Problem - Different forms of business organization

Proprietorships, Partnerships, and Corporations

Shawn Bates was working to establish a business enterprise with four of his wealthy friends. Each of the five individuals would receive a 20 percent ownership interest in the company. A primary goal of establishing the enterprise was to minimize the amount of income taxes paid. Assume that the five investors are taxed at the rate of 15% on dividend income and 30% on all other in- come and that the corporate tax rate is 30 percent. Also assume that the new company is expected to earn $400,000 of cash income before taxes during its first year of operation. All earnings are expected to be immediately distributed to the owners.

Required - Calculate the amount of after-tax cash flow available to each investor if the business is established as a partnership versus a corporation. Write a memo explaining the advantages and disadvantages of these two forms of business organization. Explain why a limited liability company may be a better choice than either a partnership or a corporation.