Step 4: Prepare Your Presentation
Using the information you gathered from your reading and research, you now are ready to prepare a narrated PowerPoint. Because you want to record yourself and critique your own work, it should follow the form of asynchronous presentations. After doing some research, you find that the best presentations are organized by using the following guidelines:
· Tailor your presentation to suit the audience.
· Include a title slide, with your name on it, introducing the presentation.
· Include only the major bullet points for each issue on the presentation slides.
· Include no more than 15 slides (not counting title page or references list).
· Cover all the elements of your plan as outlined in Step 1.
· Use your narration to provide the supporting rationale for each major bullet point.
· Include a script of your narration in the Notes section of PowerPoint.
· Include a clear summary of your major conclusions and any recommendations on the conclusion slide.
· Include a reference page in APA format citing any sources you used to develop your presentation.
· Title your files using this protocol: lastname_New Venture_date.ppt.
Presentation should probably be a general partnership according to the conference call script.
Project 4: Structuring a New Business Venture Step 1: Research the Steps to Create and Manage a Small Business
You decided to take a week of vacation time from Colossal to devote yourself entirely to developing your new business venture. You begin by going into your home office to work on the task at hand—the preparation of a narrated PowerPoint to practice your presentation to potential investors. The presentation will address all of the key issues related to the legal form and organizational structure of your business. Specifically, you will include the following in your narrated PowerPoint:
· A name for your business, a brief mission statement reflecting the primary goals of the business, and an explanation for why you chose this name and mission statement. You will explain how this mission statement is drafted so that it is clear, concise, and meaningful to your business’s stakeholders.
· An examination of the three most appropriate legal forms of business for your venture. Include a detailed examination of the advantages and disadvantages of these three forms and an evaluation of these six factors:
· creation and maintenance
· ownership and control
· personal liability
· compensation and division of profits
· A choice of the best legal form of business for your new company from the three you considered and a full explanation of your choice.
· A detailed diagram of your organization chart and a rationale explaining structural decisions reflected in your organization chart, including:
· the titles of the different individuals and why you chose those titles
· the tasks the different individuals and groups will have for contributing to the aims of the company
· the reporting structure (who will report to whom and why)
· a choice regarding outsourcing the human resources function, including a detailed analysis of the pros and cons of outsourcing the human resources function
· all other relevant factors (for example, will your business structure be functional, centralized, decentralized, etc.), including how your chosen structure will contribute to your long-term aims of going national and international, or how it will need to be modified to achieve these aims
After reviewing the above outline of your presentation, you recall the recent conference call with your potential business partners, Roza and Gary. You realize that you will need this information to make the best legal and organizational decisions for your business. You’re asked by one of your collaborators to examine some resources on creating and managing a new business and on drafting a mission statement.
In order to complete this task, you realize that you must do some additional research to address the legal and strategic implications of your decisions if your business is to get off the ground.
Four icons: gears, light bulb, smartphone, two people
Conference Call Script
· You: Gary and Roza, it’s great to be working with you. I think we make a great team based on our skill sets. Let me tell you more about the new product and how it will be invaluable to the solar energy industry. It’s a solar energy–fueled charger that charges a variety of products on the go, including cell phones and other electronic devices. We need to come up with a name for it.
· I showed you the prototype last month. It’s just about ready to roll, but now I just need some time to work the kinks out. I project that it will take approximately two years to develop this prototype for large-scale distribution, but once the product is on the market, there is excellent growth potential. Think of how much money people could save on electricity by using this product to recharge their cell phones and other electronics.
· However, you know that my skills are in engineering, and you probably know that finance, marketing, and politics are not my strong suits. Also, I have to admit that I’m not very interested in the day-to-day business operations of the company. I’d rather spend most of my time inventing new products and would like to focus on research and development.
· Roza: I think this is a great product and loved seeing the prototype in action last month, but we’re going to need additional investors and expertise to get this business off the ground. We should develop a business plan that will be attractive to potential investors and partners. They’re going to have concerns about joining a new startup. We should work to address these from the start. My background in marketing could help with this, and I also have some experience in new business formation. First, we need to choose the right legal form of business. We also need to develop our mission statement and structure our organization to serve that mission. What do you think are the main priorities of our new enterprise?
· You: Last time we discussed this we identified innovation, sustainability, and timely customer service as our top priorities. I think these are spot on.
· Gary: We need to think about how we will bring in the additional skills we need to be successful. I have decades of experience managing sales in cutting-edge technology companies. Roza has a background in marketing, and you are our research and development idea person. We definitely will need someone with finance skills, and we’ll need to hire staff to handle product development, production, finance, accounting, marketing, sales, and human resources. We should organize our business with this in mind. My colleague, Katie Bourne, has expressed interest in working with us, but she would need an upper five-figure salary and benefits to entice her to leave her current position. She does not want to be an owner given her desire for work-life balance, but she would consider joining us as an employee.
· We also need a visionary CEO. Ideally, a person with connections and experience in the solar industry. Since our last conversation, I spoke to Elijah Hecal, a forward-thinking figure in the solar energy field, who is known for being a rainmaker. Hecal has expressed some interest, but it will take significant incentives to get him on board. He will want to see the potential to make a lot of money. I know some companies use stock options to retain executives; perhaps we should look into that possibility.
· We also need to think about raising some start-up capital. I have about $100,000 I can invest in this company. How about you guys?
· Roza: Unfortunately, at this time, I don’t have much money to invest. But I do have some connections with a wealthy potential investor, Carmen Palombo. I’ve already talked with her, and she thinks our product has a lot of promise. Carmen would like to play an active role in running the business and could invest approximately $500,000 up front. However, she would want to join the three of us as founders of the company. She was very firm about requiring an ownership stake as well as some protection for her own very considerable personal assets. I’ve told Carmen about our plan to start locally, go national within a few years, and then international. She seems very interested. I suggest we plan a dinner with the four of us in the near future. I’ll check for available dates with Carmen and circle back to you.
