14 Key 1. The three basic forms of business organizations are limited partnerships, S corporations, and limited liability companies. Answer: False The law recognizes three basic forms of business organizations and several hybrid forms that contain attributes of two or more basic forms. The three basic forms include sole proprietorships, partnerships, and corporations. 2. Family-owned and family-operated businesses are common examples of publicly held organizations. Answer: False Some organizations are owned by only a few persons. Such organizations are said to be closely held. Family-owned and family-operated businesses are common examples of closely held organizations. 3. Corporate form of organizations enables shareholders to transfer their ownership without interfering with the organization's management. Answer: True When a business is publicly held by a large number of owners, the form of organization usually is a corporation. The reason for this corporate form being used is that shareholders can transfer their ownership without interfering with the organization's management. 4. Usually, the cost of creation of a business entity is not a major factor in considering which form of operation to choose. Answer: True Significant factors to consider in selecting the best organizational form for a particular business activity include the cost of creating the organization. 5. Factor continuity refers to the legal steps necessary to form a particular business organization. Answer: False The word "creation" means the legal steps necessary to form a particular business organization. The most significant creation-related issues are how long it will take to create a particular organization and how much paperwork is involved. 6. A dissolution is any change in the ownership of an organization that changes the legal existence of the organization. Answer: True The crucial issue with this continuity factor is the method by which a business organization can be dissolved. A dissolution is any change in the ownership of an organization that changes the legal existence of the organization. 7. The failure to consider how to overcome disputes involving managerial control can cause business activities to suffer and the organization to fail. Answer: True The failure to consider how to overcome disputes involving managerial control can cause business activities to suffer and the organization to fail. Therefore, consideration of potential conflict and mechanisms to resolve disputes are essential to consider when selecting a form for a business venture. 8. Although expensive to create, the use of sole proprietorships is becoming all the more common. Answer: False The use of sole proprietorship is very limited because multiple owners cannot create a proprietorship. A sole proprietorship is the easiest and least expensive business organization to create. 9. A business might shift away from the proprietorship form as it becomes more successful. Answer: True The ease of the steps used to create a proprietorship makes it an attractive alternative when beginning a new business venture. However, as the other factors might dictate, a business might shift away from the proprietorship form as it becomes more successful. 10. One of the advantages for a proprietor is that he may transfer the ownership of his proprietorship whenever desired. Answer: False The fact that the proprietorship's business activity may be more stable than the proprietor's willingness to remain actively involved in the business indicates that the sole proprietorship is a less desirable organizational form. Ownership of a sole proprietorship cannot be transferred. 11. A sole proprietor has limited liability for the obligations of the proprietorship. Answer: False A sole proprietor is personally obligated for the debt of the proprietorship. Legally speaking, this owner has unlimited liability for the obligations of this type of business organization. 12. A sole proprietorship is not taxed as an organization. Answer: True A sole proprietorship is not taxed as an organization. All the proprietorship's income subject to taxation is attributed to the proprietor. 13. Whenever two or more people wish to own a business together, a joint venture is a possible organizational form. Answer: False Whenever two or more people wish to own a business together, a partnership is a possible organizational form. 14. Partnership is the most easily formed business organization compared to all others. Answer: False When compared to other forms of business organizations (other than the sole proprietorship), a partnership is easily formed. The cost of forming a partnership is relatively minimal. 15. The creation of a partnership requires permission from each state in which it does business. Answer: False The cost of forming a partnership is relatively minimal. In addition, the creation of a partnership is made easier since it does not need to get permission from each state in which it does business. 16. A common interest in business is one of the satisfying definitional elements of partnership existence. Answer: True The key to a partnership's existence is satisfying the elements of its definition. It includes (1) two or more persons, (2) a common interest in business, and (3) sharing profits and losses. 17. A dissolution essentially terminates the business of a partnership. Answer: False A dissolution does not necessarily destroy the business of a partnership. Dissolution is not the same thing as terminating an organization's business activity. 18. All partners in a general partnership have unlimited liability for their organization's debts. Answer: True All partners in a general partnership have unlimited liability for their organization's debts. These partners' personal assets, which are not associated with the partnership, may be claimed by the partnership's creditors. 19. Shareholders elect the officers of a corporation. Answer: False In the corporate form of organization, the shareholders elect the members of the board of directors. These directors set the objectives or goals of the corporation, and they appoint the officers. 20. A limited partnership is solely made up of limited partners. Answer: False A limited partnership basically has all the attributes of a partnership except that one or more of the partners are designated as limited partners. The management is left in the hands of one or more general partners who remain personally liable for the organization's debts. 