Running Head: Business entity b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b b 1
Business Entity: Memorandum with Appendix
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Subject: Recommendation for ideal business entity type
A. Justification for choosing the recommended taxable entity
On the basis of the tax research that has been conducted, the most viable business entity
option for Bob Jones is a partnership form of business. In a partnership, two or more individuals
combine their resources in order to carry out business activities. By choosing this business type
Bob and his daughter Mandy would be able to share the risks as well as profits and losses of the
newly formed business. Based on the business type, the tax would be computed as personal tax,
and they would have to pay the tax only once on the income. Based on the Internal Revenue
Service (IRS), a partnership entity has to have to file an annual information return for reporting
the income along with deductions, losses and gains (Partnerships: Internal Revenue Service).
Form W-2 would be issued and the partnership would have to furnish copies relating to Schedule
K-1 to the partner.
B. Accounting Method
The accounting method that would be applicable to the partnership business can give rise to a
host of advantages for the new entity. The accrual method of accounting would be adopted,
which would ensure that the company can record the income, regardless of when the actual cash
is received by it. It would help to give a true and fair picture of the financial position of the entity
(Surepno, 2015). The cost of preparing the income tax returns would be negligible as Mandy
already pays for her personal tax. The same process would be adopted in the case of the
partnership form of business. A major benefit of the partnership method is that the business
would have to pay the tax amount only once, and thus, there is no issue pertaining to double
taxation. The partners, i.e., Bob and Mandy would not be taxed as entities but as individuals
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(Leonard, 2022). However, a major concern is that the members would be held personally liable
in case of any loss or financial obligations. The employees would be able to enjoy a number of
benefits in the business entity in the form of retirement benefits, insurance benefits, etc.
C. Tax law pertaining to the recommended business entity type
One of the distinguishing features of the partnership form of business is the approach that is
adopted for the computation of its taxation. A partnership entity is a pass-through tax entity. It
implies that the business does not need to pay taxes on the profits that are made by it (Agarwal,
2021). Instead, the individual partners who serve as the owners of the partnership business have
the responsibility to pay the tax for the income that has been made by the business. Based on this
principle of taxation, in the specific context, Bob and Mandy would have to pay the tax just as
one has to pay tax on their personal income. They would have to abide by the guidelines that
have been laid down by the Internal Revenue Service. For instance, Form 1065 would have to be
used by them in order to report their income along with other adjustment figures relating to
deductions, as well as credits. The partnership business entity can give rise to a major advantage
from the taxation perspective.
D. Tax effects – In case of withdrawing cash or paying dividends
The decision to provide $ 180,000 annually for the client’s salary and $ 70,000 annually
for his daughter’s salary can give rise to tax-related implications that must be taken into account.
Any kind of disbursement that will be made by the business must be discussed in the Board
meeting since it can impact the tax that will have to be paid by the business. In case salary is paid
to the client and his daughter, the amount is subjected to income tax. Thereby, if $ 250,000 ($
180,000 + $ 70,000) is withdrawn from the partnership business for the purpose of paying salary,
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the partnership will have to withhold the tax amount and remit it to appropriate authoritative
parties in the taxation department. According to Internal Revenue Service (IRS), each partner of
a partnership business is supposed to report their specific share of partnership income or loss on
their respective personal tax return (Partnerships: Internal Revenue Service).The decision to pay
salary will reduce the taxable amount of the partnership business.
In case the partnership business would pay a dividend to the client and his daughter, the
dividend amount will be taxable at the income tax rate of the individual partners. The dividend
amount is not considered to be a deductible amount in the context of a partnership business, and
hence it has to be paid to the partners out of the after-tax profits. The dividend policy that is
adopted by a business entity has a direct implication on income smoothing, which is a form of
managing and adjusting the business revenue (Firnanti, 2019). By paying the dividend to the
partners, the business will get the opportunity to adjust and manipulate how it represents the
revenue that has been earned by it.
