[LO 1] What are the more common legal entities used for operating a business? How are these entities treated similarly and differently for state law purposes?
Corporations, limited liability companies (LLCs), general and limited partnerships, and sole proprietorships. These entities differ in terms of the formalities that must be observed to create them, the legal rights and responsibilities conferred on them and their owners, and the tax rules that determine how they and their owners will be taxed.
2. [LO 1] How do business owners create legal entities? Is the process the same for all entities? If not, what are the differences?
The process of creating legal entities differs by entity type. Business owners legally form corporations by filing articles of incorporation in the state of incorporation while business owners create limited liability companies by filing articles of organization in the state of organization. General partnerships may be formed either with or without written partnership agreements, and they typically can be formed without filing documents with the state. However, limited partnerships are usually organized by written agreement and must typically file a certificate of limited partnership to be recognized by the state.
3. [LO 1] What is an operating agreement for an LLC? Are operating agreements required for limited liability companies? If not, why might it be important to have one?
An operating agreement is a written document among the owners of an LLC specifying the owners’ legal rights and responsibilities for dealing with each other. Generally, operating agreements are not required by law for limited liability companies; however, it might be important to have one to spell out the management practices of the new entity as well as the rights and responsibilities of the owners.
4. [LO 1] Explain how legal entities differ in terms of the liability protection they afford their owners.
Corporations and LLCs offer owners limited liability. General partners and sole proprietors may be held personally responsible for the debts of the general partnership and sole proprietorship. However, limited partners are not responsible for the partnership’s liabilities.
5. [LO 1] Why are C corporations still popular despite the double tax on their income?
Corporations have an advantage in liability protection compared to sole proprietorships and partnerships. In addition, corporations have an advantage if owners ever want to take a business public. As a result, corporations remain desirable legal entities despite their tax disadvantages.
6. [LO 1] Why is it a nontax advantage for corporations to be able to trade their stock on the stock market?
Having the ability to issue stock in the stock market provides corporations with a source of capital typically not available to other types of entities. In addition, going public provides a mechanism for shareholders of successful closely-held corporations to sell their stock on an established exchange.
7. [LO 1] How do corporations protect shareholders from liability? If you formed a small corporation, would you be able to avoid repaying a bank loan from your community bank if the corporation went bankrupt? Explain.
A corporation is solely responsible for its liabilities. One exception to this is for payroll tax liabilities. Shareholders of closely-held corporations may be held responsible for these liabilities. If a corporation were to go bankrupt, the bank may have priority in the corporation’s assets but it could not come to the shareholders to satisfy the outstanding bank loan. The shareholders may lose their investment in the corporation but their personal assets would be safe from the bank.
8. [LO 1, LO 2] Other than corporations, are there other legal entities that offer...
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