· Gary: Great idea, Roza. Let’s definitely plan that dinner. We’ve talked about this before, and none of us mind sharing ownership if Carmen is willing to put that kind of money into this business. Even if Carmen does join us, I’m still concerned that we may not have the right level of capital and expertise to ensure our success, especially with the growth we anticipate. We should look into getting some additional advisors or put together a group of people to help us with large-scale management. We should find a way of getting some advisors regularly involved in the company.
· You: This is great! I’m really excited to be working with you both and I’m looking forward to meeting Carmen. I agree with everything that’s been said today and will take a stab at developing a presentation for Carmen and other investors. Let’s talk again soon.
· Gary: Bye.
· Rosa: Have a great one!
Creating and Managing a New Business
There are many things to consider when creating and managing a new business. Planning a business involves many considerations, including:
•choosing a business entity type
•registering with required government agencies
•acquiring licenses and permits
•opening bank and credit accounts
•adopting management agreements
•adopting a business plan and organizational structure
•adopting a marketing plan
•developing a mission statement
•developing a code of conduct or ethics code
•joining relevant professional organizations
•choosing a stakeholder set of employees, customers, suppliers, advisors, and investors
All of these actions should be researched and achieved in the 12 months or so before starting a new business.
One common reason small businesses fail is because of inadequate preparation and planning before beginning a new business. The reality of business practice is that no one can predict every potential issue or dilemma. Nevertheless, the resolution of unknown issues will be expedited and a process will be in place to address them through instruments such as management agreements, mission statements, business plans, and codes of conduct.
Moving a business from local to national or even international involves many additional considerations of management, structure, tax, law, culture, and strategy. Preparing in advance for such an expansion is a key element of successfully expanding to other markets. Those who treat international expansion as an afterthought frequently face a more difficult time when trying to transition to other markets. Moreover, many companies have blundered by not considering the cultural norms of targeted markets when attempting to expand beyond local distribution.
1. Mission Statement
In the contemporary economic environment, businesses must often take on roles beyond those of mere profit centers. A well-crafted mission statement assists in defining the role of a company by succinctly outlining its core purpose and values. All other organizational documents, such as codes of conduct, should be created to support the mission statement of the organization. Once crafted, a mission statement should play a role in employee training, advertising, and management. It is the core principle that states who a business is and what it does.
2. Project 4: Structuring a New Business Venture Step 2: Determine the Legal Structure of Your Business: Gather and Analyze Information
Now that you have read a broad overview of new business creation and management, you recognize that the next step in creating your new business is to decide on one of the many legal forms of business you will use to form your new company. You want to show the investors that you really know your stuff, so you decide to select three forms of business to analyze and you’ll explain in your presentation why the option you chose is the best for your new venture.
Legal Forms of Business
Business entities are an integral part of business practice and economic productivity. An effective business practitioner must understand the characteristics of the major types of business entities, as these attributes can dramatically affect the nature of the business’s relationships. Before beginning to conduct business, one should always weigh the benefits and burdens of the different types of business entities and make a conscious decision about which type of entity to form to conduct one’s business.
Depending on the type of business, the people involved, and the goals of the business, some entities may be more appropriate than others for a particular business. To make the decision about the appropriate type of entity to form, one should consider factors including the following:
•creation and maintenance—the effort associated with forming and maintaining the entity
•continuity—the continuity or stability of the organization upon given occurrences
•ownership and control—the ownership rights and control of those involved with the business
•personal liability—the potential for personal liability of those involved with the business
•compensation—the compensation and division of profits among business owners
•taxation—the taxation of the organization’s earnings and its distributions of profits to the owners
Weighing these and related factors, which vary in consequence depending on the entity, informs the choice of the type of business entity best suited to one’s business. Examination of these characteristics will make obvious the effect of these attributes on stakeholders of the business entity. The decision of which entity is right for a particular business impacts many facets of a business’s operation, including accounting, management, and finance.
3. Business Entities
Business entities are legal organizations that exist by virtue of state law. One way to view a business entity is as a separate person. The business entity carries on business activity on its own behalf. The owners of the business entity are representatives of the entity. Business entities benefit society by allowing individuals to aggregate their resources and efforts in furtherance of a business activity. The legal entity is essentially a bundle of contracts that provides for the rights and duties of the owners and employees of the business entity. Each individual state passes its own substantive and procedural laws regarding business entities. A business must choose its state of formation or organization. The home state may be the location where the business is headquartered or it may be any other state where the business organizes and establishes a registered agent. If the business wishes to carry on business outside of its home state, it must qualify to do business and register as a foreign entity doing business in the other state. Carrying on business is generally defined pretty broadly to include marketing or sales activity. A business may carry on the majority or all of its business in a state or states where it is registered as a foreign entity. The business entity must comply with the laws of any state in which it does business.
For example, I want to form a business entity in my home state of New York. The rules prescribed by New York will govern the formation process. I want to also carry on business in Pennsylvania. To do so, I will register my business in New York and then register as a foreign entity doing business in Pennsylvania.
Main Types of Business Entities
The main types of business entity discussed here are as follows:
•sole proprietorships—The sole proprietorship is not considered a separate business entity, but it is the basis from which business entities are defined.
•general partnerships—The general partnership is the most basic type of business entity. While the general partnership is commonly understood to be a legal business entity, some legal theorists do not regard the partnership as a formal legal entity.
•limited partnerships—This is a hybrid form of partnership that allows for a class of partner known as a “limited partner.”
•limited liability limited partnership—This is a hybrid form of partnership that allows professional practitioners to organize as partners with limited personal liability.
•limited liability companies—This is the most common form of business entity in the United States. The reason for this fact is based upon the blend of informal and protective characteristics of the LLC.
•corporations—The corporations is the oldest form of business entity. The corporation is generally divided based upon its tax status as C-Corporation, S-Corporation, and non-profit Corporation.