E. Percentage of ownership
The type of business entity that has been recommended in the case of the client business
is a partnership. Based on the ideal business type that has been identified, the percentage of
ownership that must be considered is 60 % for Bob Jones and 40 % for Mandy Jones. According
to the available salary figures that have been presented, the total salary of the client and his
daughter stand at $ 250,000 ($ 180,000 + $ 70,000). Based on the new ownership % between the
father and the daughter, Bob’s salary is $ 150,000 (i.e., 60 %of $ 250,000), and Mandy’s salary is
$ 100,000 (i.e., 40 % of $ 250,000). Such a percentage of ownership has been determined based
on a number of factors. Firstly, the used car business originally belongs to Bob, and he has
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decided to expand it further, so he needs to have a higher percentage of ownership in the business
as compared to his daughter, who will newly join it. As Bob has made a significant contribution
to the business in the form of investment, land and building, etc., his share in ownership is higher.
The ‘special allocation’ rule must be taken into consideration in the case of the partnership
business so that the profits and losses can be distributed in a systematic manner between Bob and
Mandy (Nicolo et al., 2019).
According to the provided case scenario, Bob intends to introduce Mandy into the
business as an owner and manager with a probable 40 % interest. By following the 6:4 (or 3:2)
ownership ratio, the burden of liability on Mandy in relation to the business operations can be
restricted, and she will be able to actively take part in the business activities, including the
decision-making process. The partners of a partnership business are liable to outsiders as they
have to incur debts along with other obligations during the normal course of the business
(Slorach & Ellis, 2021). Although both partners will be jointly liable for the financial obligations
of the company, the lower percentage of ownership will ensure that the burden on Mandy is
lower in comparison to that of her father, and thus, she will also have an advantage in terms of
the tax that will be charged on her income.
F. Tax Planning Proposal
A well-planned tax management approach must be in place that can help the client’s
family to save taxes in case the client dies. A number of strategies have been identified that can
enable the family to legitimately reduce the tax burden. Some of the main strategies are:
Estate planning – A well-defined estate planning must be in place that can help to create a
blueprint on how the client’s assets will be divided after his demise. Such a technique can help to
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reduce the estate tax. The assets can be passed on to the family member each year in small
quantities when the client is still alive so that gift tax will not have to be incurred. A trust can be
established, which will be responsible for holding the assets. It can lower the tax amount for
individual taxpayers.
Making donations to charity – The client can make donations to the charity of his choice (such
as a 501 (c)3 organization so that the value of the estate can be reduced, which can further reduce
the associated tax burden (USA.Gov). As certain charitable donations are tax-deductible, it will
help in reducing the income tax liability of the family members after his death.
Retirement Accounts – In case the client has retirement accounts such as IRA (individual
retirement account) or 401(k), he can name his children as the beneficiary. Such a decision can
help reduce the tax on the specific account.
G. Strategic Plan
In order to effectively handle the estate, the client must create a will. A will refers to a
legal document that highlights how the assets of an individual will be distributed after his demise.
While making a will, some of the key elements that must be taken into consideration are
identification of the assets, ascertainment of how the assets will be distributed among the
successors, appointment of an executor who will be responsible to ensure that the instructions in
the will are followed and regular updating of the will. ‘Wills’ play a cardinal role when it comes
to making wealth or asset transfers (Tilse et al., 2016). The will must contain details on how the
client will gift certain sections of his asset during his lifetime. Similarly, it must also capture his
decision to make charitable donations.
H. Recommended estate planning strategies
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In the case of the client, the ideal estate planning strategies that have been identified include:
Charitable donations – A financially viable decision involves making charitable donations that
will help in decreasing the value of the estate and thereby help in minimizing the tax that will
have to be paid on it. Money must be given to the organizations that are identified as charitable
organizations by the Internal Revenue Service (IRS) so that the associated tax benefit can be
availed (Internal Revenue Service).
