1. Chapter 8 Forms of Business Organization and Personal Liability
Dr. David P Echevarria
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Accounting and Finance for Entrepreneurs
EBD-301

2. Business Organizations
Decision Criteria
Desired degree of personal liability
The method of taxation of business profits
Principal Forms of Business Organization
Sole Proprietorship
Partnership
S-corporation
C-Corporations
Limited Liability Company (LLC)
Dr. David P Echevarria
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3. Business Organizations
In the early going for any new venture, the owners of a new business will be personally liable for all the obligations incurred by the business to its trade suppliers and to any lenders from whom they borrowed funds regardless of the form of business.
Sole proprietorships and partnerships will always be liable for all of the obligations incurred by the business
As businesses get larger, the corporate form is the preferred organizational form to limit personal liability
Dr. David P Echevarria
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4. Business Organizations
Corporation Forms
C-Corporation
Major draw back is the double taxation of business income
S-Corporation
Avoids the double-taxation of business income
Critical Issue: Piercing the Veil of Limited Liability
Owner/managers may face personal liability for debts of the business if the business declares bankruptcy
See: justifications-for-piercing-the-corporate-veil/
Dr. David P Echevarria
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5. Sole Proprietor Simplest form of business organization
Unincorporated business owned by a single individual
Owner and business treated as one tax entity
Owner files a form 1040, U.S. Individual Income Tax Return along
Schedule C: Profit or Loss From Business
Schedule SE: Self-Employment Tax
Form 941 or 944: Employer’s QUARTERLY Federal Tax Return
Form 940: Employer's Annual Federal Unemployment (FUTA) Tax Return
IRS Publication 334 should be consulted for specific issues regarding filing and paying business taxes, accounting methods, computing profits (or loss), legal business expenses, self-employment taxes, several important issues, and frequently asked questions (FAQs).
Dr. David P Echevarria
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6. Sole Proprietor Business can be run full or part time
important distinction; “trade or business is generally activity carried on to make a profit.”
Even an individual with a full time employment and operating a business “on the side” is considered to be self-employed.
Hobby or Business? A hobby is an activity not engaged in for profit.
Major disadvantage: owner is personally responsible for all of the business’s liabilities.
Dr. David P Echevarria
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7. Partnership
An unincorporated business venture in which 2 or more individuals share the operation and profits of the business.
IRS Publication 541 Partnerships is the reference document
Partnership must file Form 1065 U.S. Return of Partnership Income
Each Partner must receive and file Schedule K-1 (Form 1065) along with their Form 1040
Each partner must file and pay self-employment tax and pay roll taxes the same as sole proprietors
Dr. David P Echevarria
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8. Partnership Two Categories of Partnerships
General: GPs manage the company
Limited: LPs are mainly investors
Personal Liability of Partners
Partners are personally liable for the partnerships obligations and debt
Each partner can act on behalf of the partnership – they can legally encumber the partnership
Limits to encumber must be spelled out in the partnership agreement
Limited Liability Partnership (LLP): Partners not liable for misdeeds of other partners. They are always liable for their own illegal acts.
Dr. David P Echevarria
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9. Limited Liability Company
Formed under state statutes
IRS Form 8832 is the key reference document
LLCs can elect to be taxed as corporations, partnerships, or as just simply on an individual’s Form1040
Filling form 8832 Entity Classification Election directs the IRS to treat and tax the LLC as a corporation. The LLC then files a form 1120 U.S. Corporation Tax Return
May also elect to be treated as a Disregarded Entity; A disregarded entity is an eligible entity that is treated as an entity not separate from its single owner for income tax purposes.
Dr. David P Echevarria
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10. Limited Liability Company
An LLC may elect to be treated as a partnership for income tax purposes
File Form 1065 U.S. Return of Partnership Income
If Form 8832 is not filed, IRS will treat the LLC as an entity not separate from its owner (effectively the same as a sole proprietor)
Dr. David P Echevarria
All Rights Reserved

11. S Corporations
Principal advantage of an S-corporation is the avoidance of the double taxation of profits. Maximum of 100 shareholders (owners)
S-Corporations file a Form 1120-S
S-corporations are exempt from taxation other than taxes on certain capital gains and on passive income (rents, royalties)
All profits pass directly to the owners – who report income on their respective Form 1040
Owners must file a form 2553, Election by a Small Business Corporation, to be taxed as an S-corporation.
Dr. David P Echevarria
All Rights Reserved

12. C corporations
Corporation is a legal form of organization of persons and material resources, chartered by the state for the purpose of conducting business
Owned by the shareholders
Business is governed by a Board of Directors
Officers are elected to run the business on a day-to-day basis
Business must abide by the laws and statutes of the state in which they are incorporated
C-Corps. May have an unlimited number of shareholders
May be public or privately held
Dr. David P Echevarria
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13. C corporations
Provides protection to its shareholders from the corporation’s liabilities
subject to the double taxation of profits
As income to the corporation
As income to shareholders who receive dividends
State corporate regulations require;
A Business Name
Certificate or Articles of incorporation along with Bylaws
Must hold annual meetings
Dr. David P Echevarria
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14. C corporations C-Corps are the best way to protect personal assets
C-Corps have better access to capital markets
Must have an Employer Identification Number (EIN)
C-Corps file a Form 1120
Dr. David P Echevarria
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15. Caveats
The preceding discussions on organizational form and taxation issues should alert the budding entrepreneur to the importance of considerations affecting the management of the business.
The IRS is the first and best source of information and instructions on the use of various forms.
Business owners should also consult competent tax accountants about specific issues not readily found in IRS publications.
Dr. David P Echevarria
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16. Homework
What are the two most important considerations when determining what type of business form you will adopt?
What are the 5 principal forms of business organization?
Which form of business organization carries the most personal liability? Which form carries the least personal liability?
What does it mean when a court of law “pierces the veil of limited liability”?
Limited liability companies are business forms formed under state law. What elections can LLCs make with respect to how they will be taxed?
Why is the form 8832 important with respect to an LLC?
Dr. David P Echevarria
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17. Homework
7. What is the limit of personal liability of a stockholder in a C-corporation?
8. Describe the purpose of the following forms:
Form 941
Form 944
Form 940
Schedule C
Schedule SE
Dr. David P Echevarria
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