L 201 Class 9- Chapter 37 and 41

Corporation Regulations

- Created under state law - State of incorporation has primary jurisdiction over what corporation may do - About 40% of corporations listed on New York Stock Exchange are incorporated in Delaware - Liberal corporation statute - Low incorporation fees

business organization

- FORM business will take - Liability - Taxation - Control

Improper Purpose:

- defrauding creditors by thinly capitalizing corporation or by looting corporate assets - Circumventing a statute - Evading an existing obligation

Why do people form a partnership?

- requires no formalities and may be formed by default - each partner's right to manage the business - taxes flow to partners - partners profit - control

Two requirements must exist for a court to pierce the corporate veil:

1) Domination of a corporation by its shareholders 2) Use of that domination for an improper purpose

Three classes of corporations:

1) For-profit (publicly held and close, most common) 2) Not for profit 3) Government owned

The following characteristic(s) distinguish(es) an S Corporation from other corporations:

An S Corporation may only be owned by individuals and trusts. - An S Corporation may have only one class of shares. - An S Corporation must elect S Corporation status under the Internal Revenue Code. - An S Corporation may have no more than 100 shareholders.

Advantages of Sole Proprietorship

Easiest to start Inexpensive Least regulated Single owner keeps all the profits Taxed once as personal income No formalities Cannot sue or be sued

T/F: A limited partnership only allows for one type of partner

False

T/F: It is possible to create a corporation without a government's permission.

False

A business form designed to combine the non-tax advantages of corporations with the favorable tax treatment of partnerships is a(n):

Limited Liability Company

Which of the following would allow or an accountant, a physician, or a dentist to incorporate their practice?

Professional Corporation

Why can a parent corporation cause its subsidiary to transact with it in a manner that benefits the parent but harms the subsidiary?

The parent elects the directors of its subsidiary and therefore, can control the management of the subsidiary

Characteristics of corporations (management, owner's liability, transferability of owner interest, double taxation)

Management: - By board of directors who is elected by shareholders - Board of directors may delegate management to officers - Shareholder has no right or duty to manage unless elected to board of directors or appointed as an officer - Directors and officers need not be shareholders Owner's Liability: - Shareholders have limited liability - Shareholders not liable for debts of corporation after have paid promised capital contributions to corporation Transferability of Owner Interest: - Generally freely transferable - Purchaser has same rights as seller Double taxation: - Corporation pays federal income taxes on income - Shareholders taxed only on distributions (dividends)

Partnership:

- A form of business organization; specifically, an association of two or more persons to carry on a business as co-owners for profit - Partners make all management decisions and all the profits are shared equally - Partners assumes personal liability for all obligations of the business and the debts - Liable for torts committed and is the assets of the business are insufficient to pay then one of the partners may have to pay more of his share - Liability: Unlimited - Not a tax-paying entity for federal income tax purposes BUT is a legal entity - All the income must be reported on the individual partners' federal income tax returns - When a partners dies or leaves the business: the partnership usually continues - A partner's ownership interest in a partnership is not freely transferable: a purchaser of the partner's interest is not a partner of the partnership (unless they both agree)

Government-owned corporations

- Owned by governments and perform governmental and business functions - A municipality city is one type, school corporations and water companies

A benefit of the sole proprietorship form of business is that

As the only owner, the sole proprietor makes all decisions and keeps all profits.

All states, except ___, permit professionals to organize as a limited liability company:

California

Greg is a sole proprietor of Greg's Bakery and owes a number of business creditors. The business creditors

Can sue Greg and not Greg's Bakery, since sole proprietorship is not a legal entity

This business form is unique from many other business forms because ownership and management are completely separate:

Corporation

Characteristics of corporations (creation, legal status and power)

Creation: permission by the government Legal Status: - Legal entity independent of its owner (shareholders) and managers (officers and board of directors) - Legal person under US Constitution - Unaffected by retirement/death of shareholders/directors/officers Power: - may acquire, hold, and covey property in its own name - may sue or be sued in its own name - Harm to a corporation is not harm to the shareholders

Jim created a shoe-manufacturing corporation by contributing $1,000. He stayed as the sole shareholder and director of the corporation. To inject further capital into the corporation, he loaned the corporation $100,000 and secured the loan in exchange for all the corporation's assets. Five years into operations, the corporation has still failed to make profits and consequently filed for bankruptcy. Who has been defrauded?

