Chapter 10: Choosing a Legal Structure

DBA Form

"Doing Business As" form for when you name your business for example "Custom Ag Chemicals" instead of "John Smith Custom Applicator of Agricultural Chemicals" so that the state can link that name with your business

Corporation

*Stock: represents person's ownership in corporation - Common: can vote for Board of Directors - Preferred: usually non-voting & has preferred redemption & sometimes higher dividends *Stockholders: elect directors- directors supervise affairs of corporation

Subchapter S Corporation Qualifications

- 75 stockholders or less - Stockholders are individuals or estates (can't be corporations) - Stockholders cannot be non-resident aliens - Must decide prior to start of corporation's fiscal/calendar year - Domestic corporation - Passive investment income (rents, royalties, interest) < 25% of gross receipts

Disadvantages to Sole Propietorship

- All loses are the owners - Unlimited liability - Only personal and business assets available (limited capital) - Business ends with death (no stability and continuity) - No financial participation by employees

Disadvantages of a Limited Liability Companies (LLC)

- Cannot deduct cost of fringe benefits as business expense - Does not automatically continue upon death of a member

How is Corporate Income Tax Unique

- Corporation subject to business tax is unlike proprietorship and partnership - Rates different than personal tax rates - Payments for labor, management, interest are tax deductible but dividends are not - Double taxation - Corporate profit + dividend

What happens in a general partnership?

- Each person participates in management decisions - Assets jointly owned - Profits/losses are shared - Operate under firm's name - Joint bank account - Single set of business records

Advantages to Sole Proprietorship

- Easiest to create and dissolve - Flexibility to make decisions based on owners best judgement - All profits go to owner - Owners has complete control and privacy/secrecy - Pays no income tax as a business

Advantages of Partnership

- Easy to start (less regulation and lower start-up costs than corporation) - More financial & personal resources than proprietorship (but less than corp.) - Taxes paid only on partner's share of profits (no business tax) - Greater management ability (division of labor)

Written Partnership Agreement should address

- How much control a partner has in business decisions - How much control a partner has over the real and personal property used in the partnership - How are profits and losses distributed among the partners - How does the partnership plan to keep records

Setting up a Corporation (continued)

- Issues stock certificates - Hold the first stockholders' meeting (elect board of directors & adopt bylaws of the corporation) - Elect corporate officers - Set wages and salaries and establish remunerations for assets to be leased to the corporation - Define the corporation's fiscal year

Disadvantages of Corporate Structure

- Lack of secrecy - Corporation taxed on profits & Stockholder taxed on dividends - More difficult to create - More difficult to organize and dissolve - More reporting of activities required

Advantages of Corporate Structure

- Liability limited to firm assets - Same individual legal rights - Operate perpetuity - Lower tax rates generally Tax-deductible employee benefits - Specialized management - Employees profit-sharing & stock purchase plans

Advantages of a Limited Liability Companies (LLC)

- Limited liability - No limit on number of members - Income distributed to individuals for taxes

Setting up a Corporation

- List the goals of the corporation, which can come from the business plan's purpose and objectives - Retain the services of an attorney who is experienced in corporate law - Engage a certified public accountant to set up the accounts and records - Obtain a state corporate charter - Divide stock in accordance with the corporate charter

General Steps of Incorporation

- Organization of responsible people to become official of the new corporation - Filling of the articles of incorporation (basic legal declarations in the corporate charter - Payment of an initial tax and certain fees - Have meeting to deal with specific details of organization and operation

Subchapter S Corporation

- Owners elect to be taxed as individuals - One class of stock

This list is a good starting point to insure that the important decisions are made with the best interest of the company/owner's needs

- Resource acquisition - Continuity of existence - Owners liability - Management participation - Management compensation - Ownership transfer-ability - Record keeping - Tax planning

Limited Partnership

- The general partner is responsible for operations & activities of business and has unlimited liability. - Limited partners can contribute capital, cannot participate in management, and liability is generally limited to amount invested - They are like investors in a corporation

