Final Exam Study Guide
Module 1:
4 Different types of business entities:
1. Sole proprietorship:
Easy to form and operate, inexpensive to form and no liability
74% of all business per 2011 Ernest & Young report
Mom and pop shops
Advantages: easy to start and run, owners have complete control and all profits
belong to the owner
Disadvantages: unlimited liability, limited access to capital, the business ends
with the owner
2. Partnership:
May be limited or general, limited partnerships enjoy liability protection, general
partnerships enjoy the ease of formation of sole proprietorships.
General partnership
o 2 or more persons (individuals or legal entities)
o Simple to form and operate, similar to sole proprietorship, although a
general partnership can also be formed by a written agreement
o No liability protection—meaning each partner is liable for the acts of the
others. Every partner has an equal voice
o Because general partnerships can be formed merely by parties actions,
the way they do business and how they hold themselves out to third
parties, lawyers often consider it the scariest legal entity. We do all sorts
of things to avoid our clients from being put into this category.
o The other difficulty with general partnerships is often third parties are left
to surmise the existence. A real life example just today. I want to
contract with a landowner to lease a ranch. They stated that the ranch in
question is operated by a general partnership and Susie, Joe and Jane sign
as partners. The trouble is I cannot verify the partnership as the owner of
the property. The property appears of record to still be in the estate of
their relatives. No probate proceeding commenced in the county in
question; no will filed. They have not filed a “dba” or statement of
partnership and are not an entity registered with the state.
Limited partnership
o Same requirements as general partnership, except there must be a
written declaration.
o In Texas, a limited partnership will be registered with the state
o Will be 2 or more partners. At least one “person” will be the general
partner with decision making authority
, o If a client wants to form a partnership, limited partnership is better to
protect their liability – and to try and limit their individual liability from
the actions of their individual partners
3. LLC
Limited liability, some tax advantages, requires organization and maintenance
Seen as best of both worlds of a partnership and corporation
Has “check the box” election for preferential tax treatment
Can be managed by members or appointed managers
Has limited liability
Many states allow single member, multi-member or multi-class system of
ownership
4. Corporation
May be S-corp or S-corp, may be publicly traded or privately held, provides the
liability protection for its owners
Entity that has been incorporated and has shareholders
It’s a formal association with required filing and meetings
Governed by Board of Directors, who turn in day to day operations to officers.
Officers answer to the board, the board answers to the shareholders
Can be for profit and not-for-profit
S-Corp: taxed like a partnership
C-corp: double taxation
Not the most common business entity structure, but they do account for most of
the business revenue in the USA
May have different classes of stock: common or preferred. They may state a par
value.
Dividends or earnings are paid to the shareholders based on stock ownership
Some decisions are made by stock holders by voting in person or by proxy
Sarbanes-Oxley:
o The Sarbanes–Oxley Act is essentially a public accounting reform act. It
sets the ethical standards for all U.S. public companies’ management.
The most significant result of this act is that certain members of
management must now individually certify the accuracy of financial
information. In addition, penalties for fraudulent financial activity are
much more severe. The act contains multiple parts which add additional
responsibilities and restraints to corporate directors, heighten required
financial disclosure, increase criminal penalties for corporate fraud and
white collar crime, and increases SEC oversight. It has fundamentally
altered the internal control procedures for corporate accountants and
audit procedures for outside auditors.
o Shareholder Suits: The are no income guarantees for the stock holders of
an entity, but there are some actions that they can maintain as an owner
of the company. Shareholders can sue the company or management
through two methods – a direct suit to enforce the shareholder’s rights
, and recover an individual loss or a derivative suit where the shareholder
brings suit on behalf of the entity for a loss the entity has suffered.
A"derivative" suit is an action brought by the shareholder on behalf of
the corporation. It can be against third parties that have wronged the
entity but more commonly it is against an officer or director for breach of
their fiduciary duties (because in all likelihood, the directors themselves
would initiate the suit against the 3rd party but are unlikely to prosecute
a suit against themselves). This type of suit requires that the shareholder
actually own stock both at the time of the incident and at the time of the
suit (because the injury was done to the company, not the shareholder,
and the damages are owed to the company, not the shareholder bringing
the suit). Also, the shareholder cannot just venture out on their own and
file a suit on behalf of the corporation; they must first attempt to get the
directors or officers to take such action by sending a notice (generally, a
written demand to act with a 90 day period for the directors or officers to
take such action). The shareholder must exhaust internal before taking
action in the name of the corporation.
o Shareholder Rights: Shareholder’s have a right to: vote their shares,
received dividends, transfer their shares, purchase newly issued stock and
examine the corporate books. Preferred stock comes with additional
rights to either have preferences over any or all other classes or series of
shares with respect to payment of distributions or with respect to the
assets of the corporation on the voluntary or involuntary winding up and
termination of the corporation (or in some instances both but to be
preferred it must have at least one preference or the other).
5. Homework:
The difference between an S and C corporation:
1. S-Corp: is taxed as a separate legal entity (like a partnership). “Profits
and losses must be allocated based on share ownership for taxation
purposes.” (Bagley, p. 58)
2. C-Corp: is taxed under Subchapter C of the Internal Revenue Code.
There is a possibility of double taxation. “The C-Corp must pay federal
corporate income tax on profits when earned, and shareholders must
treat distributions as dividends subject to tax. (Bagley, p. 58)
I will be selecting an S-Corp for my entity because of the following reasons:
1. Who will be the owners of the business? My corporation is not going to
be a widely held corporation. There are going to be less than 100
shareholders; whom are U.S. citizens or resident aliens or eligible trusts or
estates.
