BUSINESS ORGANIZATIONS
PROFESSOR MOLITOR
HILARY 2007
I. Types of Businesses
a. Legal structures for businesses:
i. How to structure a business is driven by objectives of the businesses’ founder and the firm’s investors in terms of:
1. Tax status
2. Exposure to legal liabilities, and
3. Flexibility in the operation and financing of the business
b. Sole proprietorship
i. One person undertakes a business without any of the formalities associated with other forms of organization; the individual and the business are one and the same for tax and legal liability purposes.
1. Unincorporated business with 1 natural person.
ii. No state filings are necessary; the business may just apply for a “doing business as” (d/b/a) name.
iii. Taxes:
1. The business is not taxed; the owner files taxes under his own.
2. Person reports all income and deductible expenses for the business on schedule C of their personal income tax return.
3. Earnings of the business are taxed to the person regardless of whether they are actually distributed in case.
4. No sheltering income from tax.
iv. Liability:
1. Business and personal assets are one and the same, so owner is personally liable for the debts of the business, their personal belongings can be taken.
a. Legal claimants can pursue all assets of the owner.
i. Insurance would be a good idea.
v. Note: If a P is trying to sue a sole proprietor, but that person has no money, then P should try and find someone else and make an argument that it was not a sole proprietorship, but a partnership because partnerships are jointly and severally liable.
c. Partnership
i. General
1. Consists of two or more owners.
2. Treated as a proprietorship for tax and liability purposes.
a. The business is not taxed; the owners file taxes under his own
3. Liability: Each of the owners is jointly and severally liable (this is not so good)
a. When a person sues an owner the claim need not be proportional to invested capital or the distribution of earnings.
b. The partnership is a separate entity and can sue and be sued.
ii. Limited (LP)
1. Must have at least one general and one limited partner.
a. The general partner assumes the management responsibility and unlimited liability for the business.
i. A general partner may be a limited liability entity such as a corporation of limited liability company.
ii. Jointly and severally liable.
b. Limited partner has no voice in management and is legally liable only for the amount of capital contribution plus any other debt specifically accepted.
i. If a limited partner participates in management, such limited partner could expose himself to personal liability for partnership obligations.
2. Liability of Limited Partners
a. A limited partner is not liable for the obligations of the limited partnerships unless:
i. He is also a general partner; or
ii. Participates in the management; and
iii. Control of the business.
1. However, a limited partner who participates in control (but not a general partner) is liable only to persons who transact business with the limited partnership reasonably believing, based on the limited partner’s conduct, that the limited partner is a general partner.
3. Management Rights- Safe Harbor:
a. A LP does not participate in control of the business solely by doing one or more enumerated activities listed in RULPA 303(b), or solely by exercising voting rights, thus providing a so called Safe-harbor for the limited partner.
i. Acting an IC, agent, or employee of the LP.
ii. Consulting or advising a GP with respect to the LP’s business.
iii. Acting as a surety for the limited partnership or guaranteeing or assuming o
corporation income is 35%.
ii. S Corporation
1. Afforded the tax status of a partnership, but the protection from legal liability of a corporation.
a. It is a flow through tax entity.
i. The shareholders pay taxes on their respective shares on the corporation’s income, and the entity does not pay taxes.
2. In order to qualify for S corporation tax status, the business must meet a number of restrictive conditions in the IRS Code:
a. Have only one class of stock, although differences in voting rights are allowed;
b. Be a domestic corporation, owned wholly by US citizens, and derive no more than 80% of its revenues from non-US sources;
c. Have 100 or fewer stockholders
d. Derive no more than 25% of revenues from passive sources (interest, dividends, rents, and royalties)
e. Have only persons, estates, and certain trusts as shareholders (no corporations or partnerships)
3. Needs the timely consent of all shareholders.
a. It fails if any of the conditions are broken
e. Limited Liability Company (LLC)
i. Need at least one member.
ii. Permits owners to have the option to exercise direct managerial power over the affairs of the business without risking personal liability.
iii. Formed by filing articles of organization with the state.
iv. Not a tax paying entity
1. Income taxes are paid only once by the owners of the LLC when a part of the company’s earnings are distributed to them.
a. Flow through taxation
v. A lot like the Full Shield LLP
