Running head: Business Organization Form Choice Memorandum 1
Business Organization Form Choice Memorandum
Name
Course
Instructor’s Name
Date
Business Organization Form Choice Memorandum 2
TO: Kelly Anderson, Instructor
FROM: (Your Name)
DATE: November 14, 2020
SUBJECT: Business Organization Form Choice Memorandum
Background Information
Basement Academy a newly formed business based in California. The proposed name of
the business was confirmed to be available in California by the secretary of state in California
Alex Padilla. The business will engage in real estate property by providing rental services to its
potential customers. The business will be owned by two people with a 50-50 percent ownership.
I will be in charge of running day to day operations of the firm at the start due to the limited
number of customers. However, as the number of customer increase, property management will
be hired to conduct the day to day operations of the firm. Adequate time will be devoted to the
firm. Employees will be expected to work 8 hours per day in 5 days of the week. They will also
be required to switch off every other weekend. The formation of the business would require
adequate start-up expenses. Adequate funding will be required to obtain a real estate license, as
well as the training cost required for filing the rental documents. It is estimated that $30,000
would be required to meet all the start-up expenses. The financial requirements to meet the above
start expenses will come from family and friends' contributions, bank loans, as well as my
saving. The business will also require a pool of employees. However, the number will vary based
on the demand for rental services by the customers.
The Appropriate State-Law Business Entity Form for the Business
Limited Liability Company will be the most appropriate state-law business entity form
for the Basement Academy firm. There are different types of state-law entity forms. They
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include but are not limited to a sole proprietorship, partnership, limited liability Company, and
the corporation. Limited liability can be provided by a corporation or by a company or by a
limited liability company. The corporate form of limited liability limits the personal liability for
the real estate brokers for business debts and lawsuits. This form of limited liability ensures the
owners of a corporation; the shareholders are not personally liable for corporate debts. This is,
however, exceptional for owners of small corporations as they are personally liable for the debts
and lawsuits of the small corporations (Yin& Burke, 2020). Malpractice lawsuits filed by
disappointed buyers and sellers claiming things like fraud, negligence, misrepresentations,
failure to disclose, and other violations of the agent's or broker's legal and fiduciary duties often
expose most real estate agents and brokers to a greater risk of liabilities. It is imperative to note
that limited liability provided by the corporations does not protect one from their wrongdoings
and malpractices. To this effect, ones' assets can be taken to settle the liabilities resulting from
lawsuits if their businesses are unable to a judgment obtained against them. Limited liability
provided by corporations does cover one against lawsuits against their malpractice. Errors and
omission insurance protects real estate sales professionals from their wrongdoing. Since real
estate agents (salespeople) works for the real estate broker, they are legally responsible for their
errors and omissions. The broker is protected from the malpractice committed by independent
contractor agents or employees by the limited provided by corporations or limited liability
companies. However, this is not often the case if the broker is a victim of malpractice.
Malpractice insurance is required by the estate brokers to enjoy the limited liability provided by
the corporations. It is imperative to note that the amount of limited liability provided to the
broker by the corporation is limited. The limitation varies from state to state.
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Basement Academy firm adopted a limited liability company due to its unique hybrid of a
cross between a partnership and corporation. There are several advantages associated with this
type of state-law business entity form. It's flexible, informal, and tax-effective as compared to
corporations. This justifies its dominance among many business organizations, especially real
estate professionals. Formation of an LLC requires the real estate professionals to file an article
of an organization as well as state their business filing office. Basement Academy firm will file
an article of an organization as well as state their business filing office. The management of the
LLC is spelled out in a written LLC operating agreement. The basement Academy firm will
adopt a written LLC operating agreement to lay out how it will be governed. It is imperative to
note that the default provisions of the state’s LLC act are applied if a business does not file its
article of organizations. The professional services carried on by the LLC are only affected if the
business registered as LLC is licensed. Basement Academy will be licensed to ensure its LLC
professional services are affected. This will ensure that the owner cannot be transferred to
unlicensed brokers. Since the firm operates as a real estate brokerage, licensing will the owner of
the business is only transferred to licensed LLC business organizations. LLC is taxed the same as
partnerships if they are owned by two or more people. Besides, LLC is taxed as a sole
proprietorship if it is owned by one owner. Since the Basement Academy organization is owned
by two people, it will be taxed ordinarily the same as partnerships.
