Federal Income Tax 2 – Tax Memo Entity Formation

The entities that differ in terms of their legal characteristics include corporations, limited
liabilities, general partnerships, and sole proprietorships. The corporations are formally arranged
through the filling of articles of incorporation within a specific state. Corporations are legal
entities, and the shareholders in the companies are protected from the liabilities of the company.
The laws of state corporations dictate the interaction between the corporation and its
shareholders. Therefore, the shareholders have limited flexibility to the customization of the
business arrangements. However, the governance of the state corporation will provide the rules
that will guide the initial offerings. The limited liabilities are formally created through signing a
filing odd the organization of the article with the relevant state. Just like the corporations, the
limited responsibilities separate the legal entities that protect the members from any form of
liabilities within the organization. But the limited liability corporations provide their members
with a great deal of latitude in the customization of the business arrangements (Graham and Kim,
2011). The general partnerships may be organized informally without any form of approval from
the state. That is different from the limited liability corporations (LLC), as they are required to
sign a certificate of limited partnerships within the country that they will work in operation.
Although the global alliances are considered to take part in the legal separation of entities, they
are responsible for the provision of either limited or non-liability protection to the members. The
sole proprietorships cannot be distinguished legal form the sole individual owners. The business
is very flexible, and it does not provide liability protection to the shareholders. The shareholders
are in a position to obtain protection through covering one member LLC.
Several issues and concerns exist in the formation of a new business entity, and selecting
the entity is challenging. Some of the non-tax issues that are present in the creation of a new
business entity include the time and cost in organizing the entity. Corporations, both the taxable
and the S corporations, are the hardest to form. The general partnerships are usually the most
comfortable entities to assemble because they do not provide any liability protection to the
members. The corporations and limited liability corporations (LLCs) provide essential liability
protection to the owners that any of the other entities (“U.S. Department of the Treasury. Internal
Revenue Service,” 2015). In this case, Dawn is more concerned about the level of risk of the
business and may want to put the time and cost factor into consideration. Also, Dawn, Linda, and
Mike are concerned about the flexibility of their business entity that they are starting. That is,
they want to be in a position where they will be able to provide Dawn and Linda with
performance-based compensation based on their business performance. Generally, the issue in
favor of the formation of the business entity as a partnership. Also, from the case study, we can
see Dawn wanting to create the future with an initial public offering. The IPOs are efficiently
completed in instances where the corporation is taxable. Even though partnerships and LLCs can
be easily converted into taxable corporations, they can be used in the completion of the IPOs.
More so, there are several tax issues and concerns in Dawn’s case study. One of the tax
issues is based on the provided percentages of ownership. Dawn’s case fails in the provision of
the 80% test control since Linda makes contributions to more than one service. Therefore, it will
be considered a tax transaction if a C corporation of an S corporation is formed. Both Dawn,
Linda, and Mike will be in a position to utilize any of the losses in the process of reducing the
individual income tax in the starting years of the business. The flow-through entity provides the
most relevant form of organization in such an instance. Equally, the LLCs and partnerships will
give the owners a chance to benefit through the process of increasing their tax basis using the
business debt. In such a process, the owners will be in a position to make more substantial

FEDERAL INCOME TAX 2 – TAX MEMO ENTITY FORMATION 3
deductions of the losses that the shareholders in the S corporations (Haber, 2011). Over the
years, when the business becomes profitable, particularly in year 4, the use of the LLCs,
partnerships, and the S corporations will form an elimination that will be excluded from the
double tax issue that is present in the taxable corporation form. If the owners are after the
flexibility in special allocation as a way of rewarding the owners, the entities that are taxed as a
partnership, provide a more valid form of corporation. The owners may put into consideration
making payments of the lowest possible FICA and the taxes for self-employment. In general, the
corporations which are taxable and the S corporations are favorable in the situation as the
employee and shareholder ratio will only pay 7.65% (1/2) of the totals FICA tax in any of the
salaries. Also, the shareholders in the S corporations do not take part in paying the self-
employment tax from the income that is allocated to them.
The LLCs and Partnerships, on the other hand, are required to make payments of the
Self-Employment Tax that will come from the business income allocated to them. If Dawn,
Linda, and Mike would consider adding other members to their business as owners, functioning
as a taxable corporation or S corporation will be costly. That is contributed to by the 80% control
test, which applies to the contributions made in the business. Thus, the contributions made in
LLCs and partnership, in most instances, are tax-free regardless of whether the initial input of the
following contribution form added owners is put into consideration. After considering the above
argument, Dawn, Linda, and Mike should consider forming CCS that will operate as an LLC.
Also, they are relevant to the choice of CTC since there will be a compensation plan that will
apply to all the parties. The business will be situated in two different locations, and that means
that they will have two fill two various articles in the formation of the CTS. Also, their choice is
relevant as there will be a sharing of responsibilities (Gupta, Gunasekaran, Antony, and Gupta,
2018). Dawn will take responsibility for the activities of the CTC in one location, and Linda will
take responsibility in the CTC in the other place. More so, they have the idea of developing a
performance-based incentive for the finances in each of the locations. The traits are an indication
that the CTC will be operating as a partnership under the same ownership but under separate
management. The choice is relevant as there is a distribution of risk, which is one of the
significant concerns of Dawn.

FEDERAL INCOME TAX 2 – TAX MEMO ENTITY FORMATION 4

References

Graham, J. & Kim, H. (2011). The Effects of the Length of the Tax-Loss Carryback Period on
Tax Receipts and Corporate Marginal Tax Rates. National Tax Journal, 62(3): 413-427.
Gupta, S., Gunasekaran, A., Antony, J. & Gupta, S. (2018). Systematic Literature Review of
Project Failures: Current Trends and Scope for Future Research. Journal of Computers
and Industrial Engineering, 127(14): 26-56.
Haber, G. (2011). Business Register for Maryland LLC ‘Benefit’ Law. Baltimore Business
Journal, 12(2): 14-16.
U.S. Department of the Treasury. Internal Revenue Service. (2015). Publication 17: Tax Guide
2014 for Partnerships (Cat. No. 10311G). Retrieved from http: www.irs.gov/pub/irs-
pdf/p17.pdf.