Some of the less-common types of business entity are the limited liability limited partnership (LLLP) and the professional corporation (PC). The LLLP is a special purpose entity generally used as part of special project, such as a real estate project. A professional corporation is a corporate form for small practitioner firms that is rarely used because of the unfavorable 25 percent flat corporate tax rate.
Characteristics of Business Entities
There are numerous characteristics that make a business entity unique. The major characteristics of a business entity are as follows:
•creation and maintenance—The effort associated with forming and maintaining the entity;
•continuity—The continuity or stability of the organization upon given occurrences;
•ownership and control—The ownership rights and control of those involved with the business;
•personal liability—The potential for personal liability of those involved with the business;
•compensation—The compensation and division of profits among business owners; and
•taxation—The taxation of the organization’s earnings and its distributions of profits to the owners.
This list is certainly not exhaustive; however, these primary characteristics provide a great deal of necessary insight for understanding and choosing a business entity.
4. Creation of a Business Entity
Creation of a business entity is the legal or procedural steps that one must undertake to bring the business entity into existence. There is a general dichotomy in the process or steps required to form a business entity.
5. Default Entity Status
Some business entities may arise by default without any formal procedural undertaking by the founder. That is, the business entity may arise simply by the parties undertaking some business activity with the intention of generating revenue or making a profit.
To form a general partnership, the only requirement beyond the physical activity of the founders is the subjective intent of the partners with regard to the responsibilities of each party and the allocation of proceeds (or losses) as they arise. Generally, in the event of dispute, a court will be charged with determining whether individuals carrying on commercial activity are a default general partnership. Notably, the sharing of losses is the greatest indicator of co- ownership of a business, as opposed to an employer-employee or contractor relationship.
In some cases, a court may determine that a business entity exists pursuant to the conduct or actions of the parties. Further, a court may recognize a partnership to avoid an inequitable result if an entity does not exist. This is known as “estoppel.”
6. Filing for Entity Status
Some business entities require a formal filing process through the state secretary of state’s office. This requires the filing of documents of organization in accordance with the procedural rules adopted by the state of organization. The amount of information and type of documents required will vary between states and depend on the type of entity. The general requirements for each business entity type are discussed along with that business entity.
For example, Eric wants to form an LLC. He goes to the website for the Nebraska Secretary of State’s Office and downloads the necessary forms. He files the information sheet and articles of organization and pays the applicable fee. Seven days later he receives a Nebraska state certificate of organization for his LLC.
7. Maintenance Requirements for a Business Entity
Maintenance of a business entity is summarized as the administrative steps associated with starting and carrying on business as a given entity form. It entails the process of filing documents, holding meetings, maintaining records, observing formalities, and reporting necessary information to regulators. The requirements for starting a business vary considerably between entity types. Businesses entities that require formal procedures to organize also require formalized maintenance procedures. At the most basic level, these entities require the owners to file statements each year (along with annual fees) with the Secretary of State’s office, to hold business meetings, to maintain records, and to report information to regulatory authorities. The state may require that an entity maintain certain records, such as meeting minutes and resolutions, ownership logs, capital accounts, financial statements, etc. The federal government may require that business entities file specific information related to taxation or securities issuances. State and federal reporting requirements can also be industry specific or based upon the company’s size or status as privately or publicly held.
For example, A group of friends and I form a corporation. We all vote and elect each of us as directors. We then appoint me as CEO. Our creation and maintenance requirements mean following the state-required duties for filing annual information and paying fees to the state. This could include voting as directors to approve our corporate documents. As CEO, I will be charged will filing those documents with the state.
Generally, default business entities require little or no maintenance to continue on as a business entity. These businesses arise simply through the conduct of those involved and do not involve the formalized procedure for maintaining their operating status. While there are few formal maintenance requirements for default entities, there are still numerous tax formalities to follow. The lack of formal maintenance requirements associated with default entities often causes the owners to fail to follow other business formalities.
8. Continuity of a Business Entity
The continuity of the business entity concerns the effect on the business of a major change in the ownership and organization structure. More specifically, this question addresses what types of conduct by business owners can cause the business to dissolve. Owners of a business entity must understand the stability and durability of the organization if or when an owner leaves the business. Managers are concerned with the stability of customers and suppliers and should make certain that changes in ownership or structure do not have unintended consequences on the business operations. The primary change affecting the status of a business entity is the death or dissociation of an owner. In some instances this occurrence may be grounds for the dissolution of the business. Another dissolution event may arise through a limitation on the transfer of ownership by any individual in the business. Such a scenario may effectively dissolve the business if one individual wishes to liquidate her interest.
For example, Mary, Bob, and I start carrying on business as a general partnership. We do not have a partnership agreement. When Mary decides to leave the partnership, the default rule is that the partnership dissolves.
9. Control over a Business Entity
This questions concerns who has control over operations or authority to act on behalf of the business. Each business entity type has a default control structure and level of authority vested in individuals in those roles. In many cases the owners and managers of the business are the same people. This relationship becomes convoluted when there are owners who act as managers of the business and others who do not. The issue of overlapping ownership and control becomes increasingly important in closely held business entities. Third parties dealing with a business entity want to be certain about the level of authority of the individual with whom they are dealing. Further, the business entity is concerned about its agents undertaking transactions that obligate the entity, such as taking out loans or entering into purchaser or sales contracts.
The level of authority of individuals acting on behalf of a business entity affects the potential liability of the business for the acts of those agents. Business owners may undertake procedures to outline the role and authority of each member of the business. This is normally done within the business’s organizational documents. The title attributable to any owner affects the level of control and authority that she has. Failure to follow procedures to document the authority and control within the business can result in a default level of control or authority in a member of the business that is undesirable to the other owners. Further, a lack of formalized organizational structure can cause internal disputes that affect the operational efficiency of the business.
Owners of an LLC are known as members. I am a member of an LLC. If I am a member- manager of the LLC, I have the authority to carry on all operations and act on behalf of the LLC. If I am a not a manager of a member-managed LLC, I do not have the authority to act on behalf of the business.
