BUSINESS STRUCTURE

INTRODUCTION:
Of all the decisions one make when starting a business, probably the most important one relating to
taxes is the type of legal structure you select for your company.
Not only will this decision have an impact on how much one pay in taxes, but it will affect the amount of
paperwork our business is required to do, the personal liability you face and our ability to raise money.
The most common forms of business are sole proprietorship, partnership, corporation and S corporation. A
more recent development to these forms of business is the limited liability company (LLC) and the limited
liability partnership (LLP). Because each business form comes with different tax consequences, you will
want to make your selection wisely and choose the structure that most closely matches your business's
needs.
If one decide to start a business as a sole proprietorship but later decide to take on partners, he can
reorganize as a partnership or other entity. If he do that, be sure of notifying the IRS as well as your state
tax agency.
When beginning a business, one must decide what form of business entity to establish. Your form of
business determines which income tax return form one have to file. The most common forms of business
are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC)
is a relatively new business structure allowed by state statute.  Legal and tax considerations enter into
selecting a business structure.

SOLE PROPRIETORSHIP:
The simplest structure is the sole proprietorship, which usually involves just one individual who
owns and operates the enterprise. If one intend to work alone, this structure may be the way to go.
The tax aspects of a sole proprietorship are appealing because the expenses and your income from the
business are included on your personal income tax return, Form 1040. Your profits and losses are recorded
on a form called Schedule C, which is filed with your 1040. The "bottom-line amount" from Schedule C is
then transferred to your personal tax return. This is especially attractive because business losses you suffer
may offset the income you have earned from your other sources.
As a sole proprietor, you must also file a Schedule SE with Form 1040. You use Schedule SE to calculate
how much self-employment tax you owe. In addition to paying annual self-employment taxes, you must
make estimated tax payments if you expect to owe at least $1,000 in federal taxes for the year after
deducting your withholding and credits, and your withholding will be less than the smaller of: 1) 90 percent
of the tax to be shown on your current year tax return or 2) 100 percent of your previous year's tax liability.
The federal government permits you to pay estimated taxes in four equal amounts throughout the year on
the 15th of April, June, September and January. With a sole proprietorship, your business earnings are taxed
only once, unlike other business structures. Another big plus is that you will have complete control over
your business--you make all the decisions.
There are a few disadvantages to consider, however. Selecting the sole proprietorship business structure
means you are personally responsible for your company's liabilities. As a result, you are placing your assets
at risk, and they could be seized to satisfy a business debt or a legal claim filed against you.
Raising money for a sole proprietorship can also be difficult. Banks and other financing sources may be
reluctant to make business loans to sole proprietorships. In most cases, you will have to depend on your
financing sources, such as savings, home equity or family loans.

A sole proprietor is someone who owns an unincorporated business by himself or herself. However, if you
are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect
to treat the LLC as a corporation.

If you are a sole proprietor use the information in the chart below to help you determine some of the forms
that you may be required to file.

PARTNERSHIP:

If your business will be owned and operated by several individuals, you'll want to take a look at
structuring your business as a partnership. Partnerships come in two varieties: general partnerships
and limited partnerships. In a general partnership, the partners manage the company and assume
responsibility for the partnership's debts and other obligations. A limited partnership has both
general and limited partners. The general partners own and operate the business and assume liability
for the partnership, while the limited partners serve as investors only; they have no control over the
company and are not subject to the same liabilities as the general partners.
Unless you expect to have many passive investors, limited partnerships are generally not the best choice for
a new business because of all the required filings and administrative complexities. If you have two or more
partners who want to be actively involved, a general partnership would be much easier to form.
One of the major advantages of a partnership is the tax treatment it enjoys. A partnership does not pay tax
on its income but "passes through" any profits or losses to the individual partners. At tax time, the
partnership must file a tax return (Form 1065) that reports its income and loss to the IRS. In addition, each
partner reports his or her share of income and loss on Schedule K-1 of Form 1065.
Personal liability is a major concern if you use a general partnership to structure your business. Like sole
proprietors, general partners are personally liable for the partnership's obligations and debts. Each general
partner can act on behalf of the partnership, take out loans and make decisions that will affect and be
binding on all the partners (if the partnership agreement permits). Keep in mind that partnerships are also
more expensive to establish than sole proprietorships because they require more legal and accounting
services.