LLC has advantages over sole proprietorship, partnership, and corporations. First, it
provides its owners with the same degree of limited liability for business debts and lawsuits as do
corporations. Besides, easy to form and operate since they require less legal formalities. LLC has
no ownership restriction compared to the S-corporations. This implies that the Basement
Academy will not be required to have a restricted number of stockholders. Besides, the LLC will
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select a stockholder regardless of their citizenship. LLC can use the cash method of accounting
as opposed to C-corporation that is only required to use the accrual method of accounting. This
will ensure that only income received is recorded. As opposed to S-corporation that cannot place
shares into the living trust, LLC can place membership interests in a living trust. Finally, LLC
enjoys tax flexibility hence not subject to double taxation as in C-corporations. Although LLC
has several advantages, it also has its shortcomings. Owners of LLC pays more taxes compared
to other state-law entity forms since salaries and profits of an LLC are subject to self-
employment taxes. LLC requires the owners to recognize profits made immediately, making
their profits be automatically included in the member’s income. It is a requirement that LLC
fringe benefits such as group insurance, medical reimbursement plans, medical insurance, and
parking are treated as taxable income.
A limited liability company also compares differently with a sole proprietorship state law
business entity. A sole proprietorship is easy to start as compared to a limited liability due to less
paperwork required. Owners of this state-law business entity do not have to register their entity
with the state government as required in both corporations and limited liability companies. Sole
proprietorships have a simpler tax setup compared to types of entities. Owners of sole
proprietorship do not have to apply for an employer identification number (EIN) with IRS as
required in other state-law entities. A sole proprietor does not have to pay its taxes separately for
the business as they are taxed as a pass-through entity. A sole proprietor enjoys a 20% tax
deduction provided by the Tax Cuts and Jobs Act. Sole proprietorship requires fewer business
fees. It is a requirement that a sole proprietor pays some fees before starting up a business. This
varies from one law state entity to another. For instance, LLC needs to pay a registration fee
before commencing its operations. The few legal formalities required for the formation of a sole
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proprietorship result in fewer business fees paid. A sole proprietorship has straightforward
banking. Finally, sole proprietorship has simplified business ownership as they are not required
to have company officers or registered agents. As oppose to LLC, a sole proprietor needs not
have a business checking account to operate. Just as an LLC, sole proprietorship also has its
share of shortfalls. It does not have liability protection. This means that a sole proprietor is liable
for all losses incurred by the business and any lawsuits against the business. A sole proprietor is
also liable firm’s legal, financial, or tax problems since they do have legal protections. Getting
financial and business credit for a sole proprietorship is harder compared to other law state entity
forms. Their difficulties in securing loans are due to a lack of substantial history with credit.
Lack of bank accounts and business credit cards makes a sole proprietor find it hard to build
business credit.
Just as LLC and a sole proprietorship, a partnership has both advantages and
disadvantages over other entities. Partnership requires few formal legal obligations to form.
Completion of a Corporation Tax Return is not required in the formation of a partnership.