21. A limited partner may assign his/her interest to another without dissolving the limited partnership. Answer: True The principles guiding partnerships also apply to limited partnerships if there is a change in the general partners. A limited partner may assign his/her interest to another without dissolving the limited partnership. 22. A limited partner, even if he/she participates in management, cannot be held liable as a general partner. Answer: False Under the RULPA, a limited partner who participates in the organization's management becomes liable as a general partner if a third party had knowledge of the limited partner's activities. 23. Any operating loss suffered by an S corporation is shared and immediately deductible on the returns of its shareholders. Answer: True As a rule of thumb, S corporations have distinct advantages for a business operating at a loss because the loss is shared and immediately deductible on the returns of the shareholders. 24. The IRS treats LLCs as taxable entities. Answer: False In 1988, the Internal Revenue Service ruled that limited liability companies (LLCs) would be treated as nontaxable entities, much like partnerships, for federal income tax purposes. 25. In a limited liability company, members act as agents of the LLC but are not personally liable to third parties. Answer: True For liability purposes, members do act as agents of their LLC. However, they are not personally liable to third parties. Thus, these members have attributes of both partners and shareholders with respect to liability. 26. A periodical review of the criteria used to select a form of organization enables the advantages of an organizational form to be balanced against the disadvantages. Answer: True The criteria used to select a form of organization needs to be reviewed periodically. The reviewers weigh the factors and costs involved and then select the most suitable organizational form for the business's needs at that time. Because this selection process balances advantages against disadvantages, the decision often is to choose the least objectionable form of organization. 27. It is usual for the growth in a business to be reflected in changes in organizational forms as a part of a life cycle. Answer: True It is not unusual for the growth in a business to be reflected in changes in organizational forms as a part of a life cycle. 28. In the current business environment, corporate boards are less likely to engage shareholders in governance decisions. Answer: False A first significant trend in corporate governance relates to shareholders becoming increasingly active. In the current business environment, corporate boards are now more likely to engage shareholders in governance decisions. 29. In the current business environment, there is an increased focus on legal liability for directors and officers. Answer: True In the current business environment, there is an increased focus on legal liability for directors and officers. The business judgment rule provides protection from liability to shareholders for business decisions, and corporations are generally obligated to indemnify directors and officers for third-party harm resulting from company business. 30. Criminal prosecutions for corporate wrongdoing are rising, given the current trend of business environment. Answer: False In a counter-trend, criminal prosecutions for corporate wrongdoing may be declining due to the increased use of "deferred prosecution agreements" (DPA) by the federal government. 31. Which of the following is a basic form of business organization? A. LLC B. Limited partnership C. LLP D. Sole proprietorship E. S corporation Answer: D. Sole proprietorship The three basic forms of business organization include sole proprietorships, partnerships, and corporation. 32. Which of the following is true about publicly held business organizations? A. These organizations are owned only by a few persons. B. Decisions regarding selection of appropriate organizational forms are usually limited to these organizations. C. Shareholders of such organizations can transfer their ownership without interfering with the organization's management. D. A family-operated business is a classic example of a publicly held business organization. E. The status of a shareholder in these organizations limits their liability for torts and shareholders mostly forgo their limited liability for cosigning contracts. Answer: C. Shareholders of such organizations can transfer their ownership without interfering with the organization's management. When a business is publicly held by a large number of owners, the form of organization usually is a corporation. The reason for this corporate form being used is that shareholders can transfer their ownership without interfering with the organization's management. 33. "Creation" means: A. the legal steps required to form a particular business organization. B. the concept of a business. C. the intent to create a business. D. a paradigm shift in a business. E. the relation of the organization's existence to its owners. Answer: A. the legal steps required to form a particular business organization. The word "creation" means the legal steps necessary to form a particular business organization. 34. The crucial issue with the continuity factor of a business's organizational form is: A. management style. B. profit distribution. C. the method by which the business can be dissolved. D. the method of customer service observed. E. the control exercised by managers. Answer: C. the method by which the business can be dissolved. The crucial issue with the continuity factor is the method by which a business organization can be dissolved. A dissolution is any change in the ownership of an organization that changes the legal existence of the organization. 35. When selecting a form of business venture, considering potential conflicts and mechanisms to resolve disputes refers to which of the following factors? A. Creation B. Continuity C. Liability D. Managerial control E. Taxation Answer: D. Managerial control Usually, when people are excited about getting started in a business opportunity, no one takes time to discuss methods of resolving potential deadlocks. The failure to consider how to overcome disputes involving managerial control can cause business activities to suffer and the organization to fail. Therefore, consideration of potential conflict and mechanisms to resolve disputes are essential to consider when selecting a form for a business venture. 