Businesses Are the Cornerstone Research Paper

Pages: 8 (2907 words)  ·  Bibliography Sources: 8  ·  Level: Master's  ·  Topic: Business

SAMPLE EXCERPT:

[. . .] As globalization continues its rapid advance, LLCs will also be very advantageous to foreign investors. LLCs do not have the ownership restrictions of S Corporations making them ideal business structures for foreign investors.

For U.S. federal income tax purposes, an LLC is treated by default as a pass-through entity. If there is only one member in the company, the LLC is treated as a "disregarded entity" for tax purposes, and an individual owner would report the LLC's income or loss on Schedule C. Of his or her individual tax return. Thus, income from the LLC is taxed at the individual tax rates. The default tax status for LLCs with multiple members is as a partnership, which is required to report income and loss on IRS Form 1065. Under partnership tax treatment, each member of the LLC, as is the case for all partners of a partnership, annually receives a Form K-1 reporting the member's distributive share of the LLC's income or loss that is then reported on the member's individual income tax return. On the other hand, income from corporations is taxed twice, once at the corporate entity level and again when distributed to shareholders, thus more tax savings often results if a business formed as an LLC rather than a corporation.

LLCs have been described as simpler to form and therefore less expensive than a corporation. This is commonly the case with a single member LLC where a written operating agreement is generally not required. When there are multiple members in the LLC and a written operating agreement is required, the cost of forming an LLC can easily exceed the cost of a corporation, particularly if the operating agreement is properly prepared and customized for the members and their specific business relationship. This is the case with the farm business which has roughly 5 partners altogether (Family Business Sourcebook, 1998).

An LLC with either single or multiple members may elect to be taxed as a corporation through the filing of IRS Form 8832. After electing corporate tax status, an LLC may further elect to be treated as a regular C corporation or as an S corporation. Some pundits have recommended an LLC taxed as an S-corporation as the best possible small business structure. It combines the simplicity and flexibility of an LLC with the tax benefits of an S-corporation which are self-employed tax savings

At the beginning of 2013 there were strong talk among members of both political parties of lowering the corporate rate from 35% to around 25-28% to increase the competitiveness of the U.S. In comparison to foreign nations, which may have lead to many highly profitable LLC businesses rethinking their situation and consider switching to a corporate form

LLCs do have distinct disadvantages however. LLCs often have a limited life which is often not to exceed 30 years in many states. Some states require at least 2 members to form an LLC, and LLCs are not corporations and therefore do not have stock. As such they do not often have the benefits of stock ownership and sales. As such the firm will be unable to raise funds within the capital markets.

It should go without saying that no one entity or tax classification is right for any business. Two people running the same type of business might both correctly reach different conclusions on the best entity or tax classification for operating their business. The reason is simple: there are several important factors that must be considered and weighed. Some factors will be more important than others to different people. Also, as circumstances change (adding employees, expanding your business, seeking outside investors, and so on), consideration of these same factors may warrant or require choosing a different type of entity or tax classification. As such, much of this information was omitted from the case. However, making some general assumptions, the best tax entity is a relatively easy decision (DuBois, 1998).

First, the nature of the business is important in regards to the overall tax considerations. While most businesses may be permitted to choose either a corporation or an LLC, there may be some restrictions. For anyone who must be licensed to engage in a certain occupation, trade or profession, many states and licensing boards have specific requirements or restrictions on the type of entity a licensee may choose to practice his profession. In California, for example, most licensed persons are prohibited from operating through an LLC. They must choose either a Professional Corporation or regular business corporation (Cooke, 1950).

A corporation has a well-established, formal legal structure. Every state has very detailed and time-tested laws regulating all aspects of corporations. Every corporation (excluding nonprofits) is comprised of shareholders, directors and officers. A corporation does not offer much flexibility in how the business will be managed.

An LLC, on the other hand, is a relatively new type of business structure. State laws provide less regulation of an LLC, instead leaving it to the LLC's members to enter into an operating agreement (like a partnership agreement) as the governing document of the LLC. The operating agreement establishes the rights and responsibilities, powers and limitations, and other aspects of the relationship of the members and any managers.

An LLC structure may be managed by its members, much like a partnership, or it may be managed by one or more managers with the members being more passive investors, like a corporation. In short, an LLC offers greater flexibility in managing a business than a corporation.

For a single owner, management flexibility is not an issue and either the corporation or LLC structure will work. With multiple members, the flexibility of management takes the forefront in the entity selection. If the owners desire a more detailed description of their duties and responsibilities as well as other management factors, a customized operating agreement provides far more flexibility that the corporate structure whose management is more rigidly governed by statutory laws and more standardized bylaws.

There are two types of tax classifications for any business type: one where taxes are paid at the entity or business level and one where taxes are paid only at the owner level, also known as a "pass-through" tax entity. As discussed earlier, a C Corporation, by definition, is a tax-paying entity and an S Corporation, by definition, is a pass-through tax entity. An LLC may be either depending on several factors and the preference of the members.

A single member LLC may be taxed like a sole proprietor, that is, a pass-through (or disregarded) tax entity. However, a single member LLC can also choose to be taxed as a C Corporation or an S Corporation. Why would a single member LLC choose these other classifications?

In some states, such as California, an LLC is subject to additional taxes or fees that are not imposed on corporations. By choosing to be taxed as a corporation, the entity remains an LLC entity type for legal purposes but is taxed as if it were a corporation (either C. Or S), thereby avoiding the additional fees or taxes imposed on an LLC (Klein, 2002).

Another reason is that the profits distributed to an LLC member who is actively involved in the business are subject to self-employment (SE) taxes, essentially Social Security and Medicare taxes, totaling 12.4% of the member's share of profits. By choosing to be taxed as an S Corporation, an LLC is still a pass-through tax entity but the members now become employees of the LLC and have some flexibility to establish salaries that may be less than their profit distributions. SE taxes must be paid on the salaries received but do not have to be paid on profit distributions to the member. There is an opportunity for SE tax savings, but the salary must be supportable as a reasonable amount under the circumstances. For these reasons, I believe the best tax corporation will be that of an S corporation followed by an LLC.

References:

1. Barnet, Richard; Ronald E. Muller (1974). Global Reach: The Power of the Multinational Corporation. New York, NY: Simon & Schuster.

2. Blumberg, Phillip I., The Multinational Challenge to Corporation Law: The Search for a New Corporate Personality, (1993)

3. Cadman, John William. The Corporation in New Jersey: Business and Politics,, (1949)

4. Conard, Alfred F Corporations in Perspective. 1976.

5. Cooke, C.A., Corporation, Trust and Company:… [END OF PREVIEW]

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