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A farm is one of the most important assets in a household. It is critical to maintaining the farm correctly by managing it as an enterprise among the persons who own it. As a result, it is important to choose the appropriate form of corporate arrangement to incorporate in the firm's operations, maintenance, and accounting. To ensure that a family farm stays viable in an increasingly growing industry, the owners consult an accountant on the best model of business organization to use in operating the company. The research begins by analyzing the situation of Alex, Bill, Carl, and, Devon who are the inheritors of the business formerly owned by their father but managed by Xavier, his nephew. His father ran the farm as a sole proprietor before his death. The paper further describes various business structures such as the partnership, limited liability companies, S and C corporations, and sole proprietorship expounding on their strengths and weaknesses. Based on this analysis the paper recommends the most suitable structure that Alex, Bill, Carl, Devon, and Xavier can implement in line with their requirements. The choice of a limited liability company as the most appropriate structure is justified by clearly outlining how the LLC meets their need for a minimum legal framework, less taxation and limited liability.
Key terms: limited liability, legal framework, corporation, Limited Liability Company, partnership, sole proprietorship.
There are different forms through which businesses exist. The type chosen by the owners influence the organization operations, proprietors’ legal liability, financial structure, and treatment of income taxes. These forms of business units include limited liability companies, sole proprietorship owned by one individual, partnerships, S or C corporations (Spadaccini, 2007). They have their strengths and weaknesses which affect how a company is taxed and the methods it applies in performing its operations. Therefore, it is essential to select the most appropriate form of business that meets the firm’s needs and wants.
In the case of Alex, Bill, Carl, and Devon, they inherited a farm business located in New State from their Dad who formerly managed it as a sole proprietorship business with the help of Xavier, his nephew. After inheriting the business, the new owners begin a search of a new structure that allows Xavier to continue overseeing the daily operations without necessarily owning part of the firm. They are all Christians, and their business will operate according to the Christian worldview. The corporate form should also have few legal formalities, minimize taxes, and have limited liability.
In choosing the best type of business that meets the above requirements, it is essential to discuss the different types of business units and weigh their strengths and weaknesses. Also, through comparison of the forms, I will recommend the most suitable structure that Alex, Bill, Carl, and Devon should use in managing their enterprise. The most preferred form to use in operating the firm is a Limited Liability Company.
Initially, before inheriting the organic farm from their Father, it was managed as a sole proprietorship. A sole proprietorship is the simplest form of the business unit started, owned and managed by one person. This form of ownership has various advantages such as the owner exercising leadership control alone and lack of corporate taxes on the business or its owner. Additionally, instituting and maintaining the business requires very few legal formalities and the overall business costs of operation are at a minimum (Kaliski & Macmillan).
However, the structure of a sole proprietorship business has various limitations which include taxation on the sole proprietor’s income and lack of a legal separation between the sole proprietor and the enterprise which causes unlimited liability. Moreover, if the firm is unable to cater for its financial obligations or becomes bankrupt, it is the personal assets of the owner that become liable. These weaknesses disqualify it from being the appropriate structure for satisfying the requirements of Alex, Bill, Carl, and Devon.
An alternate method different from the sole proprietorship is a partnership. Alex, Bill, Carl, and Devon want to possess the business together without necessarily being involved in the daily operations which will be managed by their cousin Xavier. Therefore, they can decide to operate it as a partnership business by making Xavier a co-owner of the farm. A partnership is a business comprising two or more people who join and consent to share the benefits of a firm which they run jointly. It implies that the firm is either operated by all partners or the partners choose one among them to act as their representative. The four thereby become partners for having formed a partnership firm.
In addition, partnerships are divided into three main categories each with its own merits and setbacks. First, there is a general partnership which involves equal share of management rights and responsibilities among the general partners. In performing the business operations, if the firm incurs losses or has debts, each of the partners shoulders full responsibility. However, the personal liability brings about some tax advantages to the firm by exempting taxation on all the partnership profits. Instead, the tax passes at lower rates to the owners on their tax returns.