36. Which of the following qualifies a sole proprietorship? A. Owned by one person B. Owned by one family C. Has only one location D. Activities in only one state E. Has only one activity Answer: A. Owned by one person A sole proprietorship is the easiest and least expensive business organization to create. In essence, the proprietor obtains whatever business licenses are necessary and begins operations. 37. Which of the following forms of organization requires no formal documentation but only business licenses for formation? A. Limited partnership B. Corporation C. Limited liability company D. Sole proprietorship E. S corporation Answer: D. Sole proprietorship Sole proprietorship requires no formal documentation but only business licenses for formation. 38. In a(n) _________, the shareholders are taxed only on income distributed. A. limited partnership B. corporation C. Limited liability company D. sole proprietorship E. S corporation Answer: B. corporation In a corporation, the shareholders are taxed only on income distributed. 39. Which of the following organizations is equally managed by the members unless a manager is designated? A. Limited partnership B. Corporation C. Limited liability company D. Sole proprietorship E. S corporation Answer: C. Limited liability company Limited Liability Companies are equally managed by the members unless a manager is designated. 40. Which of the following has a perpetual existence so long as the number of shareholders is limited? A. Limited partnership B. Partnership C. Limited liability company D. Sole proprietorship E. S corporation Answer: E. S corporation S corporation has a perpetual existence so long as the number of shareholders is limited. 41. The creation of _________ is automatic based on business conduct and is modified by agreement. A. limited partnership B. corporation C. partnership D. sole proprietorship E. S corporation Answer: C. partnership The creation of partnership is automatic based on business conduct and is modified by agreement. 42. Which of the following requires organizers to file articles of organization with state official for formation? A. Limited partnership B. Partnership C. Limited liability company D. Sole proprietorship E. S corporation Answer: C. Limited liability company A limited liability company requires its organizers to file articles of organization with state official for formation. 43. Which of the following makes sole proprietorship a less desirable form of organization? A. Creation of sole proprietorship is expensive and requires formal documentation. B. Proprietorship's business activity may be more stable than the proprietor's willingness to remain actively involved in the business. C. Proprietor may have to share his/her voice of control and responsibility for the business' success with the other acting members of the organization. D. The business is always held liable for 100 percent of the debts. E. The proprietorship is a victim of double taxation. Answer: B. Proprietorship's business activity may be more stable than the proprietor's willingness to remain actively involved in the business. The fact that the proprietorship's business activity may be more stable than the proprietor's willingness to remain actively involved in the business indicates that the sole proprietorship is a less desirable organizational form. Ownership of a sole proprietorship cannot be transferred. 44. Jonathan wants to start a business. Which form of business organization will give him the most complete and exclusive control over business decisions? A. Sole proprietorship B. Partnership C. Corporation D. S corporation E. Limited liability company Answer: A. Sole proprietorship The sole proprietor is in total control of his/her business's goals and operations. While the proprietor has complete responsibility for the business's success or failure, the owners of all other organizational forms usually share control to some degree. 45. Two or more individuals, an individual and a corporation, a partnership and a corporation, or any combination of these entities may agree to create a(n): A. sole proprietorship. B. partnership. C. corporation. D. S corporation. E. limited liability company. Answer: B. partnership. Whenever two or more people wish to own a business together, a partnership is a possible organizational form. Two or more individuals, an individual and a corporation, a partnership and a corporation, or any combination of these entities may agree to create a business organization called a partnership. 46. Which of the following forms of organization is most easily formed at minimal costs? A. Limited partnership B. Partnership C. Corporation D. S corporation E. Limited liability company Answer: B. Partnership When compared to other forms of business organizations (other than the sole proprietorship), a partnership is easily formed. The cost of forming a partnership is relatively minimal. 47. A partnership must have: A. one or more people. B. no personal liability. C. a nonprofit focus. D. a common interest in business. E. a taxability factor built within. Answer: D. a common interest in business. The key to a partnership's existence is satisfying the elements of its definition, which are, (1) two or more persons, (2) a common interest in business, and (3) sharing profits and losses. 48. Whenever two or more people wish to own a business together, they enter into a formal agreement called the: A. articles of confederation. B. articles of incorporation. C. articles of partnership. D. articles of association. E. articles of integration. Answer: C. articles of partnership. Whenever two or more people wish to own a business together, a partnership is a possible organizational form. Partners should never rely on implied agreements. Rather, their agreement should be explicitly stated among the parties and drafted into a formal document. The formal agreement is called the articles of partnership. 