Opinion on incorporating businesses
As the daycare business grows, the competing needs for the limited resources increases. Therefore, the business owners may have a problem in deciding on how to allocate the limited resources among competing needs. Such situations can easily be resolved by seeking an external source of financing. However, sole proprietorship or partnership form of business may face challenges when arranging an external source of funds. This limits their ability to grow at a rate that the management desires. Incorporation has a number of benefits and shortcomings. However, the business stands to gain a lot through incorporation. Besides, being in a structured form of business will enable the company to organize its operations, finances and other aspects of the business. Therefore, Thomas and Diana should consider incorporating the daycare business. In order to achieve this, it is important to keep proper books of accounts. For instance, the owners estimated that the total asset amounted to $250,000, the mortgage on buildings totaled to $120,000, withdrawal of assets amounted to $50,000 while the net income was estimated at $85,000. However, there are no proper records that can support these values. It is worth mentioning that all reported financial values require supporting documentation. Further, proper financial records will facilitate the process of seeking external funding and incorporation because both equity and debt capital providers, and other stakeholders are often interested in proper books of account before engaging with them (Chirelstein and Zelenak 201).
Reasons for incorporating the business
Incorporation has a number of benefits. The first major benefit of incorporating is that it will enable the business to access public markets on which securities are traded such as the stock exchange markets. This can enable the business to raise large sums of money that can be used for growth and expansion. Besides, access to these markets will grant the business ease of transfer of ownership. This can be achieved through the transfer of shares. If the ownership of a business can be transferred, then a business will continue with its operations upon the death of the two founders. Another advantage of incorporations is that the risk of losing personal property when the business becomes insolvent is minimized. This is based on the fact that a corporation is treated as a separate legal entity from its owners. In the case of an incorporated entity, the personal properties of the two owners cannot be sold to recover business liabilities (Pope, Rupert, and Anderson C-2-10).
One major drawback of incorporation is the high cost of forming the company. Examples of these costs are the annual state fees and initial formation fees among others. Also, there are several formalities that the owners will have to adhere to. Maintaining these formalities is difficult and time-consuming.
Impact of incorporation on taxable income
Incorporation has a number of effects on taxable income. The first effect is the element of double taxation. Under a sole proprietorship, the earnings are subjected to self-employment taxes only. However, double taxation exists in companies. The salaries and bonuses of employees and the profits earned at the end of the year are taxed. It is worth mentioning that the salaries and bonuses paid to the employees are among the tax allowable expenses when estimating the taxable income of the company. Therefore, the company does not pay taxes on salaries and bonuses. Another difference is that taxes are levied on dividends that are paid to the owners of the company. Thus, the element of double taxation arises because the benefits that are drawn by the owners are taxed and the profit that the company makes is also taxed (Frecknall-Hughes 103).
The move from a sole proprietorship to a company will necessitate the owners to pay unemployment insurance tax on their salaries. Under the law, a shareholder-employee is under statutory obligation to remit this category of tax. Finally, in most jurisdictions, the personal income tax is higher than corporate taxes. Therefore, the profits that a company earns are likely to be taxed at a lower rate than the income taxes that are applicable in the case of a sole proprietorship (Chirelstein and Zelenak 341). Therefore, from a taxation point of view, the business stands to benefit and lose in some aspects.
Works Cited
Chirelstein, Marvin, and Lawrence Zelenak. Federal Income Taxation, USA: Foundation Press, 2015. Print.
Frecknall-Hughes, Jane. The Theory, Principles and Management of Taxation: An Introduction, USA: Routledge, 2014. Print.
Pope, Thomas, Timothy Rupert, and Kenneth Anderson. Prentice Hall’s Federal Taxation 2016 Comprehensive, USA: Pearson Education, 2015. Print.