Non-shareholders creditors

A business form owned by shareholders who elect a board of directors to manage the business, but enjoy tax status similar to that of a partnership is called a(n):

S Corporation

A business form in which there is only one owner is called a

Sole Proprietorship

Sole Proprietorship (most common form of business in the US):

- A form of business under which one person owns and controls the business - Makes all of the management decisions Unlimited liability - All of the profits = his/hers - Not a legal entity: cannot sue or be sued (creditors sue the owner) - Under the law of agency the sole proprietor is responsible for her employees' authorized contracts and for the torts they commit - Not a tax-paying entity for federal income tax purposes, only sole prop. taxed - All the income of a sole proprietorship is income its owner and must be reported on the sole proprietor's individual deferral income tax return - Must sue the business owner - Has no life apart from its owner

Thin capitalization:

- A ground for piercing the corporate veil due to the shareholders' contributing too little capital to the corporation in relation to its needs · Defrauds creditors of a corporation · Also know as: inadequate capitalization · An example: forming a business with a high debt-to-equity ratio, such as $10 million-asset business with only $1,000 of equity capital

Limited Liability Partnership (best for professionals)

- A partnership that has elected to obtain limited liability for its partners by filing with the secretary of state, agreement of owners and limited liability statute - They have large personal liability sometimes imposed on accountants and lawyers for professional malpractice of their partners - LLP is identical to partnership EXCEPT: they have no liability for most LLP obligations and retains unlimited liability for his own wrongful acts (such as malpractice liability to a client) - May elect to have the LLP taxed like a partnership or a corporation · If taxed like a corporation, it pays federal income tax on its income, but the partners pay federal income tax only on the compensation paid and the partnership profits distributed to the partners - Transferability of owner's interest: limited - Good form of business for professionals such as consultants and auditors, allowing them management flexibility while insulating them mostly from personal liability - HAS LIMITED LIABILITY , taxes flow to partners, profit, control (advantage)

Not-for-profit corporations

- Do not issue stock and do not expect to make a profit - Provide services to their members under a plan that eliminates any profit motive - These corporations have members rather than shareholders - Generally pay no income-tax, so they can reinvest a larger share of their incomes in the business than can for-profit - Charities, churches, fraternal organizations, community art councils

S corporations

- Formation: by agreement of owners, must comply with corporation statute, must elect S Corp status under IRC - Management: Board of directors - a close corporation whose shareholders have elected to be taxed essentially like partners are taxed under federal income tax law (called subchapter S corporation) income and losses of federal income tax returns - Only shareholders taxted · Advantage: losses of the business are deductible on individual federal income tax returns · Limited to 100 shareholders or less, its ability to raise capital is severely limited ability to raise capital

Professional Corporation:

- Formed by filing with the secretary of state - Managed by a board of directors, unless a statute permits it to be managed like a partnership. - It is a ridged management structure that makes it inappropriate for some smaller professional practices - Shareholders have no personal liability for the obligations of the professional corporation, such as a building lease, they retain unlimited liability to their clients for their professional malpractice - Usually for shareholders of a professional corporation that practices a certain area, for example medicine or a dentist

Disadvantages of sole propeietorship

- Great deal of liability and very risky · Debts of the business · If the assets of the business are insufficient to pay the claims of its creditors, the creditors may require the sole proprietor to pay the claims using his individual assets from his/her own bank account · May lose everything if his/her business becomes insolvent

In a traditional partnership, the partners

- Have the right to make all the management decisions for the business. - May deduct any business losses on their individual tax returns. - Share all the profits of the business equally unless there is an agreement otherwise. - Assume personal liability for all obligations of the business.

Domination:

- If a shareholder causes the corporation to act for the personal benefit of the shareholder OR - Failing to observe corporate formalities * Maintain separate accounting records * Failing to hold shareholders and direct meetings

Limited Liability Company (LLC)

- Intended to combine the non-tax advantages of corporation's with the favorable tax treatment of partnerships. Members, who may manage the LLC themselves or elect the manager or mangers that will operate the business own an LLC. Members have limited liability. - All states, besides California permit professionals to organize as LLCs - Professionals have unlimited liability for their own malpractice - Limited free transferability of the LLC member's ownership interests

for-profit corporation

- Issue stock to their shareholders, who invest in the corporation with the expectation that they will earn a profit on their investment - Take the form of dividends paid by the corporation or increased market value of their shares - Incorporated under the general incorporation law of a state - Professional who wish to incorporate (dentists, physicians, lawyers, accountants) to incorporate under professional corporation acts - Corporations with very few shareholders whose shares are not available to the general public are called: close corporations, the controlling shareholders are the only managers of the business

Limited Liability Limited Partnership:

- Limited partnership that has elected to obtain liability status for all of its partners including general partners, by filing with the secretary of state - It is identical to a limited partnership in its management and rights and duties of its partners, however both the limited partners and general partners will have no liability for most obligations of the LLLP - Management: by general partners - Transferability: limited - Federal income taxation: usually only partners taxed, may elect to be taxed like a corp - A general partners will have unlimited liability for any torts he commits

Limited Partnership

- One or more general partners who manage the business and have unlimited liability for the obligations of the business and one ore more limited partners who have limited liability - Have unlimited liability for the obligations of the limited partnership (usually a corporation) - Have no liability for the obligations of the limited partnership once they have paid their capital contributions to the limited partnership - Have no right to manage the business - May elect to be taxed either as a partnership (usually) or as a corporation if like a corporation, pay federal income tax on net income - May be created only by complying with a state statute permitting limited partnerships - can attract large amounts of capital

