blaw chapter 32
What is a limited liability company? Explain the advantages and disadvantages of this type of business ownership?
A limited liability company (LLC) is a relatively new form of organization. Its existence must be in compliance with state law. LLC's are taxed as partnerships. Income flows through the company directly to the owners, who are called members rather than shareholders. None of the limitations associated with S Corps exist for an LLC (one class of stock, 100 or fewer owners, etc.). Members are not personally liable for debts of the company. Disadvantages of a LLC include inconsistencies among state statutes and lack of well-established case law. Formerly, LLCs automatically terminated upon the death, bankruptcy, etc. of any member unless the majority of remaining members agreed to keep the business going. Now, however, there is a trend to permit continuation after withdrawal of a member. A sale of a member's interest must be unanimously approved by the other members unless the operating agreement states otherwise. There are no standardized forms to make formation of the business easy and inexpensive.
Compare and contrast the following forms of business organization: sole proprietorship, general partnership, limited partnership, limited liability company, and corporation as to ease of formation, liability of owners, management, and tax implications.
A sole proprietorship is an unincorporated business owned by one person. It is easy and inexpensive to create and operate. However, the owner has unlimited personal liability for the debts of the business. The owner has the right to manage the business. Business income is taxed on the owner's personal income tax return; the company does not have to file a separate tax return. A general partnership is an association of two or more co-owners to operate a business for profit. Partnerships are easy to form and do not require filings with the government, although a written partnership agreement for use between the parties is recommended. A disadvantage of general partnerships is the unlimited liability of partners. Partners have joint and several liability for partnership debts. Unless otherwise agreed, partners have equal rights to manage the business. A partnership does not pay taxes itself; all income and losses are passed through to the partners and reported on their personal income tax returns. Limited partnerships have at least one general partner, who has unlimited liability but the right to manage, and at least one limited partner, who has limited financial liability but few management rights. A limited partnership must file a certificate of limited partnership with its Secretary of State, so formation is not as easy as for sole proprietorships or general partnerships. Limited partnerships, like general partnerships, are not taxable entities. Limited liability companies generally require two documents: a charter and an operating agreement. The charter must be filed with the Secretary of State. The operating agreement sets out the rights and obligations of the owners/members. All members have limited liability, and the business has the tax status of a partnership. Corporations are relatively expensive and difficult to form, but owners have limited liability. Generally, the owners/shareholders are not involved in the management of the company. Corporations are taxable entities, so they must pay taxes and file returns. The owners/shareholders must also pay tax on dividends they receive from corporations.
Briefly discuss the limitations on a corporation electing Subchapter "S" status.
For a corporation to elect Subchapter "S" status it must have: ∙only one class of stock issued. ∙100 or fewer shareholders. ∙no partnership or corporate shareholders. ∙no nonresident alien shareholders. ∙unanimous agreement of all shareholders that the company should be an S corporation.
In order to obtain limited liability, Tom and Doris formed an LLC to operate their catering business. They sometimes deposited the proceeds from catering jobs into their personal checking accounts and if they needed to pay personal bills and were short of funds, they used the business account. If creditors of the business cannot get payment for their invoices, is there anything a court can do to help the creditors?
It is common under corporate law for shareholders who do not comply with the technicalities of the law to be held personally liable for the corporate debts. This is called "piercing the corporate veil." Similarly, the members of an LLC may be held liable if they do not observe the formalities required for the business. Here, Tom and Doris were mingling business and personal funds. Courts would be likely to disregard the LLC form and hold Tom and Doris personally liable for the business debts.
Susan wishes to buy a national franchise. What information is the seller legally required to provide before she buys the franchise?
The Federal Trade Commission requires the seller of the franchise to provide Susan with an offering circular at least 14 business days before any contract is signed or money is paid. This disclosure statement must provide the following information: (1) any litigation against the company for the prior ten years and any claims the company made against franchisees during the prior year; (2) whether the company has gone through bankruptcy proceedings in the prior 10 years; (3) all fees required to be paid; (4) estimates of the required initial investment; (5) what goods must be purchased from the franchisor; (6) the number of franchisees in operation; (7) how many franchisees have gone out of business within the last three years; (8) any competition franchisees will face from other company-owned outlets, including through Internet, catalog, or telemarketing; and (9) whether others can sell in the franchisee's territory and whether it can sell outside its territory. The offering circular must also contain audited financial statements and a sample set of contracts a franchisee is expected to sign.
Andy wants to start his own business. He has decided to rent space in a "strip mall" and open a pet shop. Additionally, he will provide dog grooming services. He figures he can do almost everything himself, though he will need to hire a part-time employee on an "as needed" basis. His friend, Lacy, has agreed to work when needed. Andy is considering operating his business as a sole proprietorship. What are the primary legal advantages and disadvantages to this form of business ownership for Andy's pet shop?