10. Potential Personal Liability
Generally, individuals are responsible for their own conduct. The rules of agency may make an individual vicariously responsible for the acts of an agent, if that agent is acting with authority or within the scope of her employment. Some business entities limit the liability of business owners for the actions of agents of the business. This means that the owner is protected from being held personally liable for the debts (contracts) or tortious conduct of the business’s employees or other owners. That is, the business owner does not risk losing her personal assets for debts created or tortious activity committed by the business or its owners. This business entity characteristic is a strong motivation for individuals to form a business entity to carry on their business activities.
It is important to remember that a business entity offering personal liability protection to its owners may forfeit that protection if the Secretary of State’s office or the court disregards the business entity. The Secretary of State may dissolve a business entity for failing to follow entity maintenance requirements. More commonly, a plaintiff who is suing the business may attack the business entity status in an attempt to “pierce the veil.”
For example, the owner of an LLC has two employees who deliver goods to customers. One of the employees accidentally crashes the company vehicle into a pedestrian. The pedestrian can sue the negligent driver and the LLC for damages. The driver may be personally liable for his negligent driving. The LLC may be vicariously liable for the employee’s tortious act, since it was committed when the employee was acting in furtherance of the business’s operations. The owner’s personal assets, however, may be protected from the reach of the plaintiff.
11. How Is an Owner of a Business Compensated?
The owners of a corporation may be compensated in two primary manners. The acceptable method of compensation depends upon the type of business entity and the role that the owner plays in the business. Some business entities allow business profits to pass through the business directly to its owners. These owners receive either a percentage of the profits based upon their ownership percentage or a percentage based upon a special allocation of business profits that differs from their ownership percentage. Other business entities (specifically corporations) compensate owners by distributing dividends from business profits. Unlike flow-through profits, payment of dividends is generally a decision by the board of directors and does not represent all profits of the corporation. That is, the corporation determines the amount of any dividends paid to shareholders and may retain any percentage of profits within the corporation.
A corporate employee who is also a business owner must receive a reasonable salary for her services to the corporation. Otherwise, a portion of any share of corporate profits distributed as dividends will be treated as salary. This makes a difference in how the funds are taxed to the individual. An owner of any other type of business entity does not receive a salary and is compensated by receiving a distribution of profits.
For example, say I am a shareholder and CEO of ABC Corp. I will receive a salary for my services as as CEO, and I will receive a dividend if any are paid to shareholders. Corporate business entities (or business entities taxed as corporations) require that an owner who also serves as an employee of the business to draw a salary from the business. The salary is separate from any distribution of dividends.
12. How Business Entities are Taxed
Understanding basic taxation concepts as they apply to each entity type will give you sufficient background to understand the important tax considerations in a transaction by a given business entity. To understand taxation of business entities, it is important to understand personal taxation as well as business taxation.
13. Individual Taxation: Income
Individuals pay federal and state taxes on a percentage of their adjusted gross income (AGI) in a given tax year. AGI is calculated as an individual’s gross income, minus all deductions (either the standard deduction or itemized deductions) and the individual’s personal exemption. A person’s gross income is comprised of wages or other income, dividends, and investment interest, gains, dividends, rents, royalties, etc. Deductions are numerous categories of expenses that the state and federal government exempts from taxation. A person can either claim individual deductions, known as “itemizing deductions” or claiming a “standard deduction.”
The standard deduction in 2016 was $6,300 for single individuals. This changes for individuals filing jointly or as head of household. Each taxpayer also has a personal exemption is $4,050. The state and federal governments also allow various credits that subtract directly from the amount of income tax liability.
Each year I am required to tally all of my earnings from a number of sources. I then subtract all deductions allowed by the state and federal governments. If my individual deductions do not add up to an amount greater than the allowed standard deduction, I will subtract the standard deduction. This amount is my AGI. Calculation of my income tax liability for the year will be based upon this amount.
The income tax rates for wages and other income are tiered. All individuals pay a fixed percentage on the first several thousand dollars of their AGI, a fixed percentage on the next several thousand, etc.
The 2016 federal tax brackets for single individuals were 10, 15, 25, 28, 33, 35, and 39.6 percent. The dollar amount of income that fits in each bracket depends upon whether the individual files as a single taxpayer, married filing separately, head of household, or married filing jointly.
Assume the rates stated above apply. I am not married and file as a single taxpayer. I make $30,000 in a year in wages. I take the standard deduction and personal exemption. My AGI is $19,650. The first $9,275 will be taxed at 10 percent for a liability of $927.50. The remaining $10,400 will be taxed at a 15 percent rate for a liability of $1,560.00. My total federal tax liability for the year is $2,487.50. Note that this overly simplified example assumes that I have no additional deductions for state taxes, Medicare or social security payments that would reduce my taxable income amount.
Individuals also pay taxes on gains. Gains consist of value received and recognized when an asset is sold for a higher value than the owner’s basis in the property. Long-term capital gains (gains on certain assets held longer than 12 months) and dividends are taxed at different rates than other forms of gross income. Short-term capital gains are taxed at ordinary income rates. The tax rate for long-term capital gains and qualified dividends may also be tiered based upon income. While they are included in gross income, qualified dividends and long-term capital gains are subject to different tax rates from other sources of income.
In 2016, long-term capital gains and qualified dividends were taxed at 0, 15, and 20 percent. The 0 percent rate applied to individuals in the 10 percent and 15 percent income tax brackets. The 15 percent rate applied to individuals in the 20, 28, 33 and 35 percent income tax brackets. The 20 percent rate applied to individuals in the 39.6 percent income tax bracket.
For example, say I purchase a single share of stock in ABC Corp for $5. Six months later I sell the stock for $10. I have gains of $5. Because I held the stock for 6 months, the gains are treated like wages and taxed at that rate. If I had held the stock for longer than 12 months, the applicable tax rate would have been the applicable long-term rate.
