Chapter 14, Test 3

Forms of Business Organization

Basic Hybrid

Partnerships: Control

Each partner has equal voice; modified by agreement The possibility of deadlock among partners is very real. Care should be taken to design mechanisms to avoid or at least handle the disputes that will arise when partners share managerial control.

T/F: Ownership of a sole proprietorship can be transferred.

False

T/F: If a sole-proprietor holds money, it is not taxed.

False. If a sole-proprietor holds money, it is still taxed.

T/F: In the corporate form of a corporation, the shareholders elect the officers.

False. Know chart.

S Corporations: Creation

Incorporators apply for state charter with articles of incorporation

Limited Liability Partnership

More complex than general Used to attract investors Supposed to have limited management decision making , but if they get their fingers in management too much, they can lose their limited

Corporation: Delaware (Importance)

More than 50% of publicly traded companies and 60% of Fortune 500 companies are incorporated in Delaware There is a stable legal environment. The Court of Chancery: The Delaware court of chancery is unmatched >The main reason why so many people incorporate in Delaware is because of the great jurisdiction coming out of the Delaware Court of Chancery. >Female African American from UGA on the Court of Chancery: Tamika Montgomery-Reeves (Vice Chancellor) Other reasons: >Legislative support >No income tax for businesses that do not operate in Delaware >Incorporation is easy and efficient

Sole Proprietorship: Creation

No formal documentation - business licenses only • It's the easiest and least expensive business organization to create

Limited Partners

Not responsible for the debts of the business organization, but they're not supposed to be involved in the management

Limited Partnerships: Creation

Partnership agreement and certificate filed in public office (country) where business is conducted (add. copy w/ every office) This certificate contains: the name of the partnership, the character of the business, its location, the name and place of residence of each member, those who are to be the general partners and those who are to be the limited partners, the length of time the partnership is to exist, the amount of cash or the agreed value of property to be contributed by each partner, and the share of profit or compensation each limited partner shall receive.

S Corporations: Continuity

Perpetual, so long as number of shareholder limited

Corporation: Liability

Shareholder obligations limited to investment, absent other commitments Limited personal liability isn't guaranteed. >When courts find that a corporate organization is being misused: >>"Piercing the corporate veil" >>Once the veil has been pierced, the shareholders are treated like partners with unlimited personal liability Alter Ego Theory

Sole Proprietorship: Control

Total control by proprietor • Owned and run by one individual; there is no legal distinction between the owner and the business. ○ Individual and business are one and the same. • Business owned by one person who is entitled to all of its profits • Businesses owned by one person in which others work for them. • More than 75% of all US businesses are sole proprietorship

Continuity of the Organization

a. Associated with the stability or durability of an organization b. The crucial issue with this continuity factor is the method by which a business organization can be dissolved.

Managerial Control of decision

a. Concerns who's in charge i. You have to consider potential conflicts and the mechanisms in place to resolve disputes ii. The worst ever is family going into business together. iii. Failure to consider these kinds of disputes can cause the business to suffer or die altogether.

3. Criminal Prosecutions for corporate wrongdoing may be declining due to the increased use of "deferred prosecution agreements" (DPAs) by the federal government.

i. A DPA is used to encourage self-reporting and remediation of illegal acts before a criminal case is commenced. ii. This alternative avoids some of the harsh consequences that can accompany prosecutions while still addressing the crime itself. iii. There is some concern that the overuse of DPAs could lead to an overly lenient environment for addressing corporate malfeasance. >> 1. Perhaps some companies will be perceived as "too big" to jail.

2. Continued Defamation of a Corporation's "Personhood"

i. Corporations are considered legal persons under the law. ii. The words "persons" and "whoever" include corporations, companies, etc. as well as individuals. iii. Corporations and individuals have largely equal rights.

Technically, a ___ is an agent appointed by a shareholder for the purpose of voting the shares.

proxy

Double Taxation

when a corporation makes a profit so that it is taxed at the corporate level and then dividends are paid and shareholders are taxed too

Limited Partnerships

• The same as a partnership except 1 or more partners are designated as limited partners • Includes all the attributes of a partnership Limited Partners General Partners

Hybrid

○ Limited partnerships ○ S corporations ○ Limited liability companies ○ Limited liability partnerships

S Corporations: pros/cons

S Corporations have distinct advantages for a business operating at a loss because the loss is shared and immediately deductible on the returns of the shareholders. It is also advantageous for businesses capable of paying out net profits as earned. If net profits must be retained in the business, Subchapter S tax treatment is disadvantageous because income tax is paid on earnings not received, and there is danger of double taxation.