Gifting – Giving sections of the estate as a gift to the heirs is also a suitable strategic decision
that can help the client to manage the tax aspects. However, it is essential to make sure that the
value of the gift does not exceed $ 15,000, as if the money exceeds the threshold, it will be
taxable.
I. Best course of action if the client leaves the business in three years
As the business entity type in the specific context is partnership business, an ideal course
of action for the client if he decides to leave the business in three years is gifting the business to
his daughter Mandy Jones. While gifting the business, there are several elements that need to be
considered by Bob, such as the value of the gift that will be sent each year, the gift tax that has to
be paid by Bob, and other tax implications. As they both serve as partners in the business contest,
before leaving the business, Bob has to make sure that his assets are transferred to Mandy so that
she can be considered the rightful owner of the entire business.
J. Best course of action if the client sells the business
In case the client decides to sell the business to a third party, the client must take into
consideration the tax consequences. As the sale will be considered a capital gain which is a lump
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sum amount, Bob will have to pay tax on the amount that he will receive from the buyer. Instead
of selling the entire business, he can decide to sell his portion of the partnership business so that
the value of the capital gains can be reduced and the taxable amount can get lower.
II Conclusion
A. Advantages and Disadvantages of diverse business types
The type of business entity that is chosen by Bob Jones can have a direct implication on
the taxation rules that will be applicable to the income that is generated from the business
operations (Fuest, 2019). A comprehensive comparison has been made between diverse business
types by identifying them as tax vehicles that can meet the needs of the client.
Sole Proprietorship – From the taxation perspective, a sole proprietorship business is
considered the same as the owner. The income and expenses relating to the business are
considered the personal income of the owner. The tax computation is simple as the tax has to be
reported on the personal tax return of the owner. The main advantage is that the owner does not
have to file the tax return of the business separately. The chief disadvantage of the business type
is that it does not offer any security to the owner on personal liability.
Partnership – In a partnership business, the profits and risks are shared between partners. From
the taxation point of view, the tax amount is calculated as the personal tax of the partners. The
main advantage is that the partners need to pay the tax amount just once, as the business does not
have to pay tax on the generated income. Some of the disadvantages associated with the business
type include complex tax preparation as compared to sole proprietorship business and personal
liability for financial obligations.
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S Corporation – S Corporation enables businesses to make sure that their profits pass through to
the personal tax return of the owner. Due to such a rule, it is possible to avoid the need for
taxation, which acts as its main advantage. According to IRS, S Corporations do not have to pay
federal income tax apart from tax on specific capital gains (S corporations – Internal Revenue
Service). However, in order to operate an S Corporation, it is essential to comply with additional
legal requirements as well as scrutiny by the Internal Revenue Service (IRS). These requirements
increase the complexity of operating such a business type.
C Corporation – A ‘C Corporation’ refers to a business structure where the owners and the
entity are charged tax separately. As owners have a separate identity, they get protection
regarding liability and financial obligation, which is a major advantage. However, the main
disadvantage of the business type is that it leads to double taxation, which diminishes the
profitability and revenue of the business (Rabbi & Almutairi, 2021).
The ideal business type that Bob must consider is the partnership form of business as it
will help to share risks with his daughter while handling the tax aspects in a simple manner as
compared to S Corporation and C Corporation business types. S Corporation is not ideal as it can
lead to an increase in legal compliance requirements increasing business complexity. Similarly,
C Corporation is not a feasible option as it can lead to double taxation issues. A partnership is
safer than a sole proprietorship business type since it can help reduce business risk and decision-
making responsibilities, thereby influencing business performance (Marić et al., 2019).