Module 1:
4 Different types of business entities:
1. Sole proprietorship:
Easy to form and operate, inexpensive to form and no liability
74% of all business per 2011 Ernest & Young report
Mom and pop shops
Advantages: easy to start and run, owners have complete control and all profits
belong to the owner
Disadvantages: unlimited liability, limited access to capital, the business ends
with the owner
2. Partnership:
May be limited or general, limited partnerships enjoy liability protection, general
partnerships enjoy the ease of formation of sole proprietorships.
General partnership
o 2 or more persons (individuals or legal entities)
o Simple to form and operate, similar to sole proprietorship, although a
general partnership can also be formed by a written agreement
o No liability protection—meaning each partner is liable for the acts of the
others. Every partner has an equal voice
o Because general partnerships can be formed merely by parties actions,
the way they do business and how they hold themselves out to third
parties, lawyers often consider it the scariest legal entity. We do all sorts
of things to avoid our clients from being put into this category.
o The other difficulty with general partnerships is often third parties are left
to surmise the existence. A real life example just today. I want to
contract with a landowner to lease a ranch. They stated that the ranch in
question is operated by a general partnership and Susie, Joe and Jane sign
as partners. The trouble is I cannot verify the partnership as the owner of
the property. The property appears of record to still be in the estate of
their relatives. No probate proceeding commenced in the county in
question; no will filed. They have not filed a “dba” or statement of
partnership and are not an entity registered with the state.
Limited partnership
o Same requirements as general partnership, except there must be a
written declaration.
o In Texas, a limited partnership will be registered with the state
o Will be 2 or more partners. At least one “person” will be the general
partner with decision making authority
, o If a client wants to form a partnership, limited partnership is better to
protect their liability – and to try and limit their individual liability from
the actions of their individual partners
3. LLC
Limited liability, some tax advantages, requires organization and maintenance
Seen as best of both worlds of a partnership and corporation
Has “check the box” election for preferential tax treatment
Can be managed by members or appointed managers
Has limited liability
Many states allow single member, multi-member or multi-class system of
ownership
4. Corporation
May be S-corp or S-corp, may be publicly traded or privately held, provides the
liability protection for its owners
Entity that has been incorporated and has shareholders
It’s a formal association with required filing and meetings
Governed by Board of Directors, who turn in day to day operations to officers.
Officers answer to the board, the board answers to the shareholders
Can be for profit and not-for-profit
S-Corp: taxed like a partnership
C-corp: double taxation
Not the most common business entity structure, but they do account for most of
the business revenue in the USA
May have different classes of stock: common or preferred. They may state a par
value.
Dividends or earnings are paid to the shareholders based on stock ownership
Some decisions are made by stock holders by voting in person or by proxy
Sarbanes-Oxley:
o The Sarbanes–Oxley Act is essentially a public accounting reform act. It
sets the ethical standards for all U.S. public companies’ management.
The most significant result of this act is that certain members of
management must now individually certify the accuracy of financial
information. In addition, penalties for fraudulent financial activity are
much more severe. The act contains multiple parts which add additional
responsibilities and restraints to corporate directors, heighten required
financial disclosure, increase criminal penalties for corporate fraud and
white collar crime, and increases SEC oversight. It has fundamentally
altered the internal control procedures for corporate accountants and
audit procedures for outside auditors.
o Shareholder Suits: The are no income guarantees for the stock holders of
an entity, but there are some actions that they can maintain as an owner
of the company. Shareholders can sue the company or management
through two methods – a direct suit to enforce the shareholder’s rights
, and recover an individual loss or a derivative suit where the shareholder
brings suit on behalf of the entity for a loss the entity has suffered.
A"derivative" suit is an action brought by the shareholder on behalf of
the corporation. It can be against third parties that have wronged the
entity but more commonly it is against an officer or director for breach of
their fiduciary duties (because in all likelihood, the directors themselves
would initiate the suit against the 3rd party but are unlikely to prosecute
a suit against themselves). This type of suit requires that the shareholder
actually own stock both at the time of the incident and at the time of the
suit (because the injury was done to the company, not the shareholder,
and the damages are owed to the company, not the shareholder bringing
the suit). Also, the shareholder cannot just venture out on their own and
file a suit on behalf of the corporation; they must first attempt to get the
directors or officers to take such action by sending a notice (generally, a
written demand to act with a 90 day period for the directors or officers to
take such action). The shareholder must exhaust internal before taking
action in the name of the corporation.
o Shareholder Rights: Shareholder’s have a right to: vote their shares,
received dividends, transfer their shares, purchase newly issued stock and
examine the corporate books. Preferred stock comes with additional
rights to either have preferences over any or all other classes or series of
shares with respect to payment of distributions or with respect to the
assets of the corporation on the voluntary or involuntary winding up and
termination of the corporation (or in some instances both but to be
preferred it must have at least one preference or the other).
5. Homework:
The difference between an S and C corporation:
1. S-Corp: is taxed as a separate legal entity (like a partnership). “Profits
and losses must be allocated based on share ownership for taxation
purposes.” (Bagley, p. 58)
2. C-Corp: is taxed under Subchapter C of the Internal Revenue Code.
There is a possibility of double taxation. “The C-Corp must pay federal
corporate income tax on profits when earned, and shareholders must
treat distributions as dividends subject to tax. (Bagley, p. 58)
I will be selecting an S-Corp for my entity because of the following reasons:
1. Who will be the owners of the business? My corporation is not going to
be a widely held corporation. There are going to be less than 100
shareholders; whom are U.S. citizens or resident aliens or eligible trusts or
estates.
