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Simple Heart

Valery Salazar

Keiser University

Gregory Gosman, C.P.A

Corporate, Business, and Trust Tax

February 12, 2023

MEMO

To: Our Valued Client

From: Tax Professional

Date:2/2/2023

Re: Four Different Legal Entities Recognized by the US Tax System

This memo is intended to provide an overview of the four different legal entities recognized by the US tax system and the fundamental differences in the characteristics across business entities, as well as the pros and cons of transitioning from a sole proprietorship to a corporation. Additionally, the principles of ethical and professional conduct relating to corporate, business, and trust taxation will be discussed.

The four legal entities that are recognized by the US tax system are sole proprietorships, partnerships, corporations, and limited liability companies (LLCs) (Greenman et al., 2021). These entities differ in terms of the way they are taxed, the way they are managed, and the level of liability that owners have for the debts of the business.

A sole proprietorship is the simplest and most common business structure. One person owns and manages them, and that person is liable for all financial obligations. A sole proprietorship may be set up quickly and easily, with no additional paperwork or registrations needed at the state level. [Title of book] (Lidstone, 2021). They are also relatively inexpensive to operate, as the owner does not have to pay any taxes on the business’s profits. The downside of a sole proprietorship is that the owner is personally liable for any debts or legal claims against the business.

Similarly, to how one person may own and operate a sole proprietorship, two or more individuals can own and operate a partnership. However, each partner is personally liable for any debts or legal claims against the business (Hatfield, 2019). Partnerships also do not require any special filing with the state and are relatively inexpensive to operate. The upside of a partnership is that the profits are split between the partners, which can be beneficial for tax purposes.

Corporations are more complex than sole proprietorships and partnerships, as they are distinct authorized organizations from their proprietors. This means that the owners are not personally liable for any of the business’s debts or legal claims (Lidstone, 2021). Corporations are also more expensive to set up and operate, as they require special filing with the state and must pay taxes on their profits. The upside of a corporation is that the owners can benefit from limited liability protection, which can be beneficial in certain situations.

In many ways, limited liability companies (LLCs) combine the best features of corporations and partnerships. As separate and distinct entities from their owners, the owners cannot be held liable for the business's debts or legal claims. Creating and running an LLC also has a low financial impact (Uzoka, 2023). If the business owner has a higher marginal tax rate than the firm, then more of the business's profits will be subject to that higher rate.

When considering whether to transition from a sole proprietorship to a corporation, there are several factors to consider. One of the main advantages of transitioning to a corporation is the limited liability protection afforded to the owners. This implies that the proprietors are never individually accountable for any of the company's liabilities or legal demands, which might give more security in certain circumstances (Lidstone, 2021). Corporations can benefit from certain tax advantages, such as the ability to deduct business expenses from taxable income.

However, there are also some potential disadvantages of transitioning to a corporation. Corporations are more expensive to set up and operate than sole proprietorships, as they require special filing with the state and must pay taxes on their profits. Additionally, the owners of the corporation must comply with certain legal requirements, such as holding annual meetings and filing annual reports.

The principles of ethical and professional conduct relating to corporate, business, and trust taxation are based on standards and practices that are set forth by the Internal Revenue Service (IRS) (Pfeifer & Yoon, 2019). These standards and practices include the obligation to accurately report income and other taxable items, the responsibility to pay taxes in a timely manner, and the requirement to keep accurate records of all financial transactions (Pfeifer & Yoon, 2019). Additionally, tax professionals must adhere to certain ethical codes of conduct, such as acting in the best interests of their clients and treating them with respect.

In conclusion, it is important to understand the four different legal entities recognized by the US tax system, as well as the fundamental differences in the characteristics across these entities. Additionally, when considering a transition from a sole proprietorship to a corporation, it is essential to weigh the pros and cons of such a move. Tax professionals must adhere to certain ethical and professional standards when dealing with corporate, business, and trust taxation.

I appreciate your taking the time to read this. Should you have additional concerns or would want to pursue this matter deeper, please get in touch with us.

Sincerely,

Tax Professional

References

Greenman, C., Esplin, D., Johnston, R., & Richards, J. (2021, July 7). Understanding Ethics in the Varying Segments of the Accounting Profession. Papers.ssrn.com. https://ssrn.com/abstract=3882222

Hatfield, M. (2019). Professionally Responsible Artificial Intelligence. Arizona State Law Journal, 51, 1057. https://heinonline.org/HOL/LandingPage?handle=hein.journals/arzjl51&div=33&id=&page=

Lidstone, H. K. (2021). LLC or Inc.? Entity Selection for a Small Business. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.3938182

Pfeifer, M. G., & Yoon, S. J. (2019). IRS weapons against aggressive tax planning1. Trusts & Trustees, 25(1), 69–74. https://doi.org/10.1093/tandt/tty170

Uzoka, N. C. (2023). ADOPTING A LIMITED LIABILITY PARTNERSHIP FOR THE LEGAL PROFESSION: A CRITICAL REVIEW FROM NIGERIA’S PERSPECTIVE. LAW and SOCIAL JUSTICE REVIEW, 3(2). https://nigerianjournalsonline.com/index.php/LASJURE/article/view/2969