A. The Subject In General
– Closely held: Few owners; ownership interests not publicly traded
– Publicly held: Many owners; ownership interests routinely traded
B. An Introduction To Business Forms
– Sole proprietorship: Easy to establish; unlimited personal liability
o Single owner
o Owner is personally liable for claims and liabilities
o No legal separation between owner and business
o Pass-through tax treatment
o This entity typically is converted as the business grows
– General partnership: Association of two or more co-owners
o No filing required; restricted transferability of ownership interests; pass-through taxation
o Unlimited personal liability; easy exit makes for unstable business form
o Default form of business for businesses owner by more than one individual
o Co-ownership need not be expressed
o Riskier than proprietorship because individuals are liable for the actions of the other partners
o Creates a risk because it may be dissolved upon the wishes of any one partner
– Corporation: Separate legal entity distinct from owners (shareholders)
o Filing required; shareholders can’t participate in management, typically have no ability to compel buyout of ownership interests or dissolution of firm.
o Ownership interests may be transferred without consent of other shareholders.
o Taxed twice: (1) corp. (2) if/when income disbursed to shareholders
§ Dividends taxed at lower rate than original corp. tax
§ Subject to franchise taxes
o May be either closely held or publicly traded
§ A closely held business is a business with relatively few owners whose ownership interests are not publicly traded on an established market
§ A publicly held corporation is a business that has a larger number of owners with ownership interests that are routinely bought and sold on a public market
· Most publicly traded and listed companies are corporations
o The majority of business assets in the United States are held in corporations
o Pyramid hierarchy
§ Board of directors at top
§ Officers in the middle
§ Shareholders at the bottom
o Closely held corporations may be subject to veil piercing
o Creates limited liability for all participants
o Commences upon the filing of the “Articles of Incorporation” in the relevant jurisdiction
– Limited partnership: General or Limited partners; filing required
o General: Unlimited liability; manage business
o Limited: Limited liability; largely passive investors
§ Built by contract
§ Structural flexibility; restricted transferability of ownership; pass-through taxation; exit rights restricted.
– Limited liability partnership: General partnership providing limited liability for tort and contract obligations.
– Limited liability company:
o Separate and distinct legal entity from owners
o Can be structured to provide management rights to members OR to a designated group of managers, offering limited liability to the members for all of the venture’s obligations.
o Exit rights restricted like corporations.
o Structural flexibility; restricted transferability of ownership; pass-through taxation.
o Avoids double taxation and franchise tax (in most states).
D. Federal Income Taxation: Basic Principles
– Expenses deducted from receipts in order to compute taxable income. 4 different individual tax rates.
– Corporate tax rates:
o Marginal: Amount of tax paid on an additional dollar of income; for an individual, will increase as income rises. (Corp. is 35%)
o Average: Ratio of the total amount of taxes paid to the total tax base.
– Most assets other than inventory and property used in business are capital assets.
– Long-term capital gains/losses: Gains/losses from the sale or exchange of capital assets held for more than one year.
o Capital losses are available to offset capital gains + up to $3,000 of ordinary income in any year; excess may be carried over to offset capital gains in future years.
o Short-term gains/losses are separately netted to determine the net short-term capital gains/losses; same goes for long-term.
§ Investment longer than one year is long term
§ Less = short-term; taxed as personal income
– Proprietorship reports income/loss on personal income tax return.
– Unincorporated business with single owner is disregarded as separate legal entity for fed. income tax purposes unless entity selects otherwise (“Check the box.”)
– Under Subchapter K, taxable income is computed and filed, after which the income/loss is “passed-through” to partners in accordance with partnership agreement, where each partner includes their amounts on their personal income tax return.
o Amounts allocated for tax are based on income calculations of business and not on amounts distributed in cash/property to the member(s). Tax is paid whether distributions are made or not.
o Partnership taxation is most complex area of tax law because of LLC’s.
– S Corp (Less than 100 shareholders) cannot have nonresident alien individuals/non-individuals and may not issue more than 1 class of stock. No max size in terms of assets/revenue; taxed differently than C corp.
o Modified pass-through tax similar to unincorporated business; reported on individual income.
– C-Corporations (Double Tax)
o Have to pay their own taxes on profits
o Dividends are also taxed when they are distributed to the owners of the shares
– Tax planning for business: Focus on marginal rate; address liability of business & owners when selecting form.
Ch. 2: Agency
– Agency relationships define the rights and responsibilities of individuals who work for/on behalf of business.
o Most common is employm
lationship. Such authority is based on the principal’s manifestations to a 3rd party. Thus, it cannot be created by the mere representations of an agent/other actor.
o Doctrine of estoppel applies when the principal has not made any manifestations of authority to the third party at all. Instead, the principal is held responsible under the estoppel doctrine because the principal contributed to the third party’s belief or failed to dispel it:
§ Applicable when the person against whom estoppel is asserted has made no manifestation that an actor has authority as an agent but is responsible for the third party’s belief that an actor is an agent and the 3rd party has justifiably been induced by that belief to undergo a detrimental change in position.
§ Estoppel doctrine may apply when apparent authority is unavailable.
– Inherent Authority (Inherent agency power): The power of an agent which is derived not from authority, apparent authority or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent.
o A general agent for a disclosed/partially disclosed principal has inherent authority to bind the principal “for acts done on his [the principal’s] account which usually accompany or are incidental to transactions which the agent is authorized to conduct if, although they are forbidden by the principal, the other party reasonably believes that the agent is authorized to do them and has no notice that he is not so authorized.”
– Ratification: Even if an agent acts without authority, the principal will be liable to a third party if:
1) The agent purports to act on the principal’s behalf, despite not having actual authority
2) The principal affirmatively treats the agent’s act as authorized (express ratification), or the principal engages in conduct that is justifiable only if the principal is treating the agent’s act as authorized (implied ratification).
o Ratification does not occur unless the principal, at the time of the ratification, is fully aware of all of the material facts involved in the original transaction.
o Express ratification most often occurs through oral/written statements.
§ Implied: When the principal has knowledge of an unauthorized transaction entered into purportedly on his behalf, but the principal nevertheless accepts the benefits of the transaction.
§ Function of ratification – Pg. 31