Besides, a partnership is not required to complete a confirmation statement required to start other
entities, such as limited liability companies. Formation of a partnership is simple as it can be
formed verbally or in written form without the need to register with Companies House. It is also
simple to register a business partnership for taxation with HMRC. Compared to a sole
proprietorship, members of a partnership can share the burden resulting from losses incurred
within the business—partnership results in a better decision-making process. In contrast to the
LLC that must present its financial documents before the Companies House for public
inspections, partnership enjoys privacy as it does not have to present its financial documents
before the Companies House for public inspection. Compared to a sole proprietorship, a
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partnership has easy access to profits since the profits of the business are shared between the
partners (Rozario, 2020). By contrast, in a limited company, profits are retained by the company
until paid out, whether as salaries under PAYE or, with the approval of shareholders, as
dividends. There are also disadvantages associated with the partnership. A partnership is
dissolved upon the resignation or death of one partner as the business has no independent legal
status from the partners. LLC, by contrast, is legally independent of its owners hence cannot be
dissolved upon the death of a member. The partnership has unlimited liability making partners
liable for the debts and losses of the firm. LLC, by contrast, has independent legal existence
distinct from its owners hence losses incurred in the business as well as any lawsuits against the
firm. The liability of the partnership is jointly shared among the partners. This implies that the
personal assets of the partners can be used to settle the debts of the business. Access to capital is
limited compared to LLC. By contrast, Limited liability companies provide separate personality
and sense of performance required by banks; hence have greater chances of accessing the initial
capital required for its formation. The Decision-making process in partnership is slower and
more difficult compared to a sole proprietorship, where all the decisions are made by the single
owner of the business. All the profit of the business is shared among the partners equally. This
does not take into consideration the inputs of each shareholder. The efforts of hardworking
partners are demoralized through equal sharing of profits. In an LLC, by contrast, profits or
dividends are shared among the shareholders based on the percentage of their shares in the
company.
The advantages and disadvantages associated with the formation of a corporation are
slightly similar to those of a limited liability company. First, owners of the corporation are
legally protected from the corporation’s lawsuits and debts. This is similar to the personal
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liability protection in LLC. However, in corporations, personal liability protection is only
effective if the owners are not involved in the malpractice. Corporation has higher access to
capital since most of the corporations sell ownership through the publicly traded stock.
Corporations have some of its shortcomings. Unlike sole proprietorships and partnerships,
corporations are subject to double taxation. The formation process is lengthy due to a lot of legal
formalities required. Owners of the corporation are required to file an article of incorporation
with the secretary of state before the commencement of its operations. Partnership, in contrast,
does not require such documentation for its formation.
The Appropriate Federal Tax Regime for the Business
There are several types of federal tax regime. Disregarded entity taxation (Schedule C of
the Form 1040 most likely), partnership taxation (Subchapter K of the Internal Revenue Code), s
corporation taxation (Subchapter S of the Internal Revenue Code), and c corporation taxation
(Subchapter C of the Internal Revenue Code) are the most common types of the federal tax
regime. Basement Academy will adopt corporate taxation. As mentioned previously, a
corporation exists in two forms; C-corporation and S-corporation. S corporation is taxed
similarly to a partnership since it is regarded as a pass-through entity. C Corporation, on the
other hand, pays its taxes separately. This takes into account the income taxes on the net income
as well as filing tax returns with the IRS. Their income tax rates are unique to other entities.
Besides, the corporation can provide its employees with tax-free fringe benefits and deduct the
total cost of the benefits from the corporation's income as a business expense since it is a
separate tax-paying entity. In S corporation, in contrast, it cannot provide such tax benefits to the
employees and deduct from the corporation's income since they are pass-through entities that are
taxed similar to partnerships.
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Basement Academy will adopt the C corporation taxation. There as several advantages
associated with this type of taxation. As mention previously, C corporation taxation can provide
its employees with tax-free fringe benefits and deduct the total cost of the benefits from the
corporation's income as a business expense since it is a separate tax-paying entity, which is not
possible in other types of federal tax regimes (Donohoe, Lisowsky, &Mayberry, 2019). Although
it results in double taxation, it is generally lower due to the recent introduction of a 21%
corporate tax rate. Its ability to allow the business owners to create a more favorable tax situation
as well provision of them with adequate time to time shareholder's distributions makes it more
flexible than other federal tax regimes. This form of taxation allows the owners to write off all
the bonuses and salaries of the shareholders who work as employees of the entity. In contrast to
S corporation, business with this type of federal tax regime can easily be forgiven by the IRS,
especially during their difficult situations such as continuous loss-making.