S Corporations: Liability

Shareholder obligations limited to investment, absent other commitments • A corporation whose shareholders elect to pass income, losses, etc. to their shareholders for income tax purposes ○ Allows the S Corp to avoid the double tax ○ May not be good if the profits are not distributed to the shareholders

5 Factors to Consider When Selecting a Business's Organizational Form

1. Cost of creation 2. Continuity of the Organization 3. Managerial control of decision 4. Owner Liability 5. Taxation

Publicly held

Businesses held by hundreds or thousands of persons Examples: businesses whose stock is traded on a public exchange

Corporation : Taxation

Corporate income taxed; shareholders taxed only on income distributed Net operating loss to a corporation can be used only to offset corporate income earned in other years. Double Taxation

Types of Partnerships

General Partnership Limited Liability Partnership Joint Venture Partnership

Taxation

a. Often viewed as the most critical factor b. Some formations are single-tax, and others are double-tax. c. Which is better depends on your organization. i. A single tax is not always better than a double tax.

Proxy

an agent appointed by a shareholder for the purpose of voting the shares.

Limited liability company (LLC): taxation

nontaxable entities

Sole Proprietorship: Pros/ cons

• Pros: ease of management • Cons: unlimited liability, tax

Basic

○ Sole proprietorships ○ Partnerships ○ Corporations

Corporate Control: Closely held

In closely held corporations, those who rule the majority have managerial control. One shareholder may be able to control a closely held corporation. Those who own a majority of a closely held corporation can rule with near-absolute authority. The owners of the minority interest are subject to the decisions of the majority.

Corporate Control: Publicly held

In publicly held corporations, control is maintained with a very small percentage of stock ownership through the use of corporate records and funds to solicit proxies. Management can, at corporate expense, solicit the right to vote the stock of shareholders unable to attend the meetings at which the directors of the company are elected. >An outsider must either own sufficient stock to elect the directors or must solicit proxies at his or her own expense. The management of a large corporation usually can maintain control with only a small minority of actual stock ownership.

1. Emergence of a Benefit Corporation

i. Benefit corporation combines aspects of non-profit and profit organization ii. Push forward social-oriented goals while permitting the business to make a profit iii. Comes from the perception that traditional corporate forms place too much emphasis on profit maximization.

Dissolution

i. Dissolution: any change in the owner of an organization that changes the legal existence of the organization 1. Not to be confused with "terminating" 2. Termination is not the same as disillusion. a. Terminating involves the winding up or liquidating of a business b. In dissolution, the legal form of the corporation no longer exists. 3. Dissolution can take a very long time, but termination is effective immediately.

S Corporations Qualifications

○ Needs to be a domestic corporation ○ Need to be individuals (not "persons" like corporations, partnerships, etc.) • If you have a corporation as a shareholder, it cannot be a S corporation ○ No more than 100 shareholders ○ Can only have one class of stock ○ Can't be an ineligible institution

Limited liability company (LLC)

○ Treated as nontaxable entities ○ Owners have more flexibility compared with S corporation ○ Business structure that combines the pass-through taxation of a partnership/sole-proprietorship with the limited liability of a corporation. ○ Not a corporation.

Limited liability partnership (LLP)

○ Variation of the LLC ○ Have characteristics of both a partnership and a corporation ○ Has no general partners ○ All of the owners have limited personal liabilities ○ People who don't want to be liable for another person's problems like LLCs. • You're not responsible for the other members of the LLP. ○ Licensed professionals like lawyers, accountants, doctors, etc. like LLPs

Limited Partnerships: Continuity

Dissolved when general partner withdraws A limited partner may assign his interest to another without dissolving the limited partnership.

Deciding on Organizational Form

1. Emergence of a Benefit Corporation 2. Continued Defamation of a Corporation's "Personhood" 3. Criminal Prosecutions for corporate wrongdoing may be declining due to the increased use of "deferred prosecution agreements" (DPAs) by the federal government.

