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Business Formation and Choice of Entity

1. Two brothers would like to form a small retail business. They would like your advice in structuring the business. They have heard that there are various options such as a corporation, a partnership or a sub-chapter S Corporation and would like to know the advantages and disadvantages of each form. Include both tax and non-tax consequences. They plan on contributing the following:

Joe: $100,000 in cash
Jim: Equipment with a fair market value of $100,000 and a basis to him of $80,000.

They anticipate losses of $5000-$10000 in the first two years, but then hope that they will generate a profit.

Include in your answer the tax consequences in forming each type of business, the basis they would have in their stock or partnership interest, and the basis the business would have in the assets.

2. These same brothers would also like to know how they can take out distributions while minimizing taxes once the business is up and running.

3. Finally they would like to know what the consequences would be should they wish to dissolve the business or terminate their interest in it. Discuss each form.

Solution Preview

1. The tax consequences of starting a business are minimal, the taxation begins when profits are produced or items are sold at gains. Losses of a business can be taken against other income depending on the owners other activities and choice of entity. Partnerships and S-Corporations are usually the better entity choice when there are multiple entities involved. The regular corporation is a good choice of entity when the company vision is about expansion and the need for multiple sources of financing becomes apparent.

The corporation is a legal structure that can exist way beyond the original owners' life. A partnership is a less formal structure that is easier to form; it only requires an agreement of two or more parties and the proper filing of partnership tax returns. The S-Corporation is a combination of the partnership form and corporate form. A purpose of choosing the S-corporation form is that it allows the ...

Solution Summary

This solution compares the choice of entity for two family members establishing a business and the tax consequences of taking a action.