the powers of each partner, the distribution of profits, the amounts of capital to be invested by the partners, procedures for admitting new partners, and procedures for reconstituting the partnership in the case of the death or withdrawal of a partner. Legally, the partnership is dissolved if one of the partners dies or withdraws. In such cases, settlements are invariably “sticky,” and reconstitution of the partnership can be a difficult matter. In a limited partnership, limited partners contribute capital and have liability confined to that amount of capital; they cannot lose more than they put in. There must, however, be at least one general partner in the partnership, whose liability is unlimited. Limited partners do not participate in the operation of the business; this is left to the general partner(s). The limited partners are strictly investors, and they share in the profits or losses of the partnership according to the terms of the partnership agreement. This type of arrangement is frequently used in financing real estate ventures.
A corporation is an “artificial entity “created by law. It can own assets and incur liabilities. In the famous Dartmouth College decision in 1819, Justice Marshall concluded that:
A corporation is an artificial being, invisible, intangible, and existing only in contemplation of the law. Being a mere creature of law, it possesses only those properties which the charter of its creation confers upon it, either expressly or as incidental to its very existence
The principal feature of this form of business organization is that the corporation exists legally separate and apart from its owners. An owner’s liability is limited to his or her investment. Limited liability represents an important advantage over the proprietorship and general partnership. Capital can be raised in the corporation’s name without exposing the owners to unlimited liability. Therefore, personal assets cannot be seized in the settlement of claims. Ownership itself is evidenced by shares of stock, with each stockholder owning that proportion of the enterprise represented by his or her shares in relation to the total number of shares outstanding. These shares are easily transferable, representing another important advantage of the corporate form. Moreover, corporations have found what the explorer Ponce de Leon could only dream of finding – unlimited life. Because the corporation exists apart from its owners, its life is not limited by the lives of the owners (unlike proprietorships and partnerships). The corporation can continue even though individual owners may die or sell their stock. Because of the advantages associated with limited liability, easy transfer of ownership through the sale of common stock, unlimited life, and the ability of the corporation to raise capital apart from its owners, the corporate form of business organization has grown enormously in the twentieth century. With the large demands for capital that accompany an advanced economy, the proprietorship and partnership have proven unsatisfactory, and the corporation has emerged as the most important organizational form. A possible disadvantage of the corporation is tax related. Corporate profits are subject to double taxation. The company pays tax on the income it earns, and the stockholder is also taxed when he or she receives income in the form of a cash dividend. Minor disadvantages include the length of time to incorporate and the red tape involved, as well as the incorporation fee that must be paid to the state in which the firm is incorporated. Thus, a corporation is more difficult to establish that either proprietorship or a partnership
- Limited liability companies
A limited liability company (LLC) is a hybrid form of business organization that combines the best aspects of both a corporation and a partnership. It provides its owners (called “members”) with corporate-style limited personal liability and the federal tax treatment of a partnership.