B. Liquidating the business
In case Bob has to liquidate the business, the type of business structure that is chosen will
directly influence the liquidation process. The liquidation process is simplest in the context of a
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sole proprietorship business, as the business assets will be identified as the personal assets of the
owner. The liquidation is more complex in the case of a partnership, as the partners share
ownership and responsibility. While liquidating a partnership, the proceeds from the sale of
business assets will have to be distributed based on the ownership percentage of the partners. The
complexity of business liquidation is high in the case of S Corporation as any losses or gains
from the sale of the business assets will be given to the shareholders, and the tax on the amount
will be reported on their personal tax returns. While liquidating a C Corporation business, the
losses or gains from the sale of business assets will have to be reported on the tax return of the
business, giving rise to tax complications. Thus, based on the liquidation of the business, the
most feasible business type is a sole proprietorship.
C Transferring of business entity
The process that is followed for transferring the business entity varies based on the
structure that has been adopted. In a sole proprietorship business type, the transfer of business
entity is regarded as the sale of business assets, and the new owner has to take instant
responsibility. In a partnership, a partner has to transfer his assets that are under his name so that
the other partner can be considered the rightful owner of the business. In S Corporation, the
transfer is complex as the new owner will have to buy stocks from the existing business
stockholders. The tax implications may vary depending on the period for which the stock is held
and the type of assets of the business. In C Corporation, the transfer of a business entity involves
the purchase of business stocks from the existing stockholders. Based on the nature of
transferring of business entity, the ideal business type that Bob can consider is partnership due to
its simple nature.
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III Appendix
Form 1040 and Tax Schedules
As a sole proprietorship business, Bob must use Section C of Form 1040 to report the
income as well as expenses of the business. In addition to completing Section C, Bob has to
complete other schedules depending on the specific situation of his business (IRS tax forms). The
list presented below gives an insight into the key elements that need to be fulfilled by him for
taxation purposes.
Form 1040
The form will capture details like personal information, income and
adjustments, taxable income, and payments and credits.
Schedule B
The schedule will be used for reporting dividend income and interest in the
context of sole proprietorship business.
Schedule D
It will be used for reporting capital gains and losses due to the sale of capital
assets
Schedule E
It can be used for reporting supplemental income
Schedule SE
It will be used for computing self-employment tax by individuals who are
sole proprietors.
Form 8960
It can be used for calculating and reporting net investment income tax
Forms for converting the business into a partnership form of business
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For converting the sole proprietorship business into a partnership form of business, Bob
must complete a number of forms and tax schedules relating to the taxation activities. The list
captures the main forms and =schedules that must be completed for seamless conversion.
Form 1065
It will be used to report income and expenses relating to partnership form of
business. It must be used when the business is converted into partnership so
that the income, gains, losses, credits and deductions can be reported
pertaining to the business type.
Form 8825
The form will be used for reporting the income and expenses in connection
with real estate rentals
Form 4562
The form will be used for reporting depreciation and amortization of
expenses relating to partnership the
Form 4797
It is necessary for reporting the sale of any business property
Schedule K-1
It will be used to report the partners’ share of credits, deductions and incomes.
Justification for the Tax Schedules and Forms
As partnership business type has been identified as the viable business option for Bob, it
is essential to complete appropriate tax forms and schedules that have been laid down by the
Internal Revenue Service (IRS). Form 1065 which is commonly known as the ‘U.S. Return of
Partnership Income’ is one of the most instrumental pieces of documents that Bob needs to take
into account while converting the business type into partnership. According to IRS, partnerships
utilize Schedule-B1 (Form 1065) for the purpose of providing information that is applicable to
specific entities, individuals as well as estates that either directly or indirectly own an interest of
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50 % or more in the profit, loss or capital of a partnership business (About form 1065, U.S. return
of partnership income - Internal Revenue Service).
In the case of a partnership business, the entity does not have to pay tax on the income
that is generated by it. However, the tax is passed through to its partners so that they can include
the appropriate partnership elements in their tax while filing their individual tax returns. When
Mandy and Bob would work together in the business as partners, the completion of the Form
1065 will be imperative so that the tax can be properly reported and legal complications may
arise for the partners as well as for the business partnership entity. It is instrumental to take into
account the revisions that have been made in the tax forms by IRS so that the tax computations
and calculations can be done accurately by Bob and Mandy.
Thank You
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