Chapter 12
Legal Forms
of Organization
Overview
• How to make the decision
• Legal forms of organization
– Sole proprietorship
– Partnership
– Corporation
– Limited liability company
– Professional corporations
– Nonprofit corporations
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How Would You Decide?
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Criteria for Choice
• Who will be the owners?
• Level of liability
protection required
• Operating requirements
and costs
• Effect on the tax strategy
of the company & the founders
– When do you expect to earn a profit?
– How do you want to distribute earnings?
• Effect on financing plans
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Summary of Forms
Sole Proprietor
General Partnership
Partnership
Limited Partnership
S-Corp
Bridge Forms
LLC
C-Corp
Full Corporate
Non-Profit
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Sole Proprietorship
• 76% of all businesses
• Flexible, easy, inexpensive
• Does not exist apart from
the owner, so pays no tax
• Salary or draw not deductible as expense
• Hobby rule (3 of 5 years)
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Sole Proprietorship: Disadvantages
• Unlimited liability
• Difficult to raise debt capital
• Lacks advantage of team
• Survival dependent on owner
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Partnership
• Association of two or more persons
as a business
• Doctrine of ostensible authority
– One partner can bind the partnership
• Specific property rights
• Share in profit/loss according
to contribution
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Partnership Agreement
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Duties and responsibilities
Profit/loss distribution
Transfer of interest
Duration and dissolution
Arbitration and dispute resolution
Type of partnership
– general versus limited
– secret, silent, dormant
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C-Corporation
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Legal entity
Survival of death and separation
Limited liability of shareholders
Issue different classes of stock
Raise capital by selling stock
More status
Benefit from retirement funds, profit sharing,
stock options
• Owners can lease their assets to the corp
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Disadvantages of Corporation
• Complex and costs more
• Stockholders do not have benefit of writing
off losses
• Double taxation (earnings and dividends)
• Pay taxes on profits whether or not
distributed as dividends
• Accountable to board of directors
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S-Corporation
• Not a tax-paying entity
• Owners taxed on
corporate earnings
• Deduct losses on
personal income tax
up to amount invested
• No more than 75 stockholders, US citizens
or legal residents
• One class of stock
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Disadvantages of S-Corp
• Difficult to get loans if distributes earnings
• No deductions based on medical
reimbursements or health insurance plans
• If not a cash business, may not be able to
pay taxes out of business
• Must convert to C for IPO
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Limited Liability Company
• Limited liability of corporation with pass-through
tax advantages of partnership
• Members and interests
• Articles of organization
• Managers, officers, members not
personally liable
• Most organize for tax purposes as partnership
• No limitation to membership, more than one
class of stock
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Non-Profit
• Established for charitable,
public, religious,
or mutual benefit
• IRS 501(c)(3) tax exempt
• Limited liability
• Owners give up proprietary interest
• Perpetual existence
• Apply for grants
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Take-Aways
• List what students took away from the
discussion in real time
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