A partnership structure can also take the form of a limited partnership which comprises of at least one general partner. All partners have limited liability except the general partner who have unlimited liability and risks losing personal property in case of business losses and debts. All the partners share in the business profits but not in the management of the daily operations. The general partner has full control over the management decisions. Finally, there exists a limited liability partnership structure that is more common for it allows all the partners to participate in management. This structure ensures that all partners retain tax advantages similar to those of a general partnership and are subject to limited liability (Godwyn & Gittell, 2012).
A partnership has its strengths and weaknesses compared to other business structures. Of the strengths is the speed and ease of its formation compared a corporation. Although both the partnership and corporation business forms allow the business to have multiple owners, forming a partnership requires less legal formalities and initial capital. In addition, the multiple owners share liability which minimizes the losses incurred by an individual partner in case of losses or debts as compared to a sole proprietorship. Another advantage is that more capital is available because the multiple partners invest providing more financial security to the business unlike in a sole proprietorship where only the single owner funds the business. Having a partnership firm gives freedom to the partners to choose the type of individual ownership or liability to enjoy. Once the partnerships have a general partner, they give the other owners the option of acting as limited partners with the aim of protecting their assets despite not actively participating in management. A partner can also decide to be both general and limited which provides the chance to co-own and make decisions while enjoying special rights of a passive investor. It also provides a suitable option for professional businesses especially the limited liability partnerships.
It is essential to address the weaknesses of the partnership structure before making a decision to operate such kind of corporate structure. One of its greatest limitation is the unlimited liability. In case the business incurs losses or is incapable of meeting its financial obligations, the general partners risks the loss of their personal property. It requires the long-term commitment of all the owners. Loss of interest in the business from one of the partners might lead to difficulties in management and further cause losses. It’s hard for a partner to exit as compared to sole proprietorship which is flexible, such that the sole proprietor can end the business any time upon his/her own decision. For a partnership, to leave, the partner sells his/her interests upon agreement of other partners. However, it is even harder to exit especially if the firm is incurring losses. It has a limited life, unlike a corporation. The business might fall or close upon death or bankruptcy of one of the partners. Decision process might be slow unlike in sole proprietorship because all the general partners must agree.
The third form of a business unit is corporations. It is a business formed by a group of people and perceived as a separate lawful entity. It has detached responsibility, rights, benefits, and liabilities separate from its proprietors or members. Depending on how a business wants to incur its taxes, it may decide to operate as a C or S corporation. An S type of corporation is suitable for small organizations because it does not involve payment of income taxes (Schwidetzky, 2009). The total annual wages or misfortunes of the enterprise are directed to the shareholders who in turn account for them on their returns. Towards the end of every financial year, the organization records a data return, posting the majority of its salaries, costs, and depreciation. It sends every shareholder his/her report stating their share as controlled by the rate of stock possession.
On the other hand, a C Corporation differs from an S Corporation in that; it pays at corporate rates all the taxes on its net income. The wages of officers, executives, and workers are taxable and deducted to the organization. Also, cash paid out as dividends is double taxed meaning it is imposed at the enterprise’s rate as a significant aspect of its benefit and also as wages at the stakeholder’s rate once the corporation disburses them. In addition to the taxation difference, the two types of corporations also differ in ownership and fringe benefits offered to the shareholders. For an S corporation, members should not exceed one hundred while C-Corporation has no such limit (Schwidetzky, 2009).
There are merits and drawbacks of operating a corporation. One of the merits is that stockholders have limited liability. Unlike in a sole proprietorship and partnership, the owners’ assets are not liable for the corporation’s losses or debts. They have eternal existence, that is, the death, insanity or bankruptcy of one shareholder or executive member does not terminate the operations of the enterprise. It is easier to raise capital through selling and creating different types of stock, and shareholders contributions through their investments. They exempt shareholders from self-employment taxes. Unlike in a sole proprietorship where the owner incurs self-employment tax, in a corporation profits, are not taxed but only salaries hence saving shareholders a lot of money (Todd, 2011). It is easy to transfer interests in a corporation without affecting the daily operations of the firm.
