Tom Davis Development Company

MEMORANDUM

TO: Tom Davis

FROM: Howe Accounting

RE: Tom Davis Development Company

DATE: April 27, 2015

Situation: Tom, Tony and Suzy want to form up a business to rent complex. Tom will contribute the land worth 750,000 with 75,000 basis to exchange for 42.5% interest. Tony will build the complex at a cost estimated 750,000 to exchange for 42.5% interest. Suzy agreed to provide the working capital for 15% interest. Additionally Suzy’s firm will operate the complex for next 10 years, at a price of 10% of the retaining profit which is twice of the market price. Then the remainder will split equally by Tony and Tom. The company will need 100K loan from the bank of Clark County to finish the interior of the apartment. While as a constructor Tony will likely to build other apartment in the area which may be in competition with this apartment complex. They plan to sell the business after 10 years.

Question: What form of business they should use?

Analysis: Choosing a structure is one of the most important initial decisions a business owner will make. In order to form up a new business, there are many economic and personal factors need to be considered and weighed in combination with the legal and tax consequences. There are couple main factors need to be considered such as the formation, management structure flexibility, liability, and tax consequences. Before the decision is made a basic knowledge of what business entity types available for choose is necessary. Since the company will have more than one owner, the choice of the business entity type will fall within C Corporation, S Corporation, partnership and LLC. Each of the business type has their own advantages and disadvantages.  

As an independent legal and tax structure, C Cooptation could provide limited liability to their owners. Only in fewer cases, the law permits to “pierce the corporate veil” to hold the shareholders personally liable for negligence or for corporate debts. As described in the situation part, limited liability is a must have feature for the new company since rental could be a very risky business in the liability aspects. However, the main advantage of the C Corporation is the flexibility of the ownership and unlimited growth potential. C Corporation is the only type of business in the four that could issue multiple types of stocks. And C Corporation has perpetual existence even if the owner leaves the company. If we applied our situation in, we could see, the main advantage of the c corporation is not what we really need. As a small business the owner has no intent to issue multiple types of stocks and the business will be sold in next 10 years. The life of the business is not a key issue in choose a business entity. And the disadvantage of the C Corporation also made it a very unattractive option. As a c corporation, the owner needs to face the double taxation situation. For example, Tom contributed his land in to a C Corporation, when the business is sold in year 10, the Corporation will recognized gain on the sell and pay tax on the corporation level. When the money are distributed to the shareholders, all the shareholders need to pay tax again on their personal tax returns.

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