The Ernst & Young Business Plan Guide, Third Edition

Chapter Three. Legal Forms of a Business: Focusing on the Need for Protection, Simplicity, and Taxation

Business Formation

Over the course of more than 75 years of collective practice, the authors have worked with many companies organized in numerous different structures. Some have focused on simplicity, while others have focused more closely on tax planning.

A family-owned business (Business 1) had invested a great deal of time and effort in being organized in a tax-efficient structure. Because of this, the occurrence of a major liquidity event came with minimal tax consequences. Money was earned with one level of taxation and much of the proceeds safely tucked away in generation-skipping trusts, which will effectively manage estate-tax liabilities in the future.

When discussing major liquidity events, Business 2, a business owned by venture investors and the founder, was faced with many adverse tax consequences to both the potential buyer and the seller. A transaction could trigger taxes on actual realized profits and also taxes on unrealized profits that may or may not occur in the future. Each planning idea discussed was fraught with risk and uncertainty, and could require the payment of large up-front taxes to execute. A sale of the business would create either two levels of taxation or a reduction in the selling price to compensate the buyer for lost tax benefits.

While tax efficient, Business 1 has had a structure with a great deal of complexity and high bills for tax compliance. ...