49. While selecting a name for the partnership, if the name is other than that of the partners, the partners must give notice as to their actually identity under the state's: A. fictitious-name certification law. B. annexed-name statute. C. suppositious-name law. D. fictive-name rule. E. assumed-name statute. Answer: E. assumed-name statute. Since a partnership is created by agreement, the partners select the name of the partnership. If the name is other than that of the partners, the partners must give notice as to their actual identity under the state's assumed-name statute. 50. Which of the following is true about a general partnership? A. It is dissolved any time there is a change in partners. B. It can be transferred to new owners without affecting the original agreement. C. It has no liability. D. It is taxed as an entity. E. It requires permission from each state in which it does business during formation. Answer: A. It is dissolved any time there is a change in partners. A general partnership is dissolved any time there is a change in the partners. For example, if a partner dies, retires, or otherwise withdraws from the organization, the partnership is dissolved. Likewise, if a person is added as a new partner, there is a technical dissolution of the organization. 51. To prevent problems that may arise when a partner dies or withdraws from a partnership, the articles of partnership should include a(n): A. buy and sell agreement. B. escrow instruction. C. dissolution contract. D. purchase contract. E. interest agreement. Answer: A. buy and sell agreement. To prevent problems that may arise when a partner dies or withdraws from a partnership, the articles of partnership should include a buy and sell agreement. This agreement, which should be entered into when the business entity is created, provides for the amount and manner of compensation for the interest of the deceased or withdrawing owner. 52. Which of the following is true about managerial control in a general partnership? A. The agreement has to provide for each partner to have equal voice in the firm's affairs. B. Control may be divided for the firm to include controlling partners and minority partners. C. The differences in the degree of control do not affect the business's success. D. The possibility of deadlock is higher when there are more number of partners and an odd number of them. E. Language governing issues of managerial control need to be made orally clear to all partners. Answer: B. Control may be divided for the firm to include controlling partners and minority partners. In a general partnership, unless the agreement provides to the contrary, each partner has an equal voice in the firm's affairs. Partners may agree to divide control in such a way as to make controlling partners and minority partners. 53. Which of the following is true about liability of partners in a general partnership? A. Partners have limited liability for the organization's debts. B. Partners personal assets, which are not associated with the partnership, may not be claimed by the creditors. C. From a creditor's perspective, the liability of each partner extends only to a pro rata share. D. Any partner who has to pay beyond his pro rata share will have to make use of his future buyout interest. E. A partner having unlimited liability will be jointly and severally liable for the partnership's obligations. Answer: E. A partner having unlimited liability will be jointly and severally liable for the partnership's obligations. All partners in a general partnership have unlimited liability for their organization's debts. These partners are jointly and severally liable for the partnership's obligations. 54. Which of the following is a disadvantage of partnerships? A. The cost of formation is high. B. They are based on consensual contracts. C. They are subject to more governmental supervision than corporations. D. A partnership needs to obtain a license if it wishes to operate in more than one state. E. A partnership will be dissolved any time a partner leaves the partnership. Answer: E. A partnership will be dissolved any time a partner leaves the partnership. Disadvantages of partnerships include limitation of partners, dissolution at anytime with change in partners, unlimited liability of partners, and partners being required to pay income tax on money not received. 55. A partnership: A. cannot operate in more than one state without obtaining a license to do so. B. is generally subject to more regulation and governmental supervision than a corporation. C. provides general partners with unlimited liability. D. involves significant formation costs. E. allows unlimited number of people to become partners. Answer: C. provides general partners with unlimited liability. Disadvantages of partnerships include limited number of partners; can be dissolved any time a partner leaves the partnership; unlimited liability; and, partners are taxed on their share of the profits even if they did not receive them. 56. A corporation created under the authority of a foreign country may be called a(n) corporation. A. imported B. offshore C. alien D. distant E. external Answer: C. alien A corporation created under the authority of a foreign country may be called an alien corporation. 57. Which of the following is true about the creation of a corporation? A. It is created under federal law. B. It created under state law. C. The formal application for a corporate charter is called the articles of association. D. It is regulated only by local statutes. E. Corporations are inexpensive to form. Answer: B. It created under state law. A corporation is an artificial, intangible entity created under the authority of a state's law. A corporation is created by a state issuing a charter upon the application of individuals known as incorporators. 58. The most difficult and complicated business organization to create is the: A. sole proprietorship. B. partnership. C. limited partnership. D. corporation. E. limited liability partnership. Answer: D. corporation. As a creature of state legislative bodies, the corporation is much more complex to create and to operate than other forms of businesses. 59. A corporate charter is issued following an application made by individuals known as: A. incorporators. B. corporate officers. C. board members. D. corporate panel. E. proxies. Answer: A. incorporators. A corporation is created by a state issuing a charter upon the application of individuals known as incorporators. 