A Subchapter S Corporation is slightly similar to a C Corporation. However, it has its
unique advantages and disadvantages compared to other state regimes. Business adopting this
type of form of corporate taxation can spare the profits paid as distributions to LLC members
from being subjected to social security and Medicare taxes, thereby decreasing the self-
employment tax burden on members of an LLC. Firms with this type of federal tax regime spare
its employees from the impacts of double taxation as the profits paid as distributions to LLC
members are not subjected to social security and Medicare taxes, thereby sparing its employees
from the impacts of double taxation. Although this form of taxation has several benefits, it has
some of its shortfalls. Firms adopting this type of taxation may be subjected to scrutiny by the
IRS if it is evident that it pays fewer wages to the employees and top up their earnings with profit
distribution as a strategy to evade self-employment taxes. Besides, since the business income is
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taxed at the individual tax rates, shareholders end up paying higher shareholder taxes. In C
corporation taxation, by contrast, the business is not subjected to flow-through taxation; hence
there is a reduced shareholder tax burden. S corporation taxation forces the business to use the
calendar year as the tax year, which may interfere with the firm’s taxation arrangement.
Disregarded entity taxation (Schedule C of the Form 1040) is a single-member LLC.
They are taxed similar to a sole proprietorship. Disregarded entity taxation compares differently
with other types of federal tax entities in terms of its advantages and disadvantages. Compared to
other federal tax entities such as S corporation taxation, disregarded entity taxation allows the
business to easily file its taxes. Only one tax return is filed since the business is taxed together.
Just as the S corporation, disregarded taxation provides the business with the benefit of flow-
through taxation that prevents their profits from being subjected to taxation. It is simple and easy
for a business to use disregarded entity taxation to change their tax status. Disregarded are not
subjected to double taxation, unlike other forms of taxation. Disregarded entity taxation subjects
a business to the self-employment tax that, in turn, increases their tax liability. C Corporation, in
contrast, the employees can be spared from the self-employment taxes by converting their wages
into profits distribution.
Partnership taxation is adopted by a business structure formed by two or more people to
create profit. It compares differently with other types of federal tax entities in terms of its
advantages and disadvantages. Firms employ this type of taxation do not pay income tax since
they are considered as a pass-through tax entity. Besides, partnership taxation spare business
from being subjected to double taxation since all the profits made are taxed only at a personal
level. C Corporation, in contrast, is subjected to double taxation since both the income and profit
distributions are taxed. Members of the business organization enjoy a taxation relief in terms of
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reduced taxes paid if a new partner is admitted into the business. A business employing this type
of taxation enjoys greater taxation flexibility. However, firms adopting this type of taxation may
be subjected to scrutiny by the IRS if it is evident that it pays fewer wages to the employees and
top up their earnings with profit distribution as a strategy to evade self-employment taxes
(Everhart, 2018). Besides, since the business income is taxed at the individual tax rates, partners
end up paying higher shareholder taxes. In C corporation taxation, by contrast, the business is not
subjected to flow-through taxation; hence there is a reduced shareholder tax burden. Partnership
taxation forces the business to use the calendar year as the tax year, which may interfere with the
firm's taxation arrangement.
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References
Donohoe, M. P., Lisowsky, P., & Mayberry, M. A. (2019). The effects of competition from S
corporations on the organizational form choice of rival C corporations. Contemporary
Accounting Research, 36(3), 1784-1823.
Everhart, J. R. (2018). Unlimited tax liability: a common misnomer of limited liability company
taxation in the United States. Small Business Institute Journal, 14(1), 44-51.
Rozario, R. X. Limited Liability Partnership: An Effective Alternative to Complexity of
Incorporation and the Personal Risks Associated with Partnership Law.
Yin, G. K., & Burke, K. C. (2020). Partnership Taxation. Wolters Kluwer.