The limitations of a corporation include complexity in its formation because it requires a huge amount of initial capital compared to sole proprietorship or partnerships. Other costs include annual state fee and charges for filling. It also involves a lot of legal formalities because it is required to file various documents such as corporate minutes, and articles of incorporation. Too much paperwork could be time-consuming and challenging to the owners. Leads to double taxation especially if the business is operating as a C corporation. Shareholders who are also employees of the organization are charged unemployment insurance taxes, unlike a sole proprietor or partner. Shareholders do not directly manage a corporation, but instead, they appoint a board of directors who sometimes run the organization without acknowledging the interests of the shareholders leading to management crisis in the corporation.
Limited Liability Companies are corporate organizations that protects the personal assets of the members against liability in case of debts or liabilities of the company. It combines different characteristics some which resemble a corporation, for example, limited liability to all members. It also has features of a sole proprietorship and partnership such as tax pass-through and flexibility in dividing profits. Those who own LLC are referred to as members, and they are similar to shareholders. The type of structure does not limit membership, that is, it can have one, two’ or more members (Lancuso, 2016).
LLC enjoy particular strengths compared to other business forms. First, flexibility in taxation whereby, a firm is given a chance to create a tax plan that suits it best. Depending on its size and operations, it chooses a tax policy similar to a sole proprietorship, partnership or corporation. Also, members enjoy tax advantages compared to a partnership such as tax deduction on personal income in case the company suffer losses, and no member suffers liability of his/her private property unlike for general partners. Second, it enjoys a pass through of taxes. That is, it is possible to avoid double taxation provided the company does not select a tax plan similar to that of a C corporation. Another merit is that its members enjoy limited liability. Member’s assets are not at risk of loss in case the company fails in meeting its financial duties, incurs losses or unable to settle debts. Also, it enjoys less legal requirements compared to corporations. It is not a requirement to hold special meetings and file corporate minutes. Appointing a board of directors or executive officials is not necessary. It offers different classes of stock compared to S corporation that offers only one class. In addition, it does not limit the number of members allowed to join the company. The structure increases the credibility of the business because it is more preferred by suppliers, lenders and buyers compared to sole proprietorships and partnerships.
However, few drawbacks are facing Limited Liability Companies. Raising funds for the business is difficult. Especially when the members are few, investment is also less, and the company might decide to apply for a loan. Most financial institutions require one member to act as a guarantor of the loan using his/her assets which is contrary to the principles of the business, and no member might be willing to do so. Earnings might also be subjected to self-employment taxes. There also restrictions on the transfer of interests.
The four common types of business structures discussed above share some similarities and differences with each structure bearing its merits and drawbacks. After analyzing the case scenario of Alex, Bill, Carl and Devon, it is essential to note that they want to run their inherited business with the help of their cousin Xavier without them participating in the daily operations. They also intend to select the business form that has few formalities, fewer taxes on the business and provides them with the protection of their assets. Regarding the discussion above on the merits and demerits of the different forms of business organizations, I would advise Alex, Bill, Carl, and Devon to change their newly inherited farm business to a Limited Liability Company (LLC). It is the most suitable structure in meeting their needs because it is very flexible in taxation. With the view of minimizing taxes on their business, LLC allows them to choose the tax plan suitable for them. . It also meets their wish for few legal formalities compared to corporations because it requires less paperwork in operating it. LLC also ensures limited liability thereby avoiding personal liability on the business operations. It would also enable them to maintain the organic farm as a family business because LLC restricts the transfer of interests and they would have to agree before one of them sells his interests. The plans for extension of the farm to include a vineyard are possible because LLC is a preferred structure by lenders making it easier for them to acquire a loan and expand the business.
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