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Income Tax Laws – I

Notes establishment costs and advantages of different organization forms are different, and the tax is
one of factors we should consider when we select the organization form of the enterprise.
Especially when the organization form of the enterprise has large influence to the production
and management, the tax will be the important factor which we should consider, and investors
can select the organization form of the enterprise to reduce the tax burden for the enterprise. So,
before one can embark on a study of Tax Planning for Different Organisations, it is absolutely
vital to understand the meaning of tax planning and the concept of various kinds of business
organizations and the importance of tax planning in Sole Proprietorship, Partnership and
Company. The purpose of this Unit is to enable the students to comprehend basic expressions.
Therefore, all such basic terms are explained and suitable illustrations are provided to define
their meaning and scope.

10.1 Decision Regarding Forms of Organisations

A business organization can be owned and organized in several forms. Each form of organization
has its own merits and demerits. The ultimate choice of the form of business depends upon the
balancing of the advantages and disadvantages of the various forms of business. The right
choice of the form of the business is very crucial because it determines the power, control, risk
and responsibility of the entrepreneur as well as the division of profits and losses. Being a long
term commitment, the choice of the form of business should be made after considerable thought
and deliberation.
The various forms of organization are established by state law. There are a wide variety of
business organizations recognized by the states. In order for an organization to run smoothly,
decisions must constantly be made. How those decisions are made is an important factor in the
success of a decision.

Example: A popular form of organization is the Limited Liability Company (LLC). The
LLC is a state designation. At the federal level, an LLC is taxed as a partnership. If the LLC so
chooses, it can be taxed as a corporation at the federal level.

Notes Limited Liability Company (LLC)
The LLC is a relatively new type of hybrid business structure that is now permissible in
most states. It is designed to provide limited liability features of a corporation and the tax
efficiencies and operational flexibility of a partnership. Formation is more complex and
formal than that of a general partnership. The owners are members, and the duration of
the LLC is usually determined when the organization papers are filed. The time limit can
be continued if desired by a vote of the members at the time of expiration. LLC’s must not
have more than two of the four characteristics that define corporations: Limited liability
to the extent of assets; continuity of life; centralization of management; and free
transferability of ownership interests.

10.1.1 Forms of Business Organisations

Tax is not levied at the corporate level; instead all profits are fully distributed to the shareholders,
and reported & taxed on each shareholder’s 1040. On a profitable business, this will increase each
shareholder’s taxable income, and possibly move them to a higher tax bracket.

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