Question

Tom and Jerry are going to start an ice-cream business in which they both will participate on an active basis. Limited liability is a significant factor for the owners, but equally important is the minimization of income taxes. Tom and Jerry have narrowed their choice of business form to a C corporation or a general partnership. Annual earnings before taxes are expected to be $240,000, and any after tax profit will be distributed. Tom and Jerry are both single and have a marginal Federal income tax rate of 22 percent. Advise Tom and Jerry on the choice of business form.

Answer 1

Different form of ownership have different advantages and disadvantages.
In the present case Tom and Jerry are going to start an ice-cream business. If they use partnership then they will enjoy full control over the decisions and further they can contribute and decide the amount of capital they want to invest in the business but there is a risk in partnership that if the owners had taken some loan and business is unable to make enough sales and make profit then the partners will be held responsible for the payment of creditors and loan and further their personal property can be attached for the outside payment,it is called as unlimited liability. If the partner died then the business will dissolve itself. Further, In case of profit, it will be taxed as personal income and they don't have to pay any special federal and state income tax.
If they choose C Corporation then the new business will have as separate legal entity. Corporations are owned by shareholders by subscribing to the shares of the company. The most important advantage of Incorporation of company is Limited liability i.e. owners have limited liability restricted to the amount they have invested in the company. Further the corporations finds easy to get bank loans for furtherance of business provided it is guaranteed by its owners. In corporations the owners and the persons running the company both are different therefore it can sometimes lead to troublesome if the goals of both are different.But it discourages small businesses from incorporating because it is an costly affair depending on the size of business.From Tax point of view, Corporate profits are taxed twice,first the corporation pays the taxes and second the shareholders pays the tax on dividend received. So the tax component also needs to be considered while opting for the choice of business.
In the present scenario, as the owners are single with the marginal federal income tax rate of 22% which they have to be paid separately on their personal income of $1,20,000 for each.
So it is advised that tom and jerry should opt for Partnership if they want to minimise taxes and if they want to for limited liability then they should opt for C-Corporation.