Research Memo

Partnership Tax Memorandum

Client

Date

TO: CLIENTS

FROM: TAX ADVISOR

SUBJECT: TAX FEASIBILITY FOR THE NEW COMPANY

 

Types of entities allowed under state law

The American Corporate Law provides for five kinds of entities that may be established and which are legally recognized (Hurst, 27). The first one is sole proprietorship which is an entity founded, owned and run by one person. This structure of this business simple with few legal cost and is not subjected to corporate tax.  All the liabilities and debts of the entity are borne by the propriety. Another entity is a partnership, which can either be general or limited, and this case, two or more persons come together and form an agreement which can either be implied or expressed, to found a venture for purpose of making a profit.  In accordance with U.P.A§ 7(15) a limited partnership, the personal liabilities for every partner in terms of the debt are limited to their contribution in the investment.  The other entity is a Limited Liability Company, and in accordance with LLC§ 18 (7) is a structure where the founders are not held liable for liabilities or debts of the company and follow the flow-through taxation to owners (Bagley & Dauchy, 67).  There are advantages related to this entity in that it allows owners to be flexible in the company's operations.  In addition, members are protected from the company's liabilities while there are few formalities related to operations of the company. Individuals in Limited Company are subject to various personal tax rates.

The other entity is a Corporation, which according to DGCL § 102(a), has a charter that restricts its name and range of activity. The law protects corporate stakeholders from any liability and some like employees may take advantage of various tax- free benefits like health insurance coverage. A C corporation is subjected to double taxation, which involves profits taxes and then shareholder dividends' taxes. The fifth entity is a Small Business Corporation whose provision aims at providing tax advantage to small corporations as long as requirements of IRS Code are satisfied. There is a limit on the number of owners of this corporation. For this corporation, a waiver of corporate applies and this is indicated in returns for personal federal income tax returns. This aims at preventing the case of double taxation.   The Small Business Corporation is the smallest entity provided for in the state law (Bagley & Dauchy, 67).

Recommendation

The best entity option, for now, is a Small Business Corporation which the proprietors can easily manage given that they do not have enough capital to start a large entity. This will allow them to operate their business with limited funds before the firm start earning any profits. In the future, the business should be converted to a Corporation when the increase in operations start being experienced due to growth and expansion. In addition, it is important the entrepreneurs be flexible while choosing the right entity so as to allow for a wider option in case circumstance changes that would lead to change in their strategies in investments.  The changes that may need flexibility includes the amount of resources available and prevailing number and state of the proprietors. Such changes may demand a bit of flexibility on the recommended choice of the entity owners.

 There are various documents that members may need which can guide them on issues relating to ownership and business operation. These include: a document for Company Bylaws  which defines issues such as business structure , roles of  all members  and management of the business : Operating Agreement for the Small Business Corporation and future Corporation  that describes obligations of owners , decision making , profit and loss allocation methods: A non-disclosure agreement that outlines private matters of the entity to ensure confidentiality , maintaining secrets, customer details , crucial investment and financial information in the business : a memorandum to act as a formal document in which various terms of operation and relations are properly laid down and other important agreements (Moye, 130).

 The formation of SBCs is the best recommendation since all members are US residents and even Deng Ziqi, an alien resident but Chinese citizens have not plan to leave. There are advantages that make Small Business Corporation the best entity for carrying out the business currently. The entity has benefits to the owners mostly due to legal protection and tax benefits that shareholders enjoy. For the entity, it can take into consideration of deductions, profits, and taxes and have the shareholders view them before apply federal taxation law (Bagley & Dauchy, 68). The arrangement also allows the business to avert double taxation since taxation is done only after tax returns have been filed by the shareholders. Even though federal directions relating to taxation are not followed by all states in the US, in most states, a Small Business Corporation is exempted from double taxation in many of the states.  There is a greater risk associated with using an S Corporation in relation to tax status since only some corporations are deemed eligible for the tax benefits provisions. For the Corporation, there is no practical future risk which may lead to re-characterization of the business for the purpose of tax (Bagley & Dauchy, 68).

It is not advisable for the company to have other entities of shareholder starting owning interest in it. In such a case, the other entities will still be outsiders which mean that there is no basis for relation with the form. The may be unnecessary pressure for the entity with an aim to take control. Unless such an entity aims at providing capital where limited interest may be allowed, the connection should not be maintained.  For the purpose of managing debt for the start-up, it would be important for the shareholders to bear the debt on behalf the company to enable it to break-even first ((Bagley & Dauchy, 69).  This means that entity should only start repaying the debt after break-even point, to allow for growth and stabilization.

A Small Business Corporation is a legal entity that is separately created through state law. It files for a special treatment through IRS election so that for taxation purpose it is treated as a partnership. In this case, the shareholders are the owners who will bear the tax burden which will be passed through the entity. For the entity, the arrangement serves its interest right given that there is no double taxation as would happen for the income of a C corporation (IRS, 1).  This means that a Small Business Corporation will not be expected to bear the burden of corporate income tax that allows for the business to have stable growth at the early stages of the formation.  The huge savings on tax provides large sums of funds that can be used for the expansion of the business operation of the business.  Weighing the considerations for tax related to the formation of the various types of entities supports the idea of registering the SBC.  A financial report document may be required to be attached to the returns.

 

Works cited

Bagley, Constance E, and Craig E. Dauchy. The Entrepreneur's Guide to Business Law. Mason, Ohio: South-Western, 2012. Print.  67-69

IRS.Business Structures. (n.d). Retrieved from: https://www.irs.gov/businesses/small-businesses-self-employed/business-structures

Hurst, James W. The Legitimacy of the Business Corporation in the Law of the United States, 1780-1970. Clark, N.J: Lawbook Exchange, 2004. Print. 27-31

Moye, John E. The Law of Business Organizations. Clifton Park, NY: Thomson/Delmar Learning, 2004. Print. 130-140

U.P.A § 7(15)

DGCL § 102(a)

             LLC§ 18 (7)