Chapter 1 17. LO.4,5 Marco and Cynthia hae decided to go into business together.

Question

Chapter 1

17. LO.4,5

Marco and Cynthia hae decided to go into business together. They will operate a burrito delivery business. They expect to have a loss in the first and second years of the business and subsequently expect ot make a substantial profit. Marco and Cynthia are concerned about potential liability if a customer ever gets sick after eating one of their products. They have called your office and asked for advice about whether they should run their business as a partnership or as a corporation. write a letter to Cynthia Clay, at 1206 Seventh Avenue, Fort Worth, TX 76101, describing the alternatie forms of business they can select. In your letter, explain what form or forms of business you recommend and why.

Explanation / Answer

February 25, 2013

            Cynthia Clay

            1206 Seventh Avenue

            Fort Worth, TX 76101

            Dear Cynthia:

I am writing this letter to help you decide on what form of entity to choose for your new sandwich delivery business. In our phone conversation, you indicated that you expect to have losses for the first two years in this business and then make substantial profits in subsequent years. You and Cory also indicated that you are concerned about potential personal liability.

While I can%u2019t make a conclusive recommendation based on the information you have given me, I can provide you with some general guidelines that should simplify your decision. First, given your concern about personal liability, a partnership does not appear to be a desirable option (you would both be personally liable for any injuries to customers). Similarly, given your expectation of losses in the first two years, it does not appear that a regular %u201CC%u201D corporation would be a desirable choice, at least initially. This is because any losses in the corporation could only be used to offset future corporate profits%u2014you could not use the losses to immediately offset your personal tax liability.

Thus, two choices exist which provide limited liability and deductibility of losses on your personal income tax return. These are the %u201CS%u201D corporation and the limited liability company. If you choose an %u201CS%u201D corporation, we would probably convert the entity to a %u201CC%u201D corporation when the business becomes profitable. At that point, profits would be taxed at the regular %u201CC%u201D corporation rates. A second tax would be levied on your personal income tax return for any dividends paid by the corporation once it achieves %u201CC%u201D status. In contrast, limited liability companies are taxed like partnerships%u2014all income would be taxed on your personal income tax return in profitable years. The relative desirability of each of these two forms depends on a number of factors. One of the most important factors in your situation is the relationship between your personal tax rate and the tax rate of a regular %u201CC%u201D corporation. If you are in a high tax bracket and if the income in the business is sufficiently low, you might be best off choosing the %u201CS%u201D corporation. Alternatively, if you expect the business to generate a sufficiently large profit each year, it might be best to choose the limited liability company.

If you would like me to give you a clearer recommendation, we should meet at your earliest convenience. If you have any additional questions, please call me.

Best regards,

Julian Jackson, CPA

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.