Partnership Versus Corporation


Nowadays, the sphere of business is developing quickly, and numerous organizations operate worldwide. For example, it is not difficult to establish a sole business or limited liability company. However, many business owners prefer partnerships and corporations. This paper will focus on the latter two types of organizations and will discuss details of tax rules and treatment. In addition, the advantages of partnerships and corporations will be explored to explain why business owners may be willing to take this route. Finally, the decision-making process associated with the establishment of one of the discussed types of business will be covered.

Tax Rules and Treatment

A partnership is a dependent legal entity that has multiple owners. Management responsibilities are divided among all of them so that equality can be reached (Monroe, 2013). As a result, this type of business organization is tightly connected to the owners, and they are the ones who are supposed to pay taxes, which means that the organization itself does not do so. All income obtained in the course of conducted operations can be taxed only as it belongs to the owners but not to the organization. For example, if a partnership that has $300,000 of profit belongs to three businessmen, each of them is obliged to report $100,000 in income. Furthermore, they are to pay self-employment taxes. Even though the owners of a partnership do not pay entity-level taxes because their organization is not independent, they are to focus on pass-through taxation. In other words, they share both profits and losses equally.

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Corporations are also owned by several shareholders, making them similar to partnerships. However, in this case, they can receive stock privately or on the stock market. They are legal entities that are not connected with their owners when taxation is discussed. Corporations exist separately, which means that they pay income taxes depending on the profits obtained by the whole company. The income of their shareholders is not considered in calculating the company’s taxes, and conversely, the shareholders are not required to pay taxes for the corporation. In other words, they do not deal with self-employment taxes (Schizer, 2016). Nevertheless, owners receive dividends that resort to profit appropriation. They are supposed to pay taxes for this kind of income, but the taxes involved are not as high as those shared by the owners of partnerships.

Reasons to Become a Partnership Instead of a Corporation

Two or more individuals can create either a partnership or a corporation, and that is why it is vital for them to pay close attention to the advantages and disadvantages of both types of businesses in order to select the most appropriate one.

The establishment of any business can be costly, but partnerships are not as expensive to create as corporations. The cost of the former’s set up and operation is lower due to differences in formation, filing, and annual state fees. Even though insurance costs for partnerships tend to be higher than for corporations, they do not offset expenditures.

In order to establish a corporation, its owners have to provide many legal documents to the state and adhere to numerous formalities, such as having a regular director and shareholder meeting, receiving approvals from the board of directors, and recording minutes (Monroe, 2013). Even though these activities are not difficult to maintain, they can be time-consuming. Failure to meet these requirements increases the possibility of losing personal liability protection. An establishment of a partnership, on the other hand, does not require any formalities. This type of business can exist even without any written agreement.

Many business owners must pay unemployment insurance taxes, and these can be high. As they deal with personal income, they affect shareholders’ profits adversely. However, the owners of a partnership, unlike those who are owners in corporations, do not have to pay them. Currently, this tax reaches 6% and is applied to the first $7,000 paid “to each employee as wages during the year” (Department of the Treasury Internal Revenue Service, 2016, p. 35). Thus, in creating a partnership, its owners receive an opportunity to minimalize their expenses significantly.

Advantages of a Corporation over a Partnership

Those shareholders who are willing to develop their business may find it beneficial to establish a corporation but not a partnership due to the range of benefits the former can provide to its clients. In this framework, the decision-making process should be based on a discussion of tax rules that apply to the discussed types of business as they have a number of significant differences.

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Corporations separate their owners from the legal entities, allowing them to avoid personal responsibility for business debts. In this way, even if a corporation fails to succeed and becomes bankrupt, running out of funds, the shareholders are not obliged to provide their own money because they are not liable. The owners in a partnership, on the other hand, are tightly connected to their organization and are required to satisfy the debt regardless of the situation. As a result, the inability to obtain enough money often leads to the use of personal bank accounts and even residences. However, it is vital to consider the situations in which the shareholders of a corporation are liable for business debts (Schizer, 2016). For example, if a person has personally guaranteed a corporate debt, it is necessary to satisfy it. In addition, the court is able to make a shareholder liable for corporate debts if he/she has intermingled personal and business funds or if a corporation does not hold meetings of management teams, has minimal capitalization, or violates the law (for instance, does not pay taxes). However, a business is not likely to face any associated difficulties if initial regulations are followed.

Shareholders in a partnership are to pay self-employment taxes for those profits they receive from the organization. Those who represent a corporation, on the other hand, do not have to pay them, and only their salaries are subject to tax. While the current self-employment tax is 15.3% for the first $106,800 of an organization’s “combined wages, tips, and net earnings,” shareholders in a corporation can save thousands of dollars each year (IRS, 2017, para. 5). For instance, if a partnership earns $100,000, it is required to pay a 15.3% tax for the whole amount of money. However, a corporation with the same revenue and $45,000 paid in salary will not pay the self-employment tax for the remaining $55,000. It is also important to consider that owners should not reduce their own salaries in order to minimize expenses. They are to receive a reasonable income, just like the rest of the employees.

