Which of the following is a disadvantage of a corporation when compared to a partnership

Deciding how to form your business will influence many aspects of your business, including how profits and liability are divided, how your business pays taxes and who runs the business. If you are a large business, forming a corporation offers several advantages over forming a partnership or sole proprietorship. Examining the benefits of a corporate structure can help you decide if forming a corporation is the best bet for your business.

A corporation is owned by shareholders, who profit from the company's gains. A partnership is owned by two or more people who divide the business' profits. A sole proprietorship is owned by one person who alone is responsible for losses and reaps profits. A corporation is the most complex form of business and involves the most paperwork and expenses to set up, but it can offer certain rewards that other forms of business do not.

Liability Protection

The biggest benefit a corporation offers over other business structures is liability protection, according to Entrepreneur. Shareholders do not risk losing personal assets because of a company's debts, because corporations are considered separate legal entities from the people who own them. Owners of partnerships and sole proprietorships, on the other hand, are held responsible for all company debts and legal responsibilities, and are subject to losing personal assets if the company goes bankrupt or is caught up in costly legal situations.

Access to Funds

Corporations can more easily raise funds than other forms of businesses, according to the U.S. Small Business Administration. Corporations can sell stock to raise money for business expenses or cover debts. Sole proprietors and business partners, on the other hand, must try to come up with funds on their own or turn to loans or credit programs to raise money. It takes less time and effort to sell stocks than it does to apply for loans or seek out investors for a business.

Tax Benefits

Corporations enjoy some tax benefits that sole proprietorships and partnerships do not. Corporations must file taxes separately from the shareholders. Owners of corporations pay taxes on any salaries, bonuses and dividends they earn from the corporation. However, loopholes exist to ease the burden of paying taxes as a corporation and as individual shareholders. A corporation is not required to pay tax on earnings paid as compensation to employees or shareholders, and it can deduct the payments as a business expense. Also, the corporate tax rate is usually lower than the personal income tax rate. The owners of sole proprietorships and partnerships pay income taxes at regular rates on the profits they earn from their companies.

Consider a partnership if the number of people involved is small (up to about 20) and limited liability is not necessary.

Advantages of a partnership include that:

• two heads (or more) are better than one
• your business is easy to establish and start-up costs are low
• more capital is available for the business
• you’ll have greater borrowing capacity
• high-calibre employees can be made partners
• there is opportunity for income splitting, an advantage of particular importance due to resultant tax savings
• partners’ business affairs are private
• there is limited external regulation
• it’s easy to change your legal structure later if circumstances change.

Disadvantages of a partnership include that:

• the liability of the partners for the debts of the business is unlimited
• each partner is ‘jointly and severally’ liable for the partnership’s debts; that is, each partner is liable for their share of the partnership debts as well as being liable for all the debts
• there is a risk of disagreements and friction among partners and management
• each partner is an agent of the partnership and is liable for actions by other partners
• if partners join or leave, you will probably have to value all the partnership assets and this can be costly.

To end or dissolve a partnership in Tasmania we recommend seeking legal advice regarding what is required.

Learning Objectives

1. Distinguish basic aspects of partnership formation from those of corporate formation.
2. Explain ownership and control in partnerships and in publicly held and closely held corporations.
3. Know how partnerships and corporations are taxed.

Let us assume that three people have already formed a partnership to run a bookstore business. Bob has contributed $80,000. Carol has contributed a house in which the business can lawfully operate. Ted has contributed his services; he has been managing the bookstore, and the business is showing a slight profit. A friend has been telling them that they ought to incorporate. What are the major factors they should consider in reaching a decision?

Ease of Formation

Partnerships are easy to form. If the business is simple enough and the partners are few, the agreement need not even be written down. Creating a corporation is more complicated because formal documents must be placed on file with public authorities.

Ownership and Control

All general partners have equal rights in the management and conduct of the business. By contrast, ownership and control of corporations are, in theory, separated. In the publicly held corporationA firm that is traded publicly through the sale of stock subscriptions, has many shareholders and widely dispersed ownership, and in which shareholders have little control., which has many shareholders, the separation is real. Ownership is widely dispersed because millions of shares are outstanding and it is rare that any single shareholder will own more than a tiny percentage of stock. It is difficult under the best of circumstances for shareholders to exert any form of control over corporate operations. However, in the closely held corporationA corporation with few shareholders, so that separation of ownership and control may be less pronounced than in a publicly held corporation or even nonexistent., which has few shareholders, the officers or senior managers are usually also the shareholders, so the separation of ownership and control may be less pronounced or even nonexistent.

Transferability of Interests

Transferability of an interest in a partnership is a problem because a transferee cannot become a member unless all partners consent. The problem can be addressed and overcome in the partnership agreement. Transfer of interestTransferring an ownership interest through the sale of stock from one person to the next. in a corporation, through a sale of stock, is much easier; but for the stock of a small corporation, there might not be a market or there might be contractual restrictions on transfer.

Financing

Partners have considerable flexibility in financing. They can lure potential investors by offering interests in profits and, in the case of general partnerships, control. Corporations can finance by selling freely transferable stock to the public or by incurring debt. Different approaches to the financing of corporations are discussed in Chapter 26 "Legal Aspects of Corporate Finance".

Taxation

The partnership is a conduit for income and is not taxed as a separate entity. Individual partners are taxed, and although limited by the 1986 Tax Reform Act, they can deduct partnership losses. Corporate earnings, on the other hand, are subject to double taxation. The corporation is first taxed on its own earnings as an entity. Then, when profits are distributed to shareholders in the form of dividends, the shareholders are taxed again. (A small corporation, with no more than one hundred shareholders, can elect S corporation status. Because S corporations are taxed as partnerships, they avoid double taxation.) However, incorporating brings several tax benefits. For example, the corporation can take deductions for life, medical, and disability insurance coverage for its employees, whereas partners or sole proprietors cannot.

Key Takeaway

Partnerships are easier to form than corporations, especially since no documents are required. General partners share both ownership and control, but in publicly held corporations, these functions are separated. Additional benefits for a partnership include flexibility in financing, single taxation, and the ability to deduct losses. Transfer of interest in a partnership can be difficult if not addressed in the initial agreement, since all partners must consent to the transfer.

Exercises

1. Provide an example of when it would be best to form a partnership, and cite the advantages and disadvantages of doing so.
2. Provide an example of when it would be best to form a corporation, and cite the advantages and disadvantages of doing so.

Which of the following is a disadvantage of corporation?

What are 4 disadvantages of corporations?

What are 3 disadvantages of a corporation?

Which of the following is a disadvantage of a partnership when compared to a limited liability company?