The Family Limited Partnership

- Transfer assets of the farm to family member - Allows young family members to assume managerial responsibility - Disagreements grow as the number of people in the partnership grow

Disadvantages of Partnership

- Unlimited liability of each general partner - Lack of continuity & stability (partner isn't doing fair share) - Difficult to determine value of partner's share (formula and payoff method should be in original agreement - Frozen investment - Business ends with the death of any of the partners

Corporation Types: Cooperatives

- also non-profit organizations that seek the benefits of incorporation - they distribute their profits back to their owner-users who pay taxes on these proceeds at their personal tax rates - individuals who band together to buy and sell so they can lowers their sales and increase their revenues - for this reason they seek to break even on their sales and distribute all revenues above costs back to their owners in accordance with their volume of business with the cooperative

Sole Proprietorship (definition)

- an individual who owns, manages, and assumes all the risk and derives all the profits from a business - no special legal procedures, permits, or licenses are required - not limited in size by input or output - can exist when all land and machinery are leased (not needed to own any assets - as many employees - property may be co-owned

Corporation Types: Closed (or closely held)/Subchapter S

- are a corporate set up designed for small businesses (less than 35 stockholders) - want to simplify management of the corporation and restrict ownership to a defined class of people (often family members)

What happens when a corporation is sued?

- its liability is limited to the corporation's assets including its stock

Corporation (characteristics)

- lasts the longest - it is considered a person in the eyes of the law - it has the legal rights and duties of an individual (it can make contracts, it can transact business, it can hold property, it can sue and be sued

General Partnership characteristics

- most common type of partnership - each partner has equal rights regardless of % of capital - each individual has the right to act as an agent for the partnership - Each general partner is liable for the partnerships debt and all liabilities of the partnership are shared equally

Partnership (definition)

- the voluntary association of two or more people to operate a business for profit - a partner may own some, none, or all of the assets used in the business - shared ownership of the business - each partner has equal rights and responsibilities regardless of % of capital

Corporation Types

1. Business/Subchapter C 2. Non-profit 3. Closed (or closely held) 4. Professional Corporations (PC) 5. Cooperatives

3 types of Partnerships

1. General 2. Limited 3. Registered Limited Liability

3 types of Legal Structure

1. Sole Proprietorship 2. Partnership 3. Corporation

Corporation (definition)

A legal entity that is separate and distinct from shareholders who own it, from the individuals who manage it, and its employees, that is created by state law and organized to carry on a business for profit or non-profit

Terminating a Partnership: operation of law

Dissolution by operation of law occurs in the even of death, bankruptcy, or incapacity of any partner

Terminating a Partnership

Easy to terminate. May be terminated by: agreement, at will, operation of law

Terminating a Partnership: at will

If no duration is fixed by the agreement any partner may terminate the partnership at will

Limited Liability Companies (LLC)

Resembles a partnership and a corporation

How popular is Partnership?

Second most popular

Corporation Types: Professional Corporations (PC)

are businesses composed of professionals such as physicians, lawyers, and accountants who want the benefits that a corporation has such as the tax destructibility of business expenses such as health care and malpractice insurance

Terminating a Partnership: by agreement

between the partners or by the operation of law - usually termination under agreement came to an end when duration term or business is finished

Corporation Types: Non-profit

incorporated so they can gain benefits such as limited liability

A corporation can have perpetual life meaning:

it does not cease operation when one of its owners dies.

Corporation Types: Business/Subchapter C

most common type of for-profit corporation

How popular is Sole Proprietorship?

most popular

hybrid legal structures

partnership + corporation

experienced tax attorneys and tax accountants (sometimes bankers)

show business owners ways to arrange their affairs to limit their tax and liability risks

What sets apart a corporation from partnership and sole proprietors?

the concept of legal separateness

the selection of the legal structure of a business has financial implications (financial involvement) for

the current owners, their heirs, and the existence of the business everyday