Ways to avoid double taxation

1. Payment of reasonable salaries to corporate officials 2. Use of reasonable expense accounts for employees >>Expense has to be directly related to business activity >>Meals can't be lavish; must have business right before/during/after a meal. 3. Instead of issuing stock in the full amount, the corporation can issue some stock and then borrow the rest of the money from shareholders; pay interest >>Deductible as an expense 4. Not paying dividends and allowing income to accumulate in the corporation (so that only the corporation will pay tax on this) >>When a corporation retains earnings in excess of $250,000, there is a presumption that these earnings are being accumulated to avoid a second tax on dividends. If the corporations cannot rebut this presumption, an additional tax is imposed. 5. A corporation can elect to become an S Corporation.

3 Part Test (Alli v U.S) (Piercing Corp Veil)

1. The corporate entity must be a mere instrumentality of another entity or individual 2. The corporate entity must be used to commit a fraud or wrong 3. There must've been an unjust loss or injury to the party seeking to pierce the veil.

Limited liability company (LLC): Creation

>Distinct terminology from that of a corporation. >Not incorporators, but organizers. >Organizers craft articles of organization. >The organizers file the articles of organization into the Secretary of State. > Naming: has to include some form of LLC in the title >An LLC must file annual reports with the states in which it operates.

Limited liability company (LLC): Continuity

>The owners of LLCs are called "members" rather than shareholders or partners >Membership in LLCs is not limited to individuals. >Unlike in the S corporation, a business organization can be an owner in any LLC. >Transferability is restricted similar to that of a partnership

Limited liability company (LLC): Control

>Vested in members unless the articles of organization provide for one or more managers >Members are not liable to third parties >When a member is in the minority with respect to decisions being made on behalf of the LLC, that dissenting member may have rights very much like a dissenting shareholder in a corporation. These rights include bringing a derivative lawsuit against the controlling members of the LLC. Ultimately, a dissenting member has the right to sell the membership interest to the other members of the LLC. In the absence of expressed statutory guidance, most LLCs are held to the same alter-ego corporate veil piercing as corporations. >>Harder to pierce than corp b/c have to show that members comingle funds w/ LLC

Assumed-name statute

A rule for naming a partnership If the name is other than that of the partners, the partners must give notice as to their actual identity under the state's assumed-name statute.

Partnerships: Creation

Automatic based on business conduct; modified by agreement The key to a partnership's existence is satisfying the elements of its definition: i. Two or more persons ii. A common interest in business iii. Sharing profits and losses >May be people or business organizations >>Corporations are considered "persons" in many laws >> A person can partner with a corporation >>A corporation can partner with a corporation >>3 people can partner with each other

Limited Partnerships: Taxation

All business income subject to personal taxation

Sole Proprietorship: Taxation

All business income subject to personal taxation • Not taxed as an organization ○ All the proprietorship's income subject to taxation is attributed to the proprietor. • However, the individual proprietor must pay the applicable personal tax rate on the income earned by the proprietorship whether the proprietor actually receives any of the income from the organization or not.

S Corporations: Taxation

All business income subject to personal taxation • Shareholders have to account on their individual income tax returns for shares of profits or losses • Shareholders avoid having a tax assessed on the corporate income

Partnerships: Taxation

All business income subject to personal taxation, divided equally Partnerships are not taxable, but the individuals are. Partnerships don't pay taxes, partners do. Sole proprietors don't pay taxes, sole proprietors do.

Terms describing # of owners in business organizations

Closely held Publicly held

Partnerships: Continuity

Dissolved whenever one partner withdraws This is why it's a good idea to have a buyout clause. In certain jurisdictions, you don't have to dissolve the partnership with a buyout (buy and sell agreement).

Limited Partnerships: Control

General partners have total control

Alter Ego Theory (Corporations, Liability)

IF CORP IS CONSIDERED TO BE ONLY AN ALTER AGO FOR OWNERS, SUBJECT TO PIERCE THE VIEL AND TO BE PERSONALLY UNLIMITED LIABLE >Corporations can be considered the "alter ego" for the corporate officers, directors, and stockholders. >The alter-ego theory, by which the corporate veil can be pierced, may also be used to impose personal liability upon corporate officers, directors, and stockholders. If the corporate entity is disregarded by these officials themselves, so that there is such a unity of ownership and interest that separateness of the corporation has ceased to exist, the alter-ego theory will be followed and the corporate veil will be pierced. >Simply alleging that a person is the sole owner of a corporation engaged in wrongful activity will not result in a piercing of the corporate veil.