There are many advantages to operating the pet shop as a sole proprietorship. There are no formal procedures required to create a this type of business ownership. Though he may be required by local or state law to obtain a particular license, a retail sales tax number, etc., such requirements would exist no matter what form of business ownership he selected. A proprietorship is not regarded as a separate tax entity, so Andy can report his earnings and expenses on his individual income tax return (using Schedule C). Thus, he is not subject to double taxation as is the corporate business. Additionally, as a small business, he is exempted from a great deal of statutory law that applies to larger businesses. For example, he is not subject to Title VII of the Civil Rights Act which only applies to companies with 15 or more employees, nor is he subject to the Family and Medical Leave Act which applies to companies with 50 or more employees. Certainly, Andy faces some serious disadvantages as a sole proprietor. He is personally liable for any debts or claims made against the company or his employees. As a proprietor, he will have a difficult time raising capital, since the money can only come from savings or loans. If the business is a failure, he may wind up losing all his savings and have serious debt obligations that could drive him into bankruptcy. Also, since he is sole proprietor, he has no one else to share the potential liability in the event of a claim not covered by insurance.
An S Corporation cannot have more than ____ shareholders. a.) 100 b.) 75 c.) 50 d.) 25
a.) 100
E. I. James is a writer with a best selling novel. He wishes to create a corporation called "James, Inc." He will be the only shareholder. Can James incorporate his business of writing? a.) Yes, this would be the incorporation of a sole proprietorship. b.) No, the law requires at least two people to be shareholders of a corporation. c.) No, the law does not permit a person to, in effect, incorporate himself. d.) Only if he forms an S Corporation.
a.) Yes, this would be the incorporation of a sole proprietorship.
Which of the following transactions would be considered by the IRS to be a taxable sale of assets? Changing the form of business from: a.) a corporation to an LLC. b.) a partnership to an LLC. c.) an LLC to a corporation. d.) All of the above.
a.) a corporation to an LLC.
The Federal Trade Commission requires franchisors to: a.) give prospective franchisees an offering circular at least 14 business days prior to the signing of a contract or payment of any money. b.) disclose the exact amount of the initial investment required. c.) disclose any litigation the company has ever been involved in d.) disclose how many franchisees have gone out of business in the prior five years.
a.) give prospective franchisees an offering circular at least 14 business days prior to the signing of a contract or payment of any money.
Harold and Zack have pooled their money together to buy real estate but have filed no formal papers to form a business. Harold, a lawyer, handles all the legal matters and Zack, a real estate broker, finds buyers for the property they have subdivided. Harold and Zack are engaged in a: a.) partnership. b.) close corporation. c.) limited liability company. d.) business trust.
a.) partnership.
The term "S Corporation" comes from: a.) the Internal Revenue Code. b.) the FTC rules. c.) the U.S. Constitution. d.) state corporation law.
a.) the Internal Revenue Code.
All of the following are characteristics of a closely held corporation EXCEPT: a.) the shares are publicly traded. b.) the corporation can typically operate without a board of directors. c.) the shareholders usually restrict share transfer. d.) minority shareholders are provided more protection than in regular corporations.
a.) the shares are publicly traded.
The corporate form of business: a.) was first known and used by the Greeks and then spread through the Romans to England. b.) was not known until about 1737 when Sir Francis LaRue developed the concept. c.) was first allowed in the State of New York around 1811 and is considered to be an American creation. d.) None of the above.
a.) was first known and used by the Greeks and then spread through the Romans to England.
Lance and Darrell have an equal partnership. This year, after expenses, the partnership had a profit of $100,000. Lance and Darrell will each pay taxes on: a.) whatever they receive from the partnership b.) $50,000 c.) $100,000 d.) none of the above, the partnership itself will pay the taxes on the business's profit
b.) $50,000
Murray was a partner in a large firm. He died unexpectedly. His son, Frank, wanted to take over for his father in the partnership and was well qualified to do the work his father had done. Which statement best describes Frank's rights in the partnership if he inherits the interest? a.) Frank has a right to take over for his father in the partnership. b.) Frank is entitled to the value in the partnership, but not to become a full partner. c.) Frank has no rights to his father's partnership interest. d.) None of the above.
b.) Frank is entitled to the value in the partnership, but not to become a full partner.
Seventy farmers in Morgan County joined together to gain the advantages of purchasing seed and fertilizer in bulk and of obtaining better prices when distributing and selling their crops. These farmers have formed a: a.) business trust. b.) cooperative. c.) franchise. d.) joint venture.
b.) cooperative
The form of business ownership that is the most easily transferable is the: a.) general partnership. b.) corporation. c.) limited liability company. d.) limited partnership.
b.) corporation.