60. The formal application for a corporate charter is called the: A. articles of confederation. B. articles of incorporation. C. articles of partnership. D. articles of association. E. articles of integration. Answer: B. articles of incorporation. The formal application for a corporate charter is called the articles of incorporation. These articles must contain the proposed name of the corporation. 61. In a closely held corporation, the majority shareholders: A. have no influence on management. B. elect the members of the board of directors. C. cannot be employed by the corporation. D. have the same impact on policy as minority stockholders. E. bring upon derivative suits on behalf of the corporation. Answer: B. elect the members of the board of directors. Unlike the situation with a large, publicly held corporation, one shareholder (or at least a small group of shareholders) may be able to control a closely held corporation. This can result because this individual (or the group) can own an actual majority of the issued shares. This majority can control the election of a board of directors. 62. When a derivative law suit is filed: A. majority shareholders may complain that minority shareholders are not cooperating with the board. B. majority shareholders are required to prove that they are not acting illegally or oppressing the rights of minority shareholders. C. minority shareholders are required to provide evidence that the majority shareholders are acting illegally or oppressing the rights of the minority shareholders. D. directors are suing the officers and asking for their termination due to illegal or oppressive acts directed at all shareholders. E. majority shareholders act on behalf of the organization. Answer: B. majority shareholders are required to prove that they are not acting illegally or oppressing the rights of minority shareholders. If the majority is acting illegally or oppresses the rights of the minority shareholders, a lawsuit known as a derivative suit may be brought by a minority shareholder on behalf of the corporation. If a suit is brought, the burden is on the director or officer (who may be the majority shareholder) to prove good faith and inherent fairness in such transactions. 63. When one person, or a very few persons, own all the shares of stock in a corporation, it is considered a organization. A. publicly held B. narrowly held C. closely held D. tightly held E. minority held Answer: C. closely held Unlike the situation with a large, publicly held corporation, one shareholder (or at least a small group of shareholders) may be able to control a closely held corporation. This can result because this individual (or the group) can own an actual majority of the issued shares. 64. When a court finds that the shareholders of a corporation are using the corporate structure to shield themselves from liability when acting for purely personal purposes, the court may disregard the corporate structure and impose personal liability on the shareholders treating them like partners. This is called: A. cracking the corporate shell. B. piercing the corporate veil. C. breaking the corporate shield. D. breaching the corporate defense. E. rupturing the corporate law. Answer: B. piercing the corporate veil. When courts find that the corporate organization is being misused, the corporate entity can be disregarded. This has been called piercing the corporate veil. When this veil of protection has been pierced, the shareholders are treated like partners who have unlimited liability for their organization's debts. 65. If a corporate entity is disregarded by officers or directors so that there is such a unity of ownership and interest that separateness of the corporation has ceased to exist, the corporate veil may be pierced based on the: A. alter-ego theory. B. negligent conduct theory. C. corporate confusion theory. D. corporate envelopment theory. E. corporate doppelganger theory. Answer: A. alter-ego theory. The alter-ego theory, by which the corporate veil can be pierced, may also be used to impose personal liability upon corporate officers, directors, and stockholders. If the corporate entity is disregarded by these officials themselves, so that there is such a unity of ownership and interest that separateness of the corporation has ceased to exist, the alter-ego theory will be followed and the corporate veil will be pierced. 66. Which of the following is a taxable entity? A. A partnership B. An S corporation C. A limited liability company D. A corporation E. A sole proprietorship Answer: D. A corporation Corporations must pay income taxes on their earnings. The fact that there is a separate corporate income tax may work as an advantage. 67. Which of the following is an advantage of the corporate organization? A. License fees and franchise taxes are rarely assessed against corporations. B. Control of a corporation may be held by those with a minority of the investment. C. The cost of forming and maintaining a corporation is minimal. D. Once a corporation is properly formed, it becomes automatically eligible to do business in all 50 states. E. Ownership must be divided into three or more equal shares. Answer: B. Control of a corporation may be held by those with a minority of the investment. Advantages of corporations include best means for bringing together large number of investors, control held by those with a minority of the investment, ownership divided into many unequal shares, limited liability of shareholders, perpetual existence, and benefits for shareholders. 68. Disadvantages of the corporate form of organization include: A. single taxation. B. cost of formation and maintenance. C. unlimited liability. D. dissolution from change in memberships. E. lack of benefits for shareholders. Answer: B. cost of formation and maintenance. Disadvantages of corporations include cost of forming and maintaining a corporation, assessment of license fees and franchise taxes, requirement of qualification in each state of operation, subjection to governmental regulations at all levels, and double taxation. 69. For limited partners to retain their status of limited liability, the partnership must evidence compliance with all technical requirements of the limited partnership law. A. complete B. nominal C. minor D. reasonable E. substantial Answer: E. substantial If an accurate certificate is not on record and the limited partnership continues its operation, the limited partners become liable as general partners. Substantial compliance with all the technical requirements of the limited partnership law is essential if the limited partners are to be assured of their limited liability. 