Corporation: Creation

Incorporators apply for state charter with articles of incorporation (application for corp charter) •must contain the proposed name of the corporation, and the name must end with specific words such as "corporation, limited, incorporated, etc." • The name has to be unique enough that it won't be the same as or deceptively similar to the name of any domestic corporation or that of a foreign corporation authorized to do business in the state to which the application is made. • The articles must also include the proposed corporation's period of duration, the purpose for which it is formed, the number of authorized shares, and information about the initial corporate officials. • In GA, you must include a registered agent and that agent's address • Once you complete the articles of corporation, you send them to the secretary of state. • Notice of this incorporation usually has to be advertised in the local newspaper in order to inform the public that a new corporation has been created. • The initial board of directors then meets, adopts the corporate bylaws, and approves the sale of stock. At this point, the corporation becomes operational. ○ If a corporation wishes to conduct business in states other than the state of incorporation, that corporation must be licensed in these foreign states.

Limited Liability Organization

Limited liability company (LLC) Limited liability partnership (LLP) ○ In the true sense of a hybrid, an LLC and an LLP have characteristics of both a partnership and a corporation. • Characteristic shared with corporation: limited liability • Characteristic shared with partnership: pass-through taxation

S Corporations: Control

Managed by officers, appointed by directors who are elected by shareholders Shareholders of certain corporations unanimously elect to have the organization treated like a partnership for income tax purposes No more than 100 shareholders

Corporation: Control

Managed by officers, appointed by directors, who are elected by shareholders • Shareholders ○ Elect the members of the board of directors • Board of Directors ○ Directors set the objectives or goals of the corporation, and they appoint the officers. • Officers ○ President, VP, secretary, treasurer, etc. ○ Manage the daily operations of the corporation in an attempt to achieve the stated organizational objectives or goals.

Closely held

Organizations that are owned by only a few persons Examples: family-owned and family-operated businesses

Corporation: Continuity

Perpetual, so long as it can conduct business In contrast to a partnership, a corporation usually is formed to have perpetual existence. Perpetual existence doesn't ensure success.

Sole Proprietorship: Liability

Personal obligation for all debts and liabilities • Owner has unlimited liability for the obligations of the business organization

Partnerships: Liability

Personal obligation for all debts and liabilities; joint and several liability These partners' personal assets, which are not associated with the partnership, may be claimed by the partnership's creditors.

Limited Partnerships: Liability

Personal obligation for general partners; limited partners obligated for investment General partners have unlimited personal liability Limited partners: >They give up management power to not be liable >If they give up that passive management role, then they will gain unlimited liabilities

General Partners

Personally liable for the organization's debts; have unlimited liability

Partnership: Pros/Cons

Pros: >Easily formed >Costs of formation are low >not a tax-paying entity >equal voice in management, unless there is a contrary agreement >A partnership may operate in more than one state without obtaining a license to do business >subject to less regulation and less governmental supervision than are corporations Cons: >Limited number of people > dissolved anytime a partner ceases to be a partner, regardless of whether the reason is withdrawal or death >unlimited liability >taxed on their share of the partnership's profits, whether the profits are distributed not.

Sole Proprietorship: Continuity

So long as proprietor desires, but no transfers to others • A sole proprietorship cannot be transferred. • Proprietorship's continuity is tied directly to the will of the owner

Cost of Creation

a. Creation: the legal steps necessary to form a particular business organization i. The most significant creation-related issues are how long it will take to create a particular organization and how much paperwork is involved. ii. A businessperson may be concerned with how much it will cost to have each form established, but the cost of creation is usually not a major factor in considering which form of business organization a person will choose to operate a business.

Owner Liability

a. To what degree is the owner of the business personally liable for the debts of the business organization b. When is the owner liable under the law for harm caused by the business organization? c. Most of the time owners want to limit their liability i. However, owners can be personally liable because of their actions