Business Entities

Business Entities Dr. John Abraham Professor University of Texas Pan American

Business related tutorial • http://www.sba.gov/services/training/onlinecourses/index.html

Business Plan • You need to prepare a business plan • This site will help you: • http://app1.sba.gov/training/sbabp/index.htm

Who can conduct business? • Sole proprietors • Partners • Corporations

Sole Proprietorship • An Individual – also known as the owner or self-employed person. • Performs all functions required to operate a business starting with acquiring capital. • Accepts all profits and losses and pays all taxes. • Fully responsible for all debts and obligations • Unlimited liability: a creditor can claim against all of the owners assets whether business or personal.

Advantages of sole proprietorship • Low start-up costs • Greatest freedom from regulations • Owner in direct control of decision making. • Minimal working capital is required • Tax advantages goes to the owner • All profits goes to the owner

Disadvantages of sole proprietorship • Must raise capital by self. Banks (or friends, family) may not be willing to lend money. • Unlimited liability • If the owner dies, business essentially dies. • In Texas, all property comes under common law; as such, one spouse may place all the family under great risk.

Husband and wife business. • If you and your spouse jointly own and operate an unincorporated business and share in the profits and losses, you are partners in a partnership, whether or not you have a formal partnership agreement.

Tax implications • Schedule C • Example • http://www.irs.gov/pub/irs-pdf/f1040sc.pdf • http://www.irs.gov/pub/irs-pdf/i1040sc.pdf

Partnership • An agreement in which two or more persons combine their resources in a business. • A partnership agreement is executed including percent of business owned. • Owners share the management of the business. • Each is personally liable for ALL debts and obligations of the business. A partner is liable for the actions of other partners.

Limited Partnership • For the purpose of combining capital, not to manage the business. • General partners and limited partners. • Limited partners not involved in managing the business. Limited partners are not liable for the actions of the general partners. They are liable to the extend of their investment. They can lose the capital they invested. • General partners are fully liable; may take more profits.

Advantages of partnership • Ease of formation • Low startup costs • Additional sources of investment capital • Possible tax advantages • Limited regulation • Broader management base

Disadvantages of partnership • Unlimited liability • Divided authority • Difficulty raising additional capital • Hard to find suitable partners • Problems between partners • Partners can bind others (legally) without knowledge.

Tax implications • Partnership file for an IRS identification no. • File Partnership return 1065 • File copies of K-1 • Send K-1 to each partner • Each partner to include K-1 in his/her return • http://www.irs.gov/pub/irs-pdf/f1065.pdf • http://www.irs.gov/pub/irs-pdf/f1065sk1.pdf

Corporations • An artificial legal being. • Created by registering with the government. • C & S corporations

Advantages of forming a corporation • Greater amounts of capital can be raised by the corporation (stocks and bonds). • Corporate owner’s liability is limited to the amount of investment. • Corporation ownership shares are easily transferred. • Corporations usually have longer lives than other forms of business ownership. • Professional management talent usually runs corporations. • Corporations lack “mutual agency.” (Only authorized individuals may bind the corporation to contracts.)

Disadvantages of forming a corporation • Double taxation - Corporate earnings are taxed twice (earnings before taxes and stockholder’s dividends). • Subject to extensive government regulation (SEC etc.) • Corporate ownership is separated from control of operations.

Establishing a Corporation • Articles of incorporation are filed with and, approved by, the state government * State attorney general’s office * State secretary of state’s office • The Corporation Charter * Granted by the state upon approval of the articles of incorporation

Contents of articles of incorporation. • The articles of incorporation shall specify: • (1) The name of the corporation by which it shall be known. • (2) The object of the corporation. • (3) The estimated value of the property at the time of the making of articles of incorporation. • (4) The title of the person making such articles.

Board of Directors Elected by stockholders. Responsible for management of the corporation, establishing policy, specific decision making. Management Team Hired by board of directors. Responsible for day-to-day operations of the corporation. Board of Directors and Management Team

Stocks Issued • Common Stock - Represents the primary ownership of stock in a corporation. - Is the only issue form if only one class of stock is issued. • Preferred Stock - Gives stockholders certain privileges not given to common stockholders (i.e. rights to dividends)

Rights of Common Stockholders • Receive a certificate of ownership. • Transfer shares through sale or gift. • Vote at stockholder meeting (one vote per share owned). • Right to purchase a portion of any new shares issued to maintain their percentage ownership (preemptive rights). • To receive dividends declared by the board of directors • To receive a portion of assets remaining when the corporation liquidates.

Stock Split A stock split, like a stock dividend, involves the issuance of additional shares of stock to stockholders according to their percentage of ownership. However, a stock split results in a reduction of par or stated value per share. The purpose of a stock split is to increase the marketability of the stock by lowering its market value per share. In a stock split, the number of shares is increased in the same proportion that par or stated value per share is decreased. A stock split does not have any effect on total paid-in capital, retained earnings, and total stockholders’ equity. However, the number of shares outstanding increases.

Subchapter S A section of the IRS Code known as Subchapter "S" allows a small business corporation to elect to have the undistributed taxable income of the corporation taxed as personal income for the shareholders, thus avoiding payment of any corporate income tax. See next slide also.

S corporation An S corporation is a standard business corporation that has elected a special tax status with the IRS. This tax treatment allows the corporation not to be a separately taxable entity. Instead, the income of the corporation is treated like the income of a partnership or sole proprietorship; the income is “passed-through” to the shareholders. Thus, shareholder’s individual tax returns report the income or loss generated by an S corporation.

C corporation • C corporation refers to any corporation that, under United States federal income tax law, is taxed separately from its owners. A C corporation is distinguished from an S corporation, which generally is not taxed separately. Most major companies (and many smaller companies) are treated as C corporations for U.S. federal income tax purposes.

References • Some slides are obtained from: • http://www.mycorporation.com/s-corporation/ • http://www.cuyamaca.net/al.taccone/CH12PPT/BUS%20120--Chapter%2012.ppt

Business Entities