CPA Prep REG

REG Chapter 9 Part 1: Selection and Formation of Business Entity

Summarize the processes for formation and termination of various business entities.

Finally made it to the final chapter of Business Law – just two parts to this chapter. We will cover everything you need to know about business structure: what are the similarities and differences, how they are businesses formed and how are they dissolved. Here are today’s learning outcomes.

  • Summarize the processes for formation and termination of various business entities.
  • Summarize the non-tax operational features for various business entities.
  • Identify the type of business entity that is best described by a given set of non-tax related characteristics.

Sole Proprietorship

A sole proprietorship is a business structure with a single owner.

Key Highlights:

  • One owner.
  • Unlimited personal liability.
  • No separation between the owner and the business.
  • All income, losses, assets, and liabilities belong to the owner.

Formation:

  • No filing requirements, just need to start operating the business.
  • May need federal ID for operations like paying sales tax and filing payroll reports.

Operations:

  • Owner makes all the rules and runs the business as they wish.

Termination:

  • Either the owner dies, or;
  • The owner choses not to continue with the business.
  • May terminate whenever the owner choses.

General Partnership/Joint Venture

A general partnership is like a sole proprietorship just with more than one person. Joint ventures are general partnerships for the purpose of executing a one time business venture. For example: Susan and Joe sell BBQ out of a food truck on an ongoing basis (General Partners). Susan and Joe are teaming up to sell BBQ at a county fair for a one time business ventureĀ (Joint Venture). Both are treated the same so make sure to link these two together.

Key Highlights:

  • More than one owner.
  • Unlimited personal liability for all partners.
  • All income, losses, assets, and liabilities are shared among the owners.

Formation:

  • No filing requirements, just need to start operating the business.
  • May need federal ID for operations like paying sales tax and filing payroll reports.

Operations:

  • Unless otherwise stated, partners share in business operations and management.
  • Partners share income and losses.

Termination:

  • Either one of the partners die, or;
  • The owners choses not to continue with the business.
  • May terminate whenever the owners want.
  • Partnership agreement will spell the out terms of termination. If there is no such wording in the partnership agreement or the partnership agreement doesn’t exist then Revised Uniform Partnership Act (RUPA) will govern the termination.

Limited Partnership

Similar to a general partnership but some of the partners have the benefit for limited liability. At least one partner must be a general partner for a limited liability partnership to exist.

Key Highlights:

  • More than one owner.
  • Unlimited personal liability for all general partners.
  • Limited liability for limited partners.
  • All income, losses, assets, and liabilities are shared among the owners.

Formation:

  • Legal documents must be filed with the state.
  • Governed by the Revised Uniform Partnership Act.

Operations:

  • General partners run the day-to-day operations of the business.
  • Limited partners forfeit their rights to have a say in the management of the business. If a limited partner participates in the management of the business then they will lose their limited liability protection.
  • Partners share income and losses per partnership agreement.

Termination:

  • Departure of a limited partner does not cause the termination of the partnership.
  • Departure of a general partner may lead to the termination of the partnership if there is only one general partner.
  • The owners choses not to continue with the business.
  • Partnership agreement will spell the out terms of termination. If there is no such wording in the partnership agreement or the partnership agreement doesn’t exist then RUPA will govern the termination.

Limited Liability Partnership

Limited liability partnerships are popular among professional service firms (lawyers, accountants, doctors, etc.). They give limited liability to partners for the actions of other partners. For example: Bob, Richard and Bill are partners in BRB LLP. Bob is being sued by a client for his actions. Although Bob might be personally liable for his actions Bill and Richard will be protected up to their investment in the partnership.

Key Highlights:

  • More than one owner.
  • Limited liability for partners with the exception of personal torts.
  • Limited liability for actions of other general partners.
  • All income, losses, assets, and liabilities are shared among the owners.

Formation:

  • Legal documents must be filed with the state.
  • Governed by the Revised Uniform Partnership Act.