14. Business Taxation: Income
Business taxation is more complicated than individual taxation. Business entities are either not taxed at all, or they are taxed at a corporate rate. If a business entity is classified as a pass-through tax entity, it does not pay income taxes. Rather, the business owners pay taxes on any business profits. Restated, the profits or losses from the business activity pass through to the individual and are reported on her individual income tax form. Businesses that pay taxes, such as businesses taxed under Subsection C of the Internal Revenue Code, are taxed at the corporate rate. Like the individual tax system, the corporate tax rate is tiered.
In 2016 the applicable corporate tax rates were 10 percent ($0-50,000), 25 percent ($50,000 – 75,000), 34 percent ($75,001-100,000), 39 percent ($100,001 – 335,000), 34 percent ($335,001 – 10,000,000), 35 percent ($10,000,001 – $15,000,000), 38 percent ($15,000,001 – 18,333,333), and 35 percent ($18,333,333 & up).
Pretend I formed an LLC. I can elect with the IRS for the business to either be taxed as a partnership or a corporation. If I elect to be taxed as a partnership, the LLC will be taxed as a flow-through tax entity. The business entity will not pay income taxes; rather, all profits or losses will flow directly through to me and I will report the income on my personal income tax return and pay the applicable taxes.
Business entities taxed under Subsection C of the Internal Revenue Code (IRC) pay income taxes on profits. Corporations taxed in this manner are known as C-corporations. These taxes are treated as an expense to the corporation. They are deducted, along with other expenses, to determine whether the corporation is profitable or has profits at the end of the tax year. Any distribution of corporate profits to shareholders is a dividend and is taxed to the shareholder at the applicable dividend rate. The shareholder reports those dividends on her personal income tax return.
Note that a business taxed as a C-corporation is not required to distribute profits. These are known as retained earnings. A shareholder does not pay taxes on the income until it is distributed. In a pass-through entity, the business entity does not pay taxes. As such, owners of the business must pay taxes on the profits whether the profits are distributed or no.
Say I form a corporation and elect to be taxed under Subsection C of the IRC. The corporation brings in $12,000 and has expenses of $2,000 in the tax year. The corporation has taxable income of $10,000. The applicable tax rate is 10 percent on this amount, equaling $1,000. So, after taxes, the corporation has profits of $9,000. If the corporation decides to pay a dividend to me as the sole shareholder, I will report the dividend payment on my personal income tax return and pay taxes on the dividend amount. If, however, the corporation decides to retain all of the earnings and not pay a dividend, I will not be taxed on the profits. In contrast, in a flow-through tax entity, the business entity itself would not pay taxes. Rather, all $10,000 of profit would automatically flow through to me. I would report the entire amount on my personal income tax return and pay the applicable taxes.
15. Sales Tax
Businesses that sell any sort of good are subject to sales and use tax. Sales tax is the amount that the merchant must charge to customers who purchase goods for use (rather than resale). Sales tax is generally a fixed percentage of the value of the good. Other taxes that accompany sales tax may also apply for specialty occupations, such as merchants selling luxury goods, hotels, and restaurants. The merchant must collect the tax from the customer and not simply pay the taxes from the proceeds of the sale. The taxes withheld must be deposited with the state’s department of revenue on a regular basis. The taxing state is the location where the good was sold. It does not matter the location where the seller is located.
Say I buy widgets from a wholesaler and then resale those goods to the public. Each time a customer purchase a widget for $10, I also charge the customer 6 percent sales tax. This means that the final amount is $10.60. At the end of month, I transmit all sales taxes collected to the state department of revenue in which I collected the taxes. This requires that I keep track of my location when I sold the goods and the location of the customer.
The sales tax rules become tricky when a retailer sells over the internet in state where she does not have a physical business or significant presence. Many states allow that, if the customer is located outside of the state where the retailer is located or has business operations, and the retailer ships the item to the customer, the retailer does not have to collect and deposit sales taxes. This can be a huge detriment to in-state retailers.
16. Use Tax
Use tax is a separate tax that is similar to sales tax and applies to the purchase of goods by individuals or businesses. Use tax is assessed when goods are purchased for use or consumption and sales tax is not paid on the item. This scenario may arise when a merchant purchases goods for resale, which is done free of sales tax, and then converts the item to personal use. Another common use-tax scenario is when an individual or business purchases a good in a state other than the state in which the goods will be primarily used, consumed, or located. If the sales tax assessed in the state of purchase is lower than the sales tax in the state where the goods will be used, consumed, or stored, the purchaser must pay the tax rate difference to the state where the good is used, consumed, or located.
For example, Tommy decides to purchase a new truck. He lives in Wyoming, but travels to Montana to purchase the truck. Montana has no sales tax; while Wyoming assesses a 4 percent sales tax. If he pays $30,000 for the new truck, he will owe use taxes of $1,200 to Wyoming, as that is the state where he will use the truck.
17. Self-Employment and Payroll Taxes
Employers and employees who receive any form of compensation as part of their employment are generally subject to payroll taxes. Payroll taxes were authorized under the Federal Insurance Contribution Act (FICA) and are made up of Social Security and Medicare taxes. Employers must withhold these taxes from the compensation paid to employees. The employer then contributes a similar amount to that withheld from the employee’s compensation. The employer then deposits these funds with the Internal Revenue Service (IRS). These payments go to fund the Medicare program and the Social Security benefits that the employee will receive when she is eligible.
For example, I go to work for ABC, Corp. ABC pays me a salary. Each pay period, ABC will withhold an amount of income, Medicare, and Social Security taxes. The Medicare and Social Security taxes are known as payroll taxes. ABC will contribute an amount approximately equal to the amount of payroll taxes withheld from my compensation and then deposit those funds with the IRS.
Self-employment taxes apply to individuals who are self-employed or are owners of an entity taxed as a partnership. You can think of it as the employer and the employee are one in the same. As such, the self- employed individual is responsible for paying the employer and employee portion of the payroll tax.