A partnership is the relationship existing between two or more persons who join to carry on a trade or
business. Each person contributes money, property, labor or skill, and expects to share in the profits and
losses of the business.

A partnership must file an annual information return to report the income, deductions, gains, losses, etc.,
from its operations, but it does not pay income tax. Instead, it "passes through" any profits or losses to its
partners. Each partner includes his or her share of the partnership's income or loss on his or her tax return.
Partners are not employees and should not be issued a Form W-2. The partnership must furnish copies of
Schedule K-1 (Form 1065) to the partners by the date Form 1065 is required to be filed, including
extensions.

If you are a partnership or a partner (individual) in a partnership, use the information in the charts below to
help you determine some of the forms that you may be required to file.

CORPORATION:
The corporate structure is more complex and expensive than most other business structures. A
corporation is an independent legal entity, separate from its owners, and as such, it requires complying with
more regulations and tax requirements.
The biggest benefit for a business owner who decides to incorporate is the liability protection he or she
receives. A corporation's debt is not considered that of its owners, so if you organize your business as a
corporation, you are not putting your personal assets at risk. A corporation also can retain some of its profits
without the owner paying tax on them.
Another plus is the ability of a corporation to raise money. A corporation can sell stock, either common or
preferred, to raise funds. Corporations also continue indefinitely, even if one of the shareholders dies, sells
the shares or becomes disabled. The corporate structure, however, comes with a number of downsides. A
major one is higher costs. Corporations are formed under the laws of each state with its own set of
regulations.
One will probably need the assistance of an attorney to guide you. In addition, because a corporation must
follow more complex rules and regulations than a partnership or sole proprietorship, it requires more
accounting and tax preparation services.
Another drawback to forming a corporation: Owners of the corporation pay a double tax on the business's
earnings. Not only are corporations subject to corporate income tax at both the federal and state levels, but
any earnings distributed to shareholders in the form of dividends are taxed at individual tax rates on their
personal income tax returns.
One strategy to help soften the blow of double taxation is to pay some money out as salary to you and any
other corporate shareholders who work for the company. A corporation is not required to pay tax on
earnings paid as reasonable compensation, and it can deduct the payments as a business expense. However,
the IRS has limits on what it believes to be reasonable compensation.

In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation's
capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable
income. A corporation can also take special deductions. For federal income tax purposes, a C corporation is
recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays
taxes and distributes profits to shareholders.

The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders
when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when
it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.
If you are a C corporation, use the information in the chart below to help you determine some of the forms
you may be required to file.

Corporations that have assets of $10 million or more and file at least 250 returns annually are required to
electronically file their Forms 1120 and 1120S for tax years ending on or after December 31, 2006. For
more e-file information, see References/Related Topic listed below.

S CORPORATIONS:
 

S corporations are corporations that elect to pass corporate income, losses, deductions and credit through
to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of
income and losses on their personal tax returns and are assessed tax at their individual income tax rates.
This allows S corporations to avoid double taxation on the corporate income. S corporations are
responsible for tax on certain built-in gains and passive income.

To qualify for S corporation status, the corporation must meet the following requirements:

 Be a domestic corporation
 Have only allowable shareholders
o including individuals, certain trust, and estates and
o may not include partnerships, corporations or non-resident alien shareholders
 Have no more than 100 shareholders
 Have one class of stock
 Not be an ineligible corporation i.e. certain financial institutions, insurance companies, and
domestic international sales corporations.

In order to become an S corporation, the corporation must submit Form 2553 Election by a Small
Business Corporation (PDF) signed by all the shareholders.

Limited Liability Company (LLC)

A Limited Liability Company (LLC) is a business structure allowed by state statute. LLCs are popular
because, similar to a corporation, owners have limited personal liability for the debts and actions of the
LLC. Other features of LLCs are more like a partnership, providing management flexibility and the
benefit of pass-through taxation.Owners of an LLC are called members. Since most states do not restrict
ownership, members may include individuals, corporations, other LLCs and foreign entities. There is no
maximum number of members. Most states also permit “single member” LLCs, those having only one
owner.

A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check your
state’s requirements and the federal tax regulations for further information. There are special rules for
foreign LLCs.