70. Limited partners: A. are personally responsible for debts of the business. B. control operations of the limited partnership. C. may dissolve the limited partnership by assigning their interest in a business to another person. D. may have their surnames used in the partnership's name. E. may act as a guarantor of the partnership's obligations. Answer: E. may act as a guarantor of the partnership's obligations. A limited partner may participate in the following activities and not be considered participating in management: being an agent or employee of the partnership; being a consultant; a guarantor of partnership debt; inspecting the books; receiving profits or other compensation from the business; voting on an amendment to the partnership certificate; voting on major partnership issues; and, having contributions returned after dissolution. 71. Which of the following is an activity that a limited partner may NOT engage in? A. Acting as an agent of the partnership B. Approving an amendment to the partnerships' certificate C. Participating in management D. Inspecting any of the partnership's financial records E. Advising or consulting with a general partner Answer: C. Participating in management Limited partners may not participate in the management of the limited partnership. Under the RULPA, a limited partner who participates in the organization's management becomes liable as a general partner if a third party had knowledge of the limited partner's activities. 72. Which of the following is true about an S corporation? A. It has the same legal characteristics as any other corporation except for the issue of taxation. B. It is the official designation for a corporation with 500 or less employees. C. It is the same as any other corporation except for management participation by stockholders. D. It is exactly the same as any other corporation. E. It need not file an information return with the IRS since it does not pay any taxes. Answer: A. It has the same legal characteristics as any other corporation except for the issue of taxation. The S corporation has all the legal characteristics of the corporation. The one exception to this similar treatment is that shareholders in the S corporation are responsible for accounting on their individual income tax returns for their respective shares of their organization's profits or losses. 73. An LLC is created through filing the with a state official, usually the secretary of state. A. articles of confederation B. articles of incorporation C. articles of organization D. articles of association E. articles of integration Answer: C. articles of organization An LLC is created through filings much like those used when creating a corporation. Articles of organization are filed with a state official, usually the secretary of state. Instead of "incorporators," the term "organizers" is used. 74. The owners of LLCs are called: A. shareholders. B. partners. C. proprietors. D. members. E. directors. Answer: D. members. The owners of LLCs are called members rather than shareholders or partners. 75. Which of the following is true about the trends in operating business organizations? A. With the recent financial crises, public attention is moving toward management of limited partnerships. B. Shareholders are losing interest and are becoming less active. C. The Dodd-Frank Act has mandated rules that prevent shareholders from including their own board candidates in proxy materials. D. In many cases, corporations and individuals reasonably have an equal claim to rights and protections under the law. E. The focus on legal liability for directors and officers is decreasing. Answer: D. In many cases, corporations and individuals reasonably have an equal claim to rights and protections under the law. A recent trend is the continued definition of the nature of corporate personhood. In many cases, corporations and individuals reasonably have an equal claim to rights and protections under the law. 76. How can business organizations be classified based on the number of persons who own them? Give one example of each. Answer: Relating to the number of owners of a business organization, they may be classified as closely held and publicly held. Some organizations are owned by only a few persons. Such organizations are said to be closely held. Family-owned and family-operated businesses are common examples of closely held organizations. Other businesses may be owned by hundreds, if not thousands, of persons. These organizations are publicly held ones. Examples of publicly held businesses include those whose stock is traded on a public exchange. 77. What factors should be considered when selecting the best organizational form for a particular business? Answer: Significant factors to consider when choosing a form of business are: • the cost of creating the organization; • the continuity or stability of the organization; • the control of decisions; • the personal liability of the owners; • the taxation of the organization's earnings and its distribution of profits to the owners. 78. Explain the term "creation" as a factor considered when selecting a business organizational form. Answer: The word "creation" means the legal steps necessary to form a particular business organization. Usually, the cost of creation is not a major factor in considering which form of business organization a person will choose to operate a business. The most significant creation-related issues are how long it will take to create a particular organization and how much paperwork is involved. 79. Explain sole proprietorship in terms of its continuity. Answer: A proprietorship's continuity is tied directly to the will of the proprietor. The proprietor may dissolve his/her organization at any time by simply changing the organization or terminating the business activity. The fact that the proprietorship's business activity may be more stable than the proprietor's willingness to remain actively involved in the business indicates that the sole proprietorship is a less desirable organizational form. Ownership of a sole proprietorship cannot be transferred. 