what business entity structure should be used

The company should operate as a C corporation. There are a few reasons for this choice of business structure. As a sole proprietorship, Bob faces a number of challenges, including the reality that his legal downside includes his personal property. Maintaining his business as a sole proprietorship will also have tax and timing implications for when he wants to pass the business on to his daughter. Therefore, the sole proprietorship should be a non-starter. He has the option of S and C corporations, and there are specific implications for each of these.
An S corporation elects to “pass corporate income, losses, deductions and credits through to their shareholders for federal tax purposes” (IRS.gov, 2020). The company is eligible to be an S corporation, as it meets the criteria that the IRS has laid out. One of the risks, however, is in the transfer of ownership to Mandy, in particular if she would be expected to cover any losses. While the business might be stable and profitable for many years, one never knows when a pandemic will render the business unprofitable. Losses in the event of legal action would be worse, but an S corporation would at least defend Mandy against that. However, she would have to pay taxes on her share of the profits of the dealership, even if she herself earned no cash and the dealership reinvested those profits back into the business. Thus, Mandy would find herself with a tax bill that she might not be able to pay.
According to the IRS, a C corporation is a separate tax-paying entity. This structure would mean that the company pays taxes directly to the IRS, meaning that Mandy would not have a tax burden based on her ownership of the dealership. The tax rate might also be lower. Bob could also transfer the business to Mandy at a time that brings about the lowest combined tax burden on the transfer – Bob would face a capital gain on an S corporation and so there could be significant timing implications for the transfer. Bob definitely wants to have a succession plan for his retirement, and if Mandy is part of that, this is fine, but he should also be aware that the succession plan is a holistic thing, not just a transfer of ownership to the next generation, especially at an age when the daughter’s interest in running that business might be low and her ability to do so negligible. The Small Business Association (2020) notes that there are several tax burdens that could arise from the transfer of 40% of the business, including income tax, gift tax, and estate tax, so it is worth sitting down and mapping out the cash flows, tax burdens and choosing the optimal timing. In that sense, an S corporation probably gives the greatest flexibility for Bob in being able to pass along the business to his daughter.
An S corporation, well any business, should use accrual accounting. Cash accounting is only suitable for very small sole proprietors with low capex and limited lag between revenue accrual and cash payment (Morah, 2020). Accrual accounting seeks to balance out the value of outflows with the value of inflows, and for something like a car dealership with large expensive assets and inventory, should be the standard practice.
The cost to prepare tax returns is not relevant. It costs what it costs, or one can acquire the skills themselves. Limited liability protection is important but both the S and C corporation structures give this – but limited liability is why the sole proprietorship structure should not be used for this business.
It is also possible for employees to receive benefits under either corporation structure, so this is not a differentiator between the two most viable options for Bob and his car dealership.
As such, the main differentiator is with the nature of the taxation, as the difference between an S corporation and a C corporation, and as there are significant implications for succession planning and the C corporation structure provides a lot more flexibility in this regard, and minimizes downside exposure for Mandy in particular.
References
IRS.gov (2020) S corporations. Internal Revenue Service. Retrieved April 12, 2020 from https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations
Morah, C. (2020) Accrual accounting vs cash basis accounting: What’s the difference? Investopedia. Retrieved April 12, 2020 from https://www.investopedia.com/ask/answers/09/accrual-accounting.asp
SBA.gov (2020) Selling a small business and succession planning for small business. Small Business Association. Retrieved April 12, 2020 from https://www.sba.gov/sites/default/files/files/PARTICIPANT_GUIDE_SELLING_SUCCESSION_PLANNING.pdf