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Problem Based Learning FOUR:

Question: Please identify and discuss the advantages and disadvantages of the

following form of business organizations:

1.

Sole-proprietorship

2.

Partnership

3.

Company

Solution:

What Is a Sole Proprietorship?

A sole proprietorship is a simple type of business structure that is owned and operated by the

same person. It does not involve many of the complex filing requirements associated with other

types of business structures such ascorporations.Sole proprietorships allow persons to reportbusiness income and expenses on their individual tax returns.

What Are Some of the Advantages of a Sole Proprietorship?

There are many reasons why a person would choose to start their business up using a sole

proprietorship structure. Some of the main advantages of sole proprietorships include:

Ease of formation:Starting a sole proprietorship is much less complicated than starting

a formal corporation, and also much cheaper. Some states allow sole proprietorships to be

formed without the double taxation standards applicable to most corporations. The

proprietorship can be named after the owner, or a fictitious name can be used to enhancethe business marketing.

Tax benefits: The owner of a sole proprietorship is not required to file a separate

business tax report. Instead, they will list business information and figures within their

individual tax return. This can save additional costs on accounting and tax filing. The

business will be taxed at the rates applied to personal income, not corporate tax rates.

Employment: Sole proprietorships can hire employees. This can lead to many of the

benefits associated with job creation, such as tax breaks. Also, spouses of the business

owner can be employed without having to be formally declared as an employee. Married

couples can also start a sole proprietorship, though liability can only assumed by one

individual.

Decision making:Control over all business decisions remains in the hands of the owner.

The owner can also fully transfer the sole proprietorship at any time as they deem

necessary.

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What Are the Disadvantages of Sole Proprietorships?

Forming a sole proprietorship does involve some risks, mainly to the owner of the business, as

legally speaking they are not treated separately from the business. Some disadvantages of sole

proprietorships are:

Liability:The business owner will be held directly responsible for any losses, debts, or

violations coming from the business. For example if the business must pay any debts,

these will be satisfied from the owners own personal funds.The owner could be sued for

any unlawful acts committed by the employees. This is drastically different from

corporations, wherein the members enjoy limited liability (i.e., they cannot be held liable

for losses or violations)

Taxes:While there are many tax benefits to sole proprietorships, a main drawback is that

the owner must pay self-employment taxes. Also, some tax benefits may not be

deductible, such as health insurance premiums for employees

Lack of continuity:The business does not continue if the owner becomes deceased orincapacitated, since they are treated as one and the same. Upon the owners death, the

business is liquidated and becomes part of the owners personal estate,to be distributed

to beneficiaries. This can result in heavy tax consequences on beneficiaries due to

inheritance taxes and estate taxes

Difficulty in raising capital:Since the initial funds are usually provided by the owner, it

can be difficult to generate capital. Sole proprietorships do not issue stocks or other

money-generating investments like corporations do

What is a Partnership?

Apartnership is a legally-recognized business entity comprised of two or more people. Each

member of a partnership holds ownership in the business. Partnerships are often created by

formal written agreements but may also exist on less formal terms. Laws for creating a

partnership may differ from state to state.

There are two basic types of partnerships: general partnerships and limited partnerships. In a

general partnership, each partner is typically jointly responsible for losses and violations related

to the whole partnership. In a limited partnership, each individual is responsible or liable for their

own losses.

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What are the Advantages and Disadvantages of Partnerships?

Advantages of a Partnership

Partnerships are relatively easy to establish; however time should be invested in

developing the partnership agreement. With more than one owner, the ability to raise funds may be increased.

The profits from the business flow directly through to the partners personal tax return.

Prospective employees may be attracted to the business if given the incentive to become a

partner.

The business usually will benefit from partners who have complementary skills.

Disadvantages of a Partnership

Partners are jointly and individually liable for the actions of the other partners.

Profits must be shared with others.

Since decisions are shared, disagreements can occur.

Some employee benefits are not deductible from business income on tax returns.

The partnership may have a limited life; it may end upon the withdrawal or death of a

partner.

Depending on the business needs involved, partnerships can offer many different advantages.