80. Explain the degree of control enjoyed by a sole proprietor. Answer: The sole proprietor is in total control of his/her business's goals and operations. While the proprietor has complete responsibility for the business's success or failure, the owners of all other organizational forms usually share control to some degree. As long as this control issue is carefully thought out, there can be real value in having more than one voice in control of managing a business enterprise. 81. How is the liability factor a disadvantage of sole proprietorship? Answer: A sole proprietor is personally obligated for the debt of the proprietorship. Legally speaking, this owner has unlimited liability for the organization's obligations. The business organization's creditors can seek to hold the proprietor personally liable for 100 percent of the debts and legal obligations that the proprietorship cannot satisfy. The desire to avoid the potentially high risk of personal liability is an important reason why other organizational forms might be viewed as preferable to the proprietorship. 82. Explain the possible organizational form that occurs when two or more people wish to own a business together. Answer: Whenever two or more people wish to own a business together, a partnership is a possible organizational form. In general, a partnership is an agreement between two or more persons to share a common interest in a commercial endeavor and to share profits and losses. Persons may include two or more individuals, an individual and a corporation, a partnership and a corporation, or any combination of these entities. 83. Other than a sole proprietorship, why is partnership easy to form when compared to other forms of business organizations? Answer: The cost of forming a partnership is relatively minimal. In addition, the creation of a partnership is made easier since it does not need to get permission from each state in which it does business. The key to a partnership's existence is satisfying the elements of its definition. It includes (1) two or more persons, (2) a common interest in business, and (3) sharing profits and losses. If the parties conduct their affairs in such a way as to meet these definitional elements, a partnership exists regardless of whether the persons involved call themselves partners or not. 84. How continuous is a partnership form of business organization? Answer: A general partnership is dissolved any time there is a change in the partners such as the death of a partner or the addition of a partner. Even if the partnership agreement provides that the partnership will continue for a stated number of years, any partner still retains the power to dissolve the organization. However, a dissolution does not necessarily destroy the business of a partnership. Dissolution is not the same thing as terminating an organization's business activity. Termination involves the winding up or liquidating of a business; dissolution simply means the legal form of organization no longer exists. 85. To what extent are partners in a general partnership liable for the organization's debts? Answer: All partners in a general partnership have unlimited liability for their organization's debts. These partners' personal assets, which are not associated with the partnership, may be claimed by the partnership's creditors. From a creditor's perspective, this personal liability of each partner extends to the organization's entire debt, not just to a pro rata share. These partners are jointly and severally liable for the partnership's obligations. 86. What is the purpose of a buy and sell agreement and when are they needed? Answer: The buy and sell agreement, which is entered into when the partnership is created, provides for the amount and manner of compensation for the interest of a deceased or withdrawing owner. This agreement can help to prevent problems for the business and the owners. 87. Are partnerships taxable entities? Explain. Answer: Partnerships are not a taxable entity. This does not mean that the profits of the partnership are free from income tax. Partners report their share of profits or losses, dividend income, and other items that would affect the income tax owed by a partner, irrespective of whether they have actually received the items. This aspect of a partnership is an advantage to the partners if the organization suffers a net loss since the pro rata share of the loss is allocated to each partner which will reduce the partners' personal taxable income. This may also be a disadvantage if the organization retains any profits made by the organization for the purpose of expansion. 88. What are the main advantages and disadvantages of partnerships? Answer: The main advantages of a partnership are: • easily formed; • formation costs are low; • partnerships are not a tax paying entity; • typically each partner is equal; • it may operate in more than one state without a license; • partnerships are usually less regulated than corporations. The main disadvantages of a partnership are: • limited number of partners; • can be dissolved anytime a partner leaves the partnership; • unlimited liability; • partners are taxed on their share of the profits even if they did not receive them. 89. How is a corporation form of organization identified with regard to where it has been incorporated? Answer: A corporation is an artificial, intangible entity created under the authority of a state's law. A corporation is known as a domestic corporation in the state in which it is incorporated. In all other states, this corporation is called a foreign corporation. A corporation created under the authority of a foreign country may be called an alien corporation, though it is generally treated the same as a foreign corporation under the law. 90. What are the steps that must be taken in order to form a corporation and what are the typical types of costs involved? Answer: The articles of incorporation must be drafted and then filed with the appropriate state office. Once approved, the appropriate state officer, usually the secretary of state, issues the charter. The charter is then advertised in a local newspaper, recorded, or both. The initial board of directors meets and they adopt the corporate bylaws and approve the sale of stock. They should also appoint the corporate officers. Once these steps are completed, the corporation is functional. Among the costs of incorporation are filing fees, license fees, franchise taxes, attorneys' fees, and the cost of supplies, such as minute books, corporate seals, and stock certificates. In addition to these costs of creation, there also are annual costs in continuing a corporation's operation. These recurring expenses include annual reporting fees and taxes, the cost of annual shareholders' meetings, and ongoing legal-related expenses. 