Say that Mary and I form a partnership. We both work in the partnership. As owners of a partnership, we do not receive a salary; rather, we receive compensation by splitting the profits of the business. We are considered self- employed, as we are owners of an entity taxed as a partnership. Mary and I will have to pay self-employment taxes equal to the portion of payroll taxes traditionally paid by an employee and the employer combined.
An employee must fill out form W-4 to provide necessary withholding information, which is then used to determine the amount of income to withhold. The withheld wages serve to satisfy the employee’s federal and state income tax obligations. In addition to payroll taxes, the employer will also withhold Federal Unemployment Tax (FUTA) and State Unemployment tax (SUTA) from the employee’s wages. She deposits all of the taxes withheld at regular intervals with the IRS or state taxing authority.
18. Characteristics of a Sole Proprietorship
The sole proprietorship is not a true form of business entity. This is because there is no boundary between the individual entrepreneur and business entity. The entrepreneur and the business activity are one in the same. The sole proprietorship, however, is the basis for comparing other entities. The primary characteristics of the sole proprietorship are described in the sections below.
19. Creation and Maintenance
To create a sole proprietorship the individual entrepreneur simply has to carry on some activity with the intention of seeking a profit. It is really that simple. It arises when a single individual carries on an activity for a profit (or loss). No formal filing or documentation is required. The definition of a sole proprietorship has two primary components: (1) an activity, and (2) intent to earn a profit. This definition is very broad and covers a broad range of activities. This could make a person’s actions or activity into an unintended business entity. The important thing to remember is that the entrepreneur does not have to intend to start a business and the type or manner of activity that she undertakes is irrelevant.
The definition of a sole proprietorship can be somewhat misleading, as not every sole proprietorship makes a profit. This requirement is interpreted to mean any sort of activity that intends to generate revenue. There are no maintenance requirements for the sole proprietorship, as it is not true a business entity.
For example, I am walking down the street and see a house that has lots of leaves in the yard. I need some extra money, so I knock on the door of the home and offer the owner to rake her leaves for $25. The owner agrees. I am a sole proprietor and have created a sole proprietorship through my efforts.
If the entrepreneur stops carrying on the business activity, the sole proprietorship ceases to exist. The business entity will exist as long as the sole proprietor wishes to continue doing business. Ownership in the sole proprietorship cannot be transferred because the business activity is unique to the individual. This includes selling the business or passing it to one’s heirs.
The name, property, activity can be transferred, but the actual organizational identity is unique to the individual carrying on the business. The business activity carried on as a sole proprietorship is often passed from owner to owner. This is done by transferring the actual assets of the business.
Say I start carrying on business as a sole proprietor. When I am ready to retire, I cannot pass my business to my heirs because the business is inseparable from me. There is no form of stock or ownership interest to transfer. I can, however, sell my naming rights, real estate, and business assets.
By definition, a sole proprietorship has one owner. A sole proprietorship cannot contain more than one owner or it becomes, by default, a general partnership.
The sole proprietor exercises complete control over the business entity. A sole proprietorship can have employees who work in the business. The key to this relationship is that the employees cannot hold or earn ownership interest in the business activity. This will preclude any profit sharing arrangements between the owner and employee.
The owner should be careful when compensating an employee based upon the amount of revenue produced. Such compensation should be carefully structured as a bonus system on a base salary.
Pretend I create a consulting business as a sole proprietorship. I employ several people to work for me. I stop working in the business and charge one of my employees with managing the firm. In this scenario, I still have complete control over the business as sole proprietor. The authority I vest in a manager is based upon the complete control I have over the business.
23. Personal Liability
The sole proprietor is liable for any obligations or torts arising pursuant to the business activity. An individual (employee or business owner) is generally liable in tort for her own actions; however, a sole proprietor is also personally liable for the torts of any employees committed in the course of business operations. This is a form of vicarious liability.
The personal risk to the business owner is perhaps the greatest disadvantage of carrying on business as a sole proprietor.
Say I start a coffee shop and I run it as a sole proprietor. I hire several employees. One day an employee is not paying attention and spills hot coffee on a customer. She sues the employee, the business, and me personally. The employee will likely be liable for her negligent act. Further, the business will be vicariously liable for the acts of the employee. Because the sole proprietorship does not protect the owners for liability for business obligations, I will be personally liable for any judgment rendered against the business. This means that the judgment can be satisfied (paid) from my personal assets (bank account, home, car, etc.).
Profits or losses from the sole proprietorship pass through to the business owner. The sole proprietor reports her taxable income on her personal income tax returns (Form 1040 or some variation thereof). The Form 1040 allows the individual to report any income from business operations on her personal income tax return on Schedule C. The sole proprietor does not have to prepare or file a separate tax return for the business entity.
A sole proprietorship does not withhold income taxes or payroll taxes for its owners. Sole proprietors must withhold and make estimated payments to the IRS and state taxing authority to cover the tax liability attributable to business profits. Further, the sole proprietor must make estimated payments to cover self-employment taxes. The sole proprietor also has to withhold any special business taxes imposed by the state or locality. The withheld taxes must be transferred to the appropriate government agency on the appropriate schedule.
Say I carry on business as a sole proprietor. Any business profits flow to me. At the end of the year, I will report the profits on Schedule C of my IRS Form 1040. The sole proprietorship does not file an income tax return. It does not withhold income or payroll taxes for me as owner. I must calculate the profits from the business each month or quarter and pay an estimated amount of taxes to cover my income tax and self- employment tax obligations.
25. Characteristics of a General Partnership
A general partnership is the most basic form of business entity. The primary characteristics of the general partnership are described in the sections below.
26. Creation and Maintenance
A general partnership is an agreement between two or more persons to share a common interest in a commercial endeavor and to share its profits and losses. There is no government-filing requirement to form a general partnership. The partnership can arise by default from the actions or activities of the partners. This general partnership definition contains similar elements to the sole proprietorship, but it requires more than one person. The agreement between the individuals does not have to written or expressed. It can be implied from the actions of the partners. It is important to understand that a general partnership is a default entity. That is, the partners do not have to intend to create a general partnership, nor do they have to realize that a general partnership has been formed. Under the doctrine of “partnership by estoppel,” a court may deem a relationship to be a partnership when the requisite elements are not present. This situation arises when third parties rely upon an individual representing himself as a partner or consents to another representing himself as a partner.