All partnerships depend on their owners, which means that if they die, the whole organization expires. This rule cannot be applied to corporations as they continue operating even under such circumstances. In addition, it is easier for this type of business to make money because they have a wider variety of options that can be used for this purpose. For instance, they can sell shares and develop alternative stocks with different characteristics. Investors are also more likely to cooperate with corporations than with partnerships because they can thus avoid personal liability for business debts. Finally, it is much easier to transfer ownership interests to third parties, as they can be sold without affecting organizational operations. Partnerships do not provide such an opportunity, and it is only possible to transfer a part of licenses and permits individually.

Advantages of a C-Corporation

On the basis of the provided information, it can be stated that a corporation is an advantageous type of business that can be established by several individuals. However, it is also vital to consider the two kinds of corporations: C and S. The first involves double taxation, while the second has only one level of tax. Thus, a C-corporation presupposes the necessity to pay one tax at the organizational level and another on the shareholders’ profits. This is the standard type of corporation that is usually discussed by people when they do not provide any clarification. An S-corporation, in comparison, has a special tax status. Of course, in general, both types provide shareholders with the same advantages.

A C-corporation is the best option for new business owners because it offers limited liability protection and allows owners to avoid responsibilities for debts. It is a separate legal entity that has a group of shareholders, directors, and officers who ensure that the company runs successfully. Its unique features relate to ownership, shareholder rights, and taxation. A C-corporation does not have any restrictions on ownership, which means that an unlimited number of individuals can be included (Raible, Teti, & Brinker, 2015). Moreover, these owners are not obliged to be citizens or residents of the United States. As a result, much freedom is provided to the owners, which is highly appreciated. While owners are always at the top of the organization, C-corporations presuppose the possibility to have several kinds of shareholders who have unequal voting rights as the corporations issue different types of stock. In this way, a kind of hierarchy can be established, and the votes of some individuals can count more than others. This point is extremely important because voting controls business. Finally, a C-corporation provides an opportunity to avoid the necessity to divide income and losses. The organization pays a corporate tax and personal income tax but is able to avoid responsibility in the event of bankruptcy.

Research Needed for Decision-Making

In making the decision to start a new business, future owners will develop a vision statement that allows them to identify areas of focus. At the same time, they will prepare a list of goals that are to be fulfilled in the operations of the company. For instance, they may be concerned about making money or making a contribution to society. On the basis of this information, shareholders decide what type of legal business entity they are willing to establish. It may be that their goals and vision presuppose the necessity to reduce liability exposure or to minimalize taxes, for example. Every point is vital because it affects the way the business is financed and run. In making this choice, shareholders can ensure that their organization will operate over time without being automatically terminated because of issues that may arise.

When selecting a type of business entity, owners should focus on the risk to their personal assets. Organizations differ in the level of liability, and shareholders should establish whether they are ready to take responsibility for the successes and losses of the business. Only on the basis of this information can they be assured of selecting the most appropriate option.

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Attention should be paid to the tax advantages of different business types. They have enormous effects on the eventual revenue obtained by both an organization and its shareholders. Thus, it is better to avoid multiple layers of taxation and high taxes because they preclude receiving the highest possible income and prevent the fulfillment of a goal that focuses on making a profit.

Finally, the ability to transfer ownership interests and the cost of establishing an entity should be considered. These affect the ability to alter the board of shareholders and give other people an opportunity to get involved in the business. Moreover, if owners of the new entity are limited in finances, they may not be able to support the operation and maintenance of some types of business.

Conclusion

Different types of business entities can be established by several owners. They tend to have similar characteristics, but many of them differ in the details. When starting a business, it is a good idea to consider alternatives regarding taxes, liability, and operations. These elements are critical for success even though they are not directly connected to the services or products the owner intends to provide. Legal structures have a significant impact on organizational income, and that is why it is important to pay serious attention to their selection.

References

Department of the Treasury Internal Revenue Service. (2016). (Circular E), Employer’s tax guide. Web.

IRS. (2017). Self-employment tax (social security and Medicare taxes). Web.

Monroe, A. (2013). The new revolution in partnership tax? Virginia Tax Review, 33(2), 269-312.

Raible, D., Teti, R., & Brinker, T. (2015). Is the C-corporation a better business form than the s corporation for today’s entrepreneurs? Journal of Financial Service Professionals, 69(3), 14.

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Schizer, D. (2016). Between Scylla and Charybdis: Taxing corporations or shareholders (or both). Columbia Law Review, 116(7), 1849-1913.

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