All the business forms listed below have limited liability except the: a.) limited liability company b.) general partnership c.) subchapter S corporation d.) corporation
b.) general partnership
The importance of a Subchapter S corporation is: a.) its organizational structure. b.) its treatment of shareholders for income taxation purposes. c.) its requirement of restrictive transfer rights of the shares. d.) its small cost of formation
b.) its treatment of shareholders for income taxation purposes.
Charles and Ellen, an unmarried couple, run an ice cream store. The business is not incorporated and they have filed no formation papers with the state. Their business is a: a.) sole proprietorship. b.) partnership. c.) joint venture. d.) limited liability company.
b.)partnership
Which of the following would not be personally liable for the debts of the business? a.) A sole proprietor. b.) A partner in a general partnership. c.) A general partner in a limited liability limited partnership. d.) A general partner in a limited partnership.
c.) A general partner in a limited liability limited partnership.
What federal agency requires that the seller of a franchise give the potential buyer an offering circular and audited financial statements? a.) The Securities and Exchange Commission (SEC). b.) The Interstate Commerce Commission (ICC). c.) The Federal Trade Commission (FTC). d.) The Franchise Sales Commission (FSC).
c.) The Federal Trade Commission (FTC).
The business form that is taxed as a partnership and gives all owners limited liability, is: a.) a close corporation. b.) a limited partnership. c.) a limited liability company. d.) a general partnership.
c.) a limited liability company.
John, his parents, and three brothers own all the stock of their family farm corporation. This corporation, which is taxed as a corporation, is probably: a.) an S corporation b.) a C corporation c.) closely held corporation d.) an llc
c.) closely held corporation
LLCs have become popular for all except which of the following reasons: a.) management flexibility. b.) tax status as a partnership. c.) uniformity of law. d.) limited liability.
c.) uniformity of law.
Jill was a limited partner in a retail business that was sued by a customer who fell in the store. The customer claimed the business was negligent in caring for its floors. Which statement best describes Jill's potential liability? a.) Jill has no potential liability to the customer. b.) Jill can be held personally liable to the customer since she is a partner. c.)Jill can only be liable to the amount of her investment. d.) Jill is personally liable, but the woman must first collect from the general partners before collecting from Jill.
c.)Jill can only be liable to the amount of her investment.
Which of the following forms of organization is a compromise between starting one's own business as an entrepreneur and working for someone else as an employee? a.) Limited liability company. b.) Business trust. c.) Close corporation. d.) Franchise.
d.) Franchise.
Martin, Leah, and Pablo are considering forming a business. What factors should they consider in making a choice of organization? a.) Ease of creation and operation. b.) Whether there is personal liability for the owners. c.) How the owners will be taxed. d.) All of the above.
d.) all of the above
Rachel and Cyndi started a retail business called Zebra Toy Company. The business is operated as a partnership. Under partnership law: a.) Rachel is personally liable for any business contracts b.) Rachel is personally liable for any business debts, regardless of whether she or Cyndi created the obligation. c.) Rachel is personally liable for any negligent act committed by Cyndi in the scope of the business activity. d.) all of the above
d.) all of the above
The advantage of a corporation over a partnership is: a.) shares are easily transferable to another person. b.)perpetual existence. c.) it is easier to raise funds. d.) All the above.
d.) all the above
Corporations have a distinct advantage over other forms of business organization in the area of taxation. true/false
false
Dr. Wong, a dentist, and his wife, an attorney, can protect their personal assets with limited liability from their business dealings by creating and operating a professional corporation together. true/false
false
Franchise fees can be costly, but they are usually payable over a number of years, after profits are generated from the business. true/false
false
The Federal Trade Commission will not allow the sale of franchises that are unfair to the franchisee. true/false
false
To be a close corporation, the business must be small, with under 20 owners and under $500,000 in gross annual income. true/false
false
To form an LLC, a charter and an operating agreement must be filed with the Secretary of State in the jurisdiction where the business will operate. true/false
false
a partnership is separate, taxable entity true/false
false
limited liability it a major advantage of a partnership as compared to a corporation true/false
false
the most common form of business ownership is the corporation true/false
false
A limited liability company, unlike a Subchapter S corporation, can have members that are corporations, partnerships, or nonresident aliens. true/false
true
Cooperatives may be either incorporated or unincorporated businesses. true/false
true
Filings are required to form and operate a limited liability partnership. true/false
true
Generally, a joint venture is a partnership created for one limited purpose. true/false
true
The case of Apcar v. Gaus illustrates that it is essential to comply with all the technicalities of a limited liability partnership statute. true/false
true
corporations have perpetual existence true/false
true