These include:

Control: Partnerships generally allow for a greater amount of control by the partners

than would be possible in a different business form, such as a corporation

Taxes:The partnership as an entity usually doesnt file taxes; instead, each individualfiles their own taxes. This may be desirable especially for smaller organizations

Survival of the Partnership:A partnership will generally terminate or dissolve if any of

the partners becomes deceased or incapacitated.

Creation:Partnerships are generally easy to create and will require less paperwork than

other types of business structures.

However, some of these characteristics of partnerships can work against certain business goals.

For instance, if the parties wish the organization to extend beyond the life of a partner, then a

partnership might not be the best form for the business (since the partnership willdissolve upon

any partners death). Or, perhaps the members would like more restrictions on the way theirbusiness is controlled; in that case, they might opt for a more traditional corporation structure.

Lastly, one of the main limitations of a partnership is that they have a tendency to limit the

growth of the business. This is because control is localized into only a few individuals rather

than members of a board or similar corporate features. This makes them more suitable for

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smaller start-up ventures and temporary projects. Each partnership may provide specific terms

for partners in apartnership agreement.

Corporation/Company

A Corporation, chartered by the state in which it is headquartered, is considered by law to be aunique entity, separate and apart from those who own it. A Corporation can be taxed; it can be

sued; it can enter into contractual agreements. The owners of a corporation are its shareholders.

The shareholders elect a board of directors to oversee the major policies and decisions. The

corporation has a life of its own and does not dissolve when ownership changes.

Advantages of a Corporation

Shareholders have limited liability for the corporations debts or judgments against the

corporation.

Generally, shareholders can only be held accountable for their investment in stock of the

company. (Note however, that officers can be held personally liable for their actions,

such as the failure to withhold and pay employment taxes.

Corporations can raise additional funds through the sale of stock.

A Corporation may deduct the cost of benefits it provides to officers and employees.

Can elect S Corporation status if certain requirements are met. This election enables

company to be taxed similar to a partnership.

Disadvantages of a Corporation

The process of incorporation requires more time and money than other forms of

organization. Corporations are monitored by federal, state and some local agencies, and as a result may

have more paperwork to comply with regulations.

Incorporating may result in higher overall taxes. Dividends paid to shareholders are not

deductible from business income; thus this income can be taxed twice.

There are several advantages to incorporating your business, regardless of its size. Benefits

offorming a corporation or Limited Liability Company (LLC) include:

Personal asset protection

Forming either acorporation or anLLC is similar to a partnership, minus the need for excessivepaperwork and fees. It allows the business owner to separate and protect their personal assets in

case of a lawsuit or claims against a business entity. In an effectively managed and structured

company, owners should have limited liability for outstanding business debts and obligations.

This remains as one of the leading benefits to incorporating.

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Enhanced credibility

A close second to personal asset protection, a major benefit of incorporating your business is the

stamp of approval adding an "Inc." or "LLC" after your business name gives. This distinction

affords your business with the instant credibility and authority associated with owning an

incorporated company. Potential consumers, vendors and partners may prefer to do business withan incorporated company and will look overlook those who are not.

Brand protection

In most states, other businesses may not file your exact corporate or LLC name in the same state.

From a branding standpoint, this not only helps protect your company's reputation from being

diminished by or confused with another company bearing a similar sounding name, but

strengthens your businesses in terms of brand identity and marketing efforts.

Perpetual existence

Corporations and LLCs continue to exist throughout ownership or management changes within

your business. Sole proprietorships and partnerships simply end if an owner dies or leaves the

business. Forming a corporation ensures that your company's legacy can be preserved, as well as

continue to provide employment and services for clients should any changes in ownership take

place.

Tax flexibility and incorporation tax benefits

There are several tax advantages and benefits of incorporating a small business. While profit and

loss typically "pass-through" an LLC and get reported on the personal income tax returns of

owners, an LLC can also elect to be taxed as a corporation. Likewise, a corporation can avoid

double taxation of corporate profits and dividends by electing Subchapter S tax status.

Deductible expenses

Corporations and LLCs may deduct normal business expenses, including salaries, before they

allocate income to owners. This means that the money you put towards growing your business

can be deducted from your business income in determining your actual taxable income.