Classifications

The federal government does not recognize an LLC as a classification for federal tax purposes. An LLC
business entity must file as a corporation, partnership or sole proprietorship tax return.

An LLC that is not automatically classified as a corporation can file Form 8832 to elect their business
entity classification. A business with at least 2 members can choose to be classified as an association
taxable as a corporation or a partnership, and a business entity with a single member can choose to be
classified as either an association taxable as a corporation or disregarded as an entity separate from its
owner, a “disregarded entity.” Form 8832 is also filed to change the LLC’s classification.

Effective Date of Election

The election to be taxed as the new entity will be in effect on the date the LLC enters on line 8 of Form
8832.  However, if the LLC does not enter a date, the election will be in effect as of the form’s filing
date.  The election cannot take place more than 75 days prior to the date that the LLC files Form 8832 and
the LLC cannot make the election effective for a date that is more than 12 months after it files Form
8832. However, if the election is the “initial classification election,” and not a request to change the entity
classification, there is relief available for a late election (more than 75 days before the filing of the Form
8832).

Organizational Structure of MNCs

 Defining Organizational Structure

Vertical Differentiation

 Arguments for Centralization

 Horizontal Differentiation

 International Division

 Worldwide Area Structure

 Network Structure.
Chapter Summary:

Organizational structure is a representation of the formal reporting relationships within an organization.

While a narrow span of control creates a tall organization with many managers and centralized decision
making, wide span creates a flat organization with fewer managers and more delegation of authority. The
degree to which authority is delegated determines centralization and decentralization.

Though centralization helps avoid conflict of interest that could arise in a decentralized environment, it
generally leads to slower, ineffective and inefficient decision-making. Horizontal differentiation is
concerned with how the departments in an organization function together. An organization based on
functions is the traditional and the most logical. 

But a firm offering many product lines, will find this structure less successful. In a product division based
organizational structure, product heads are responsible for all functions relating to a product. This enables
the managers to gain expertise of various functions relating to the product. Marketing plans can vary
among product groups and need not be tied up with the overall organizational marketing plan. 

Most MNCs in their initial stages of globalization employed an international division covering certain
regions of the world to supervise the functions in those regions. But conflicts could arise between the
functional heads and the heads of the international division. 

WorldWide Area Structure and Strategic Business Units (SBU) are more popular forms of organizational
structure in big corporations. SBUs function as independent organizations with a separate income
statement and balance sheet. But the challenge of globalization and the growth in technology have
brought about more complex organizational structures like the Matrix structure and the management
networks. 

Matrix organizations are a hybrid of the functional and divisional structures. Normally, this results in a
subordinate having to report to two bosses. But matrix structures can prove very effective without any
conflict in the reporting relationships, if they are well chalked out. Network or virtual organizations use
technology to collect and disseminate information. They identify customer requirements and deliver
products and services through a network of specialists.
EVOLUTION OF MNC:
Historically, a firm reorganizes as it internationalizes to accommodate new strategies. The structure
typically continues to change over time with growth and with increasing levels of investment or diversity
and as a result of the types of entry strategy chosen. Internationalization is the process by which a firm
gradually changes in response to international competition, domestic market saturation, and the desire for
expansion, new markets, and diversification. As discussed in Chapter 6, the firm's managers weigh
alternatives and decide on appropriate entry strategies. Perhaps the firm starts by exporting or by acting as a
licensor or licensee and then, over time, continues to internationalize by engaging in joint ventures or by
establishing service, production, or assembly facilities, or alliances, abroad, moving into a global strategy.
At each stage, the firm's managers redesign the organizational structure to optimize the strategy's chances to
work, making changes in the firm's tasks and relationships and designating authority, responsibility, lines of
communication, geographic dispersal of units, and so forth. This model of structural evolution has become
known as the stages model, resulting from Stopford and Wells' research on 187 U.S. MNCs. Of course,
many firms do not follow the stages model because they may start their internationalization at a higher level
of involvement - perhaps a full-blown global joint venture without ever having exported, for example. 