Corporation (raise largest amount of capital):

- Owned by owners, called shareholders, who have no inherent right to manage the business, and is managed by a board of directors that is elected by the shareholders - Board of directors often selects officers to run the day-to-day affairs of the business - Ownership and management may be completely separate: no shareholder has the right to manage, and no officer or director needs to be a shareholder - Shareholders have limited liability for the obligations of the corporation, even if a shareholder is elected as a director or selected as an officer - Directors and officers have no liability for the contracts they or the corporation's employees sign only in the name of the corporation - Managers have liability - Shareholders, officers, and directors have limited liability for the obligations of the business - Tax-paying entity for federal income tax (pays tax on profits) - Do not deduct corporate losses on their individual returns, however they deduct their investment losses after they have sold their shares of the corporation - Share holders may elect to have the corporation and its shareholders taxed under Subchapter S of the Internal Revenue Code - Special corporate form: B-Corp

What is/are the advantage(s) of a manager-managed limited liability company?

- The LLC and its members may elect to receive federal tax treatment similar to the S Corporation and its shareholders. - The LLC has no restrictions on the type of owners it may have. - The LLC has no limit on the number of owners it may have. - Limited Liability

Piercing the Corporate Veil

- There is an imaginary wall until something happens - Then, loss of limited liability Requirements: - Domination of a corporation by its shareholders AND - Use of that domination for an improper purpose (thin capitalization, looting, circumventing a statute, evaluating an existing obligation)

History of corporations

- special charter from state legislatures; few granted - late 1700's, general incorporation statutes (at first, for limited purposes beneficial to public and many restrictions) - During the last 150 years, restrictive provisions have mostly disappeared - Modern incorporation statutes mostly enabling, granting great flexibility in establishing, financing, and operating

Looting:

- transfers of corporate assets to shareholders for less than fair market value (also defraud creditors) · May also occur when one corporation (called parent corporation) owns at least a majority of the share of another corporation (called the subsidiary corporation) · Parent is liable for its own obligations and the subsidiary is liable for its own obligations, parent is not liable for the parent's debts

Three main reasons for LP:

1) By using a corporate general partner, no human will have unlimited liability for the debts of the business 2) If the limited partnership is taxed like a partnership, losses of the business are deductible on the owners' federal income tax returns 3) Investors may contribute capital to the business yet avoid unlimited liability and the obligation to manage the business (attract large amounts of capital)

Advantages of Limited Liability Company

1) Limited liability advantage and if manager-managed, the management advantage of the corporation 2) Members may elect to receive federal tax treatment similar to the S corporation and its shareholders 3) has no limit on the number or types of owners 4) Most flexible

Main reasons to start a corporation:

1) No human has unlimited liability for the debts of the business 2) Investors may contribute capital to the business, avoid unlimited liability, escape the obligation to mange the business and easily liquidate their investments by selling their shares 3) attract large amounts of capital

Which of the following statements about professional corporations is FALSE?

A professional corporation's shareholders have personal liability for the obligations of the professional corporation

The business form that is identical to the limited partnership, except that both limited partners and general partners have no liability for most obligations is called a(n):

Limited Liability Limited Partnership

A business form that is managed by partners who all share the same rights and liabilities, limits partners' liability to only their individual torts, and is formed by agreement of the owners in compliance with the relevant statute is a(n):

Limited Liability Partnership

Which of the following business forms is an especially good form of business for professionals such as consultants and auditors, allowing them management flexibility while insulating them mostly from personal liability?

Limited liability partnership

For a business needing millions of dollars of capital, wanting only a few owners to manage the business, and expecting to lose money in its early years, what business form would be particularly attractive?

Limited partnership or limited liability limited partnership.

Disadvantage of LLP

Must comply with limited liability partnership statute

In which of the following business forms are all of the partners liable for the torts that are committed in the course of business by their partners?

Partnership

Which of the following business forms includes unlimited liability, allows for the partners to be taxed individually, and can be formed automatically when there are people acting in concert and do not select an alternative business form?

Partnership

A liability inherent in a sole proprietorship is that the sole proprietor is:

Personally liable for costs associated with poor business decisions.

Which of the following business forms means personal liability for the owner of the business?

Sole proprietorship

The limited liability partnership is a business form that was created first in the state of __, in __.

Texas, 1991

The primary difference between a limited partnership and a limited liability limited partnership is

The limited partners and the general partners in a limited partnership (LP) will have no liability for most obligations of the limited liability limited partnership. LLLP no liability

T/F: In a close corporation, the controlling shareholders are usually the people who manage and operate the company.

True

T/F: The decision on what form of business to make a startup business is important because it will affect the business owner's liability and control of the business.

True

Disadvantage of partnership:

bear all risk of loss jointly and severally