After 20+ years of working for other firms, Penelope (Enrolled Agent, age 41), M

Question

After 20+ years of working for other firms, Penelope (Enrolled Agent, age 41), Mark (CPA, age 43) and John (CVA, age 65) want to leave the firms they are currently employed by and  become their own bosses.  Penelope specializes in Taxes, Mark is the Auditor and John is a Business Valuation expert.

There are so many options available to how they can structure the new business(s). The appropriate business entity for any individual(s) will depend on their particular facts and circumstances.

You are a valued colleague and friend of this three-some and they have come to you seeking advice as to how to structure their new business.  They have the knowledge to figure it out themselves, but are looking for the advice of an unbiased 3rd party.  Please consider the following tax and non-tax considerations as you recommend an entity choice to Penelope, Mark and John.

Prepare a tax memo (900 word minimum; 1,200 word maximum) to Penelope, Mark and John addressing the Entity Selection issue and discussing the following tax and non-tax considerations, point by point:

Part I:  Discuss the various forms of organization that are available to Penelope, Mark and John.

Part II:  Make your recommendation as to what form  of  organization you believe will be best and be sure to explain the reasoning for your choice.

Part III:  Discuss the tax consequences of contributing cash, property and/or services to the new entity.

Part IV:  Discuss, in detail, how this entity is taxed (if at all) and what filing requirements it has with the IRS.

Part V:  Discuss how income and distributions may/will be allocated to Penelope, Mark and John.

Part VI:  Discuss, in detail, how the individuals are taxed (if at all) with respect to the net profits from this entity and what filing requirements they will each have with the IRS.

Part VII:  Discuss how Penelope, Mark and John will calculate their "basis" in the new entity. Be sure to include the impact that debt has on basis, if any.

Part VIII:  Limited Liability - Discuss the exposure that Penelope Mark, and John's personal assets will have to the debts and lawsuits of the entity you have recommended.

You Decide: It's your turn as a tax professional to decide on the best course of action from a tax perspective on these issues as presented.

After 20+ years of working for other firms, Penelope (Enrolled Agent, age 41), Mark (CPA, age 43) and John (CVA, age 65) want to leave the firms they are currently employed by and  become their own bosses.  Penelope specializes in Taxes, Mark is the Auditor and John is a Business Valuation expert.

There are so many options available to how they can structure the new business(s). The appropriate business entity for any individual(s) will depend on their particular facts and circumstances.

You are a valued colleague and friend of this three-some and they have come to you seeking advice as to how to structure their new business.  They have the knowledge to figure it out themselves, but are looking for the advice of an unbiased 3rd party.  Please consider the following tax and non-tax considerations as you recommend an entity choice to Penelope, Mark and John.

Explanation / Answer

Recommendation:
The various considerations have been answered as below
I. The various forms of organisations available to Penelope, Mark and John are
partnership, corporation, Limited Liability Company, professional association and
other legal entities.

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II. Out of the various available forms of organisation, the best and recommended form is
a Limited Liability Company. It is a hybrid entity which has certain characteristic
of a partnership and certain of a corporation. It has the limited liability feature of a
corporation and the flow-through taxation to members as in the case of a
partnership. It is the most suitable form of organisation because the three can take
advantage of its benefits but not get affected by its disadvantages. Its
disadvantages being that it cannot function in the event of death or insolvency of a
partner and is not suitable where the objective is to become a public listed
company; are not having an impact on the purposes of Penelope, Mark and John.
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III. The contribution of cash, property and/or services to the Limited Liability Company is
not taxable either at the hands of the LLC or the members.
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IV. By itself, a LLC is not classified as a taxable entity for federal income tax purposes.
An LLC business entity must make an election through filing Form No.8832 with
IRS and thereafter file a tax return as the elected entity being a corporation,
partnership or sole-proprietor. It is recommended that Penelope, Mark and John
elect for a partnership LLC. The partnership entity itself will not be taxed but the
individual partners pay tax based on their share of ownership. It needs to file an
information return Form 1065 with the IRS.

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