Even a mature MNC needs to make structural changes from time to time to facilitate changes in
strategy - perhaps a change in strategy from globalization to regionalization (as discussed in Chapter 6. or an
effort to improve efficiency or effectiveness. The reorganization of Aluminum Company of America
(Alcoa), for example, split the company into smaller, more autonomous units. This reorganization gives
more focus to growing businesses, such as automotive products, where the market for aluminum is strong. It
also enables Alcoa to link businesses with similar functions that are divided geographically - that is, to
improve previously insufficient communication between Alcoa's aluminum operations in Brazil and its
Australian counterparts.
The typical ways in which firms organize their international activities are shown in the following list.
(Larger companies often use several of these structures in different regions or parts of their organization.)
After discussing some of these structural forms, we will introduce new, transitional organizational
arrangements. 

• Domestic structure plus export department 

• Domestic structure plus foreign subsidiary 

* International division 

• Global functional structure 

As discussed, many firms - especially the smaller ones - start their international involvement by exporting.
For this they may simply use the services of an export management company, or they may reorganize into a
simple domestic structure plus export department. 

To facilitate access to and development of specific foreign markets, the firm can take a further step toward
worldwide operations by reorganizing into a domestic structure plus foreign subsidiary in one or more
countries (as illustrated in Exhibit 8-1.. To be effective, subsidiary managers should have a great deal of
autonomy and should be able to adapt and respond quickly to serve local markets. This structure works well
for a company with one or a few subsidiaries located relatively close to headquarters. 

With further market expansion, the firm may then decide to specialize by creating an international division,
organized along functional, product, or geo graphic lines. With this structure, the various foreign
subsidiaries are under the international division, and subsidiary managers’ report to its head, typically called
as organization structure.

The Organization Structure of a Multinational Company:

Multinational companies are faced with two opposing forces when designing the structure of their
organization. They are faced with the need for differentiation that allows them to be specialized and
competitive in their local markets. They are also faced with the need to integrate. The structures adopted
therefore have to find a balance between these opposing needs and also remain in strategic alignment for the
company to thrive. Multinational companies have therefore evolved many structural permutations to suit
their business needs.

Subsidiary Model:
1. Owning foreign subsidiaries is one of the most basic structural models of a multinational company.
The subsidiaries are self-contained units with their own operations, finance and human resource functions.
Thus the foreign subsidiaries are autonomous allowing them to respond to local competitive conditions and
develop locally responsive strategies. The major disadvantage of this model however is the decentralization
of strategic decisions that makes it difficult for a unified approach to counter global competitive attacks.

Product Division:
2. Organizational structure of the multinational company in this case is developed on the basis of its
product portfolio. Each product has its own division that is responsible for the production, marketing,
finance and the overall strategy of that particular product globally. The product organizational structure
 allows the multinational company to weed out product divisions that are not successful. The major
disadvantage of this divisional structure is the lack of integral networks that may increase duplication of
efforts across countries.

Area Division
3. Organization using this model is again divisional in nature, and the divisions are based on the
geographical area. Each geographical region is responsible for all the products sold within its region.
Therefore all the functional units for that particular region namely finance, operations and human resources
are under the geographical region responsibility.This structure allows the company to evaluate the
geographical markets that are most profitable. However communication problems, internal conflicts and
duplication of costs remain an issue.

Functional Structure:
4. Functions such as finance, operations, marketing and human resources determine the structure of the
multinational company in this model. For example, all the production personnel globally for a company work
under the parameters set by the production department. The advantage of using this structure is that there is
greater specialization within departments and more standardized processes across the global network. The
disadvantages include the lack of inter department communication and networking that contributes to more
rigidity within the organization.

Matrix Structure:
5. Matrix organizational structure is an overlap between the functional and divisional structures. The
structure is characterized by dual reporting relationships in which employees report both to the functional
manager and the divisional manager. Work projects involve cross-functional teams from multiple functions
such as finance, operations and marketing. The members of teams would report both to the project manager
as well as their immediate supervisors in finance, operations and marketing. The advantage of this structure
is that there is more cross-functional communication that facilitates innovation. The decisions are also more
localized. However there can more confusion and power plays because of the dual line of command.

Transnational network:
6. Evolution of the matrix structure has led to the transnational network. The emphasis is more on
horizontal communication. Information is now shared centrally using new technology such as "enterprise
resource planning (ERP)" systems. This structure is focused on establishing "knowledge pools" and
information networks that allow global integration as well local responsiveness.