Operations:

  • General partners run the day-to-day operations of the business.
  • Limited partners may have a say in the management of the business without forfeiting limited liability protection.
  • Partners share income and losses per partnership agreement.

Termination:

  • Similar rules to other partnerships listed above.

Corporation

A Corporation is a separate entity from its owners. They have some similarities with partnerships but key differences set them apart.

Key Highlights:

  • Double taxation – taxed at the corporate level and again when it pays dividends to stockholders.
  • Limited liability for stockholder.
  • Has perpetual life.
  • More dynamic than most entities.

Formation:

  • Legal documents must be filed with the state.
  • Must have articles of incorporation
    • Corporate name
    • Number of authorized stock
    • Filed with the secretary of state
    • Must have bylaws and reoccurring meetings with the board of directors

Operations:

  • Shareholders are considered the “owners.”
  • The stockholder elect a board of directors that oversee the company.
  • The board of directors hire the officers (CEO, CFO, CMO etc.).
  • The officers run the day-to-day operations of the corporation.
  • In small corporations you can have an individual who is a shareholder, member of the board, and a corporate officer.

Termination:

  • Directors vote to dissolve the corporation.
  • Involuntarily dissolved judicially (bankruptcy, cases of fraud, etc.)
  • Failure to pay annual fees or file annual reports.

S-Corporation

An S-Corporation is a hybrid entity with the benefits of a corporation but the taxation of a partnership.

Key Highlights:

  • Structure of a corporation with the pass through advantages of a partnership.
  • Limited liability for stockholder.
  • Has perpetual life.
  • No more than 100 shareholders.

Formation:

  • Legal documents must be filed with the state.
  • Same incorporating process as C-Corp.
  • Limits on number of shareholders and type of shareholders (no foreign owners).

Operations:

  • Shareholders are considered the “owners.”
  • The shareholders elect a board of directors that oversee the company.
  • The board of directors hire the officers (CEO, CFO, CMO etc.).
  • The officers run the day-to-day operations of the corporation.
  • In small corporations you can have an individual who is a stockholder, member of the board. and a corporate officer. This is common for S-Corps where the owner also manages the business

Termination:

  • Directors vote to dissolve the corporation.
  • Involuntarily dissolved judicially (bankruptcy, cases of fraud, etc.).
  • Failure to pay annual fees or file annual reports.

Limited Liability Corporation (LLC)

An LLC is a hybrid entity with the benefits of a corporation but the taxation of a partnership. It is has the same benefits of an S-Corp but with fewer restrictions for formation.

Key Highlights:

  • Structure of a corporation with the pass through advantages of a partnership.
  • Limited liability for stockholder.
  • Has perpetual life.
  • Has the choice of being taxed as a Corp or as a Partnership.

Formation:

  • Legal documents must be filed with the state.
  • Same requirements and incorporating process as C-Corp.

Operations:

  • Shareholders are considered the “owners.”
  • The shareholders elect a board of directors that oversee the company.
  • The board of directors hire the officers (CEO, CFO, CMO etc.).
  • The officers run the day-to-day operations of the corporation.
  • In small corporations you can have an individual who is a shareholder, member of the board, and a corporate officer. This is common for LLCs where the owners also manage the business

Termination:

  • Directors vote to dissolve the corporation.
  • Involuntarily dissolved judicially (Bankruptcy, cases of fraud, etc.).
  • Failure to pay annual fees or file annual reports.

Key Takeaways

  • Know the different types of entities.
  • Know the formation process and which entities require filing formal documentation.
  • Be able to spot a business entity given specific qualities of the entity (i.e. double taxation means C-Corp).

Jeremias Ramos is a CPA working at a nationally recognized full-service accounting, tax, and consulting firm with offices conveniently located throughout the Northeast. Jeremias specializes in tax and business consulting with focus areas in real estate, professional service providers, medical practitioners, and eCommerce businesses.

0 comments on “REG Chapter 9 Part 1: Selection and Formation of Business Entity

Leave a Reply

%d bloggers like this: