Entrepreneurship is the art of determining the right business entity to venture into; it involves coming up with business risk and threats mitigation strategies. Different factors determine the nature of the entity that an entrepreneur invests in; some of the factors include the availability of time, factors of production, experience, licenses, and education background. Businesses entities can be classified into three main categories as companies, partnerships, and sole proprietorship. The different entities have their advantages and disadvantages (Livingston, 2008). This paper uses two case studies method to discuss control, taxation, and liability issues in partnerships and sole proprietorship business entities.
Case 1: Restaurant/Bar
In this case, Lau and Jose have the idea of opening a bar and restaurant with big screens where customers can be watching sporting events as they dine and wine in the bar; however, they are limited by finance to operate the establishment. Miriam comes to their rescue and offers to offer them capital in exchange for some ownership of the entity. The above is the case of a partnership; Lau and Jose are to offer management and operational time while Miriam takes care of the capital part of the deal.
In the United States, the central government does not have a codified law to govern partnerships in the economy; however, every state has its own legislation that governs and gives control to the mode of partnership control. Despite the lack of codified law, the country uses the uniform Partnership Act (UAP) and Uniform Limited Partnership Act, when determining the legal aspects of a contract mostly in court matters.
When operating a partnership, control functions are conducted by the partners on the ground; they are the active members who are engaged in day to day operations of the company. Providers of capital may have some sort of control as he holds some voting rights by virtue that his being a partner. In the case of Miriam, Lau, and Jose, Miriam will control the business through the rights that he will be accorded by the memorandum of understanding and the partnership deed they will make. Lau and Jose will be on the ground making most of the day-to-day decisions, they will have control of the business from the decisions they make and enact to be followed. The fact that Lau and Jose have contributed no or little capital does not mean they don’t have some voting rights or decision-making power of strategic direction of the company. They have the rights as specified in the memorandum of understanding and/or articles of association.
Inland taxation laws have some requirements that they have recommended being considered when taxing partnership entities; the regulations are contained in Subchapter K of Chapter 1 of the U.S. Internal Revenue Code (Title 26 of the United States Code. According to the laws, when taxing partnership, the partners are considered as individuals and subjected to graduated taxation method; they form “flow-through” entities which means they do not pay taxes on their own or at the capacity of being a business entity. some of the incomes that are considered taxable on an individual capacity from the partnership include, interest on capital, bonuses, salaries, annuities, dividends, or any other gain that a partner gets from the partnership by the virtue of being a partner. The federal tax law allows partners to determine the rate at which they will allocate their income from the business entity; it is the distributive share that taxation of the partners will be based on. In the case of Miriam, Lau, and Jose, each partner will be liable to the payment of taxes at an individual capacity; when making taxation returns they will include the gains from the partnership to calculate the taxable amount.
Liabilities in a partnership are determined by the nature of the partnership; in a limited liability partnership, the formation of the contract requires that the partner’s personal wealth is different from the wealth and liability of the partnership. This implies that in the event a business engages in business and accidentally suffers a loss or has a liability that it cannot be able to pay; personal partner’s properties cannot be attached to clear the liability. The only loss that the partnership will incur is their capital contribution to the organization and in the event of loss, they will have to divide the loss among themselves using their predetermined way or percentages. In the case of unlimited liabilities, the structure and operation are different; in this case, business liabilities can be offset against personal properties and assets. This means that other than the capital provided by a partner, in the event of loss, personal properties can be attached to clear the loss. The rate of attachment/share of the liability is governed by the memorandum however in most cases it is the rate of profit/loss share.
If Miriam, Lau, and Jose make their entity to be limited, then in the event of liability sharing, their personal properties will not be attached to cater for the loss. In the event they make it an unlimited liability, then their personal products can be attached to share the liability (Shane, 2003).
Case 2: Extermination business
In this case, Frank has the time, idea, and capital to start an extermination business across the United States; the nature of the business is a sole proprietorship.
Soles are a one-man show where the entrepreneur undertakes the role of being the financier and the manager of the business; he may be assisted by family members or other hired professionals but he enjoys all the profits and suffers all losses.
Federal laws establish that there is some sole proprietorship in the economy; the business entities are considered to have some special attributes that make them unique to other business entities. The laws define a sole proprietor as a business entity where the owner has no stock share (like the case of a corporation), has no partners, or has attracted members.
The owner of a sole proprietor has full control of the business; he has the power to decide since there are no other owners and no legal restrictions on the ownership. The owner has the control and ability to make any decision that is going to offer the business the highest gains possible. The style of management and control is different from the style adopted in partners where they are controlled by Partnership agreement or LLC operations agreement. If the owner makes a decision that leads the company to lose, he will personally be liable for the loss and suffering as an individual.
The Inland taxation laws have some specifications on how sole proprietors should be taxed; the laws are governed by U.S. Individual Income Tax Return, Schedule C (Form 1040), Profit or Loss from Business, and Schedule C-EZ (Form 1040), Net Profit from Business; at the end of an accounting period, sole proprietors are expected to file tax returns on Schedule C of owner’s personal tax return. After calculating the taxable income which will be composed of the gains from the sole business, then the amounts are subjected to the owner’s personal rate of calculating taxation. The person is given tax relief like any other person deriving income from places like employment. Losses in a sole proprietorship are carried forward to the next accounting period when calculating the taxable income. In the case of Frank, he will be accountable for the payment of taxes; he will calculate his taxable income and using graduated taxation rates calculate the liability that he has to the Inland taxation authority.
Frank will be personally liable for debts of the business; this means that there will be no differentiation of business properties and personal properties. Sole proprietor’s taxes and personal liabilities are also business liabilities; in the event that a certain liability cannot be handled at a personal level or business level, the owner can consider business or personal properties to finance the liability (Ebbena & Johnson, 2006).
Partnerships and sole proprietorship businesses have differences in their ownership, liability, and are governed by different taxation laws. In limited partnerships, the liability of members extends to the amount invested in the business whereas in sole proprietorship personal properties can be attached to finance business liabilities.
Ebbena, J., & Johnson, A. (2006). Bootstrapping in small firms: An empirical analysis of change over time, Journal of Business Venturing, 21(6), 851-865.
Livingston, J. (2008). Founders at work: stories of startups’ early days, Berkeley, CA: Apress ; New York
Shane, S. (2003). A General Theory of Entrepreneurship: the Individual-Opportunity. Nexus. Edward Elgar