91. What must a corporation do if it wishes to conduct business in states other than the state of incorporation? Answer: If a corporation wishes to conduct business in states other than the state of incorporation, that corporation must be licensed in these foreign states. The process of qualification usually requires payment of license fees and franchise taxes above and beyond those paid during the initial incorporation process. If a corporation fails to qualify in states where it is conducting business, the corporation may be denied access to the courts as a means of enforcing its contracts. 92. How is control decided in publicly held and closely held corporations? Answer: In large publicly held corporations, control is held by the incumbent management (officers and directors) through stock they own and through solicitation of proxies from the other stockholders. In closely held corporations, the majority shareholders control the business by controlling the election to the board of directors. They can elect themselves. The board hires the officers who run the business day-to-day, so the control is real and almost absolute. 93. Explain why corporations are said to be double taxed. Answer: When it occurs, double taxation for a corporation is the taxing of profits first at the entity (corporate) level and then again at the shareholder level when the shareholder receives a dividend (a company profit distribution). The dividend is taxed as ordinary income to the shareholder. Therefore, by the time the company profits are in the hands of the owners, the profits have been taxed twice. 94. What are the techniques employed by corporations to avoid double taxation? Answer: Corporations have employed a variety of techniques for avoiding the double taxation of corporate income. • First, reasonable salaries paid to corporate officials may be deducted in computing the taxable income of the business. • Second, corporations provide expense accounts for many employees, including shareholder employees. • Third, the capital structure of the corporation may include both common stock and interest-bearing loans from shareholders. • The fourth technique for avoiding double taxation, at least in part, is simply not to pay dividends and to accumulate the earnings. • Fifth, a corporation may elect to file under Subchapter S of the Internal Revenue Code. This election eliminates the corporate tax. 95. What are the drawbacks of corporate form of organization? Answer: Among the frequently cited disadvantages of the corporate organization are the following: • The cost of forming and maintaining a corporation, with its formal procedural requirements, is significant. • License fees and franchise taxes often are assessed against corporations but not partnerships. • A corporation must be qualified in all states where it is conducting local or intrastate business. • Generally, corporations are subject to more governmental regulation at all levels than are other forms of business. • Corporate income may be subject to double taxation. 96. You have been asked to join a partnership. What must you consider when choosing to become a general or limited partner? Answer: If you become a general partner, you will have unlimited liability for the partnership debts. As a general partner, you will have the right to participate in the management of the partnership. Were you to become a limited partner, the liability for partnership debt would be limited to the extent of your capital contribution. As a limited partner, you would have no right to participate in management, so the business is in the other partner's hands. 97. What are some of the business activities a limited partner may engage in? Answer: A limited partner may participate in the following activities and not be considered participating in management: • being an agent or employee of the partnership; • being a consultant; • a guarantor of partnership debt; • inspecting the books; • demanding true and full information about the partnership whenever circumstances render it just and reasonable; • receiving profits or other compensation from the business; • voting on an amendment to the partnership certificate; voting on major partnership issues; • having contributions returned after dissolution. Feedback: Refer: Sidebar 14.7 98. What are the advantages of an S corporation? Answer: As a rule of thumb, an S corporation has distinct advantages for a business operating at a loss because the loss is shared and immediately deductible on the returns of the shareholders. It is also advantageous for businesses capable of paying out net profits as earned. In the latter case, the corporate tax is avoided. 99. Identify the degrees of liability and taxation faced by an LLC. Answer: For liability purposes, members do act as agents of their LLC. However, they are not personally liable to third parties. Thus, these members have attributes of both partners and shareholders with respect to liability. State laws and the IRS recognize LLCs as nontaxable entities. Careful analysis is needed in every situation to determine whether this type of tax treatment is in the members' best interests. 100. One of the newer trends in corporate governance is the concept of say-on-pay. What is say-on-pay and how does it affect corporate governance? Answer: Shareholders have asked for more say in the level of executive compensation. The recent Dodd-Frank Act seeks to provide shareholders with the ability for greater oversight or "say-on-pay" by requiring periodic, nonbinding shareholder votes on compensation. There is concern that such compensation is excessive in some cases and insufficiently scrutinized by the board of directors. Test Bank for The Legal and Regulatory Environment of Business O. Lee Reed, Marisa Pagnattaro, Daniel Cahoy, Peter Shedd, Jere Morehead 9780073524993, 9780077437336, 9781260161793
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