In some situations a court may determine that principles of fairness and equity require that the activities of individuals constitute a partnership. This is known as a “partnership by estoppel.”
For example: I learn about an opportunity to make money by raking leaves for a local business. I approach Elsa and ask her to help me rake leaves to make money. We agree to split all proceeds from raking leaves. We have formed a general partnership.
Individuals may enter into a written agreement, known as a “partnership agreement,” establishing a general partnership. A partnership agreement is the governing document for any type of partnership. Partnership agreements are not mandatory, but it is advisable for any partnership to have an agreement governing the partnership relationship.
Documenting the relationship between individuals in a business activity can serve to characterize the relationship as either a general partnership or employer-employee relationship. In the absence of a formal agreement, states have default rules governing the operations of the partnership and the relationship between the partners. While the default rules are comprehensive, they often do not always align with the specific intent of the parties.
If you wish to hire an individual (not bring her on as a partner) and compensate her with a share of the profits, you will need to document the employment relationship. This may require special structuring of any profit sharing as a bonus paid to the employee, rather than as an ownership percentage in any profits.
A general partnership has no formal maintenance requirements. There are, however, default rules that provide for the rights of partners with regard to the partnership. This may include the right to vote for certain partnership decisions and a right to profits of the partnership. These rules are a form of governance requirement that may be considered maintenance of the business entity.
The duration of a partnership is determined by the intent of the parties. An “at-will” partnership has no stated date. The partnership will continue until the partners dissolve the business. The partners can designate a time period for the general partnership, after which the partnership dissolves. This is known as a “term partnership.” This means that the parties may have some duty to the partnership to remain partners for the pendency of the state time period. If the parties do not designate a specific purpose or time for the partnership’s existence, it is considered an at-will partnership. This means that partners can dissociate from the partnership at any time.
If there is a dispute between parties over assets or income at the time of dissolution, each partner is entitled to an “accounting” of partnership assets. This is an equity action used to determine the partner’s rights to partnership assets. This right is important, as partners are generally not allowed to sue each other in court over dollar damages as a result of dissolution.
Pretend I form a partnership with Maria. We specifically state that the partnership will last until the current work project is complete. We have a term partnership and we have a duty to the partnership to remain partners until the completion of the project. If we do specifically state that the partnership ends at the conclusion of our project, our general partnership is an at-will partnership. We can both leave the partnership at any time without violating any duties to the partnership.
Any partner in a partnership may dissociate at any time. This, and certain other actions by partners, may give rise to dissolution. Absent an agreement otherwise, the following activities generally give rise to dissolution of the partnership: change in partners; winding up process; expulsion of partner that is breach of partnership agreement; it becomes impossible to continue business; or the partnership activity becomes illegal; death or bankruptcy of a partner; or pursuant to a court order for gross misconduct or willful breach of partnership agreement.
Note that if partnership wrongfully dissolved, remaining partner may continue. Must settle up with withdrawing partner.
Continuity of the partnership is determined by the partnership agreement. If the partners do not have a partnership agreement stating otherwise, the partnership does not have continuity. That is, the default rule in many states is that a general partnership dissolves when a member dissociates. As such, a partnership interest cannot be transferred or passed along to one’s heirs. Most states, however, allow the remaining partners to take steps to reform the general partnership and continue in business after cashing out the dissociating party’s interest.
The transfer of a general partner’s interest, death or incapacity, may give rise to a right of dissociation by other partners. An exception to the default dissolution rule is when a partner passes away or dissociates by reason of incapacity. In such a case the general partner does not automatically dissolve.
I form a partnership with Cliff. We state in the partnership agreement that either party may leave at any time. We include provisions for the continuation of the business and the obligation of the partnership to purchase the leaving partner’s business interest. Without this agreement, the partnership would dissolve upon Cliff or me leaving.
As stated above, partners can change the default rules governing the general partnership by entering into a partnership agreement. The agreement may also designate the procedures for winding down the business or allowing the remaining partners to continue the business. It can further allocate responsibility for debts of the general partnership or allocate the proceeds upon continuation or dissolution. These types of agreements are known as “buy-sell agreements.”
General partners are the sole owners of the general partnership. The parties may agree on each partner’s percentage of ownership. In the absence of a partnership agreement, default partnership rules govern the relationship. By default, partners are entitled to equal ownership rights. This means that the partners share equally in profits or losses, unless the parties specifically agree to some other allocation of profits and losses. Further, the default rule is that ownership interests cannot be transferred to third parties without the consent of the existing partners. Attempting an unapproved transfer of an ownership interest is grounds for dissolution of the partnership.
Katie and I form a partnership. We do not have a partnership agreement. As such, by default, Katie and I are equal owners of the partnership. We later enter into a partnership agreement that establishes me as 70 percent owner and Katie as 30 percent owner. This will replace the default rule that we are equal owners.
The general partners have complete control over the partnership. This means that partners have decision-making authority with regard to the governance and strategy of the partnership, as well as authority to act on behalf of the partnership as a general agent. The partners may establish a partnership agreement that changes or limits any partner’s right of control or voice in the management of the partnership. This does not, however, limit the authority of a partner to obligate the partnership by entering into transactions or relationships with third parties, such as loan or sales agreements. The partnership can limit the authority of a partner to act on behalf of the partnership by specifically giving any third party notice that the partner’s authority is limited. Some partnership decisions require consent of both partners.
For example, Terry and I form a partnership. Terry and I have equal ability to make decision for the partnership. If Terry wants to enter into a purchase contract, she has the authority to do so. If we decide to limit Terry’s authority in a partnership agreement, this does not limit her authority with respect to third parties. I will need to provide notice of that agreement to any third parties who may interact with the partnership through Terry.
30. Personal Liability
A general partnership is similar to a sole proprietorship in that it does not offer the business owners any form of personal liability protection. Each partner is personally liable for any debts, obligations, or tortious conduct of the business. This means that, if the business stops operating or goes bankrupt, the owners are liable for the debts and obligations of the business. In fact, each partner can be held totally liable for the entire debt of the business. This is known as “joint and several liability.” Per the law of agency, the partnership is liable for the obligations established by its agents or their tortious conduct committed within the scope of employment. As such, each partner is potentially personally liable for the actions of partners and employees of the partnership. This may be true even if a partner or employee exceeds her authority under a partnership agreement or employment agreement. These facts alone make a general partnership a potentially risky entity form under which to carry on business.
For example, Eric and I from a partnership. We hire an employee, Jane. Jane is careless and injures a third party when driving the company truck. The injured party sues Jane and the business. If Jan receives a judgment against the business, Eric and I will be personally liable for the business debt. If the business does not have funds or assets to satisfy the debt, our personal assets will be at risk.
General partners are compensated by receiving a draw of partnership funds (generally profits). This is known as the partner’s distributive share. By default, this draw is often representative of the percentage of ownership of each partner. The partners may, however, enter into an agreement allocating the distribution of profits or losses differently from the ownership structure. That is, a partner may receive a percentage of partnership profits or losses that is greater than or less than her ownership percentage. This must be justified based upon an economic reality of the partnership, such as one partner spending more time working for the partnership.
Partners are not entitled to receive a salary based upon their ownership percentage or for services rendered to the general partnership. Only employees of the partnership who are not also partners may receive a salary as compensation.
Say that Tanya and I form a partnership with equal ownership. We have one employee, Josh. At the end of the year, the partnership has $10,000 in earnings. The only expense is Josh’s salary of $2,000. Tanya and I will receive a distribution of $4,000 each. Josh, who is not an owner, received a salary. It does not matter whether Tanya and I work in the partnership. As owners we do not receive a salary.
General partnerships are not taxable entities; rather, they are pass-through tax entities. The partnership will subtract expenses and other deductions from revenue to determine the annual profits or losses. Like a sole proprietorship, partners report their share of general partnership profits or losses on their personal income tax returns. The general partnership does, however, have to prepare a tax return. This return is known as an “informational return” and is filed on IRS Form 1065. The return outlines the revenues and expenses attributable to operations. It will also outline the percentage or amount of the profit or losses to which each party is entitled. The partnership is obligated to provide individual partners with a Form K-1 outlining that partner’s share of profits or losses. These amounts are then recorded on the owner’s individual tax return.
A partner is required to pay taxes on her allocated percentage of partnership profits, whether she withdraws the profits from the partnership or leaves those profits in the business entity.
For example, Barry and I form a partnership. At the end of the year, the partnership has profits of $10,000. Barry and I are equal partners, so we are each entitled to 50 percent of the profits. The partnership will prepare and information return and provide K-1s to Barry and me. The K-1 will indicate that we received $5,000 in profits, which we must report when filing our individual income tax returns.
33. Step 3: Determine Your Organization’s Structure: Gather and Analyze Information
After selecting the most appropriate legal form of business, you’re messaged by one of your colleagues in the collaboration, Roza Worrell:
1. . Organization Structure and Design
The structure of an organization plays a pivotal role in how everyday tasks are handled, in how resources are allocated, in employee supervision and reporting, and in coordination amongst employees. It impacts employee behavior, demeanor, and psyche in ways that are still being studied by theorists today. Organizational structure may play a role in employee motivation and even productivity.
A primary factor in creating and managing a new business involves choosing the best organizational structure for it. Some types of business are better suited for a clear hierarchical structure, while others are more apt to work within a flatter organizational structure, with fewer or even no levels of authority. From time to time, a business may reorganize, as online shoe retailer Zappos did when moving from a hierarchy to a flatter “holacracy.” There were reportedly mixed results spurring from this major shift in business structure (Reingold, 2016).
As the Zappos case and others reveal, business structure plays an integral role in organizational success. Thus, one should clearly define the initial organizational structure at the outset of starting a new business and monitor it through the business life cycle, tweaking it and shifting it as necessary.
1. Outsourcing the HR Function
Outsourcing is a technique used by some companies in which they transfer or contract out certain work to external companies, typically in an effort to save costs. Outsourcing the human resources (HR) function involves the transfer of the tasks usually performed internally by human resources employees to external companies. Depending on the structure of the organization, the human resources office often handles such matters as managing employee compensation and benefits, recruiting new employees, ensuring compliance with employee rights and safety laws, overseeing employee relations, and often the provision of certain employee training.
There are advantages and disadvantages associated with outsourcing the HR function. In addition to the potential cost savings, outsourcing the HR function provides companies with a means of garnering expertise in the growingly complex areas of employee rights and employment compliance without hiring additional staff. Outsourcing the HR function may also give companies, whether large or small, a layer of protection from some lawsuits. By outsourcing, a company can more readily focus on its primary purpose and avoid potential distractions.
Outsourcing the HR function, like any outsourcing, creates distance between the employees of a company and the outside contractors. This distance may lead to a culture mismatch between the company and its contractor, delays in processing, and reliance on another company to manage a critical function (i.e., loss of control). The best HR managers align their actions with the organization’s strategic goals. HR managers typically have organizational and financial knowledge that comes from being a part of the company. Can the outside contractor provide the necessary alignment with the company’s strategic interests? This outside contractor may or may not be as dedicated to making process improvements as your own company is, and so, particularly when in a long-term contract, may not expend resources to improve the quality of service.
For multinational organizations, there are special challenges. Best HR practices may not transfer effectively between countries due to cultural and institutional differences. Can the outside contractor adapt to local practices and customs while standardizing the best HR practices across country borders?
These, and other, advantages and disadvantages of outsourcing the HR function should be weighed carefully and discussed prior to action.