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CHAPTER 21-STARTING A BUSINESS: LLCS AND OTHER OPTION
TRUE/FALSE
1. Corporations have perpetual existence.
Answer: True
2. The most common form of business ownership is the corporation.
Answer: False
3. To be a close corporation, the business must be small, with no more than 20 owners and no
more than $500,000 in gross annual income.
Answer: False
4. Limited liability is a major advantage of a partnership as compared to a corporation.
Answer: False
5. Generally, a joint venture is a partnership created for one limited purpose.
Answer: True
6. Alan, a dentist, and his wife Martha, an attorney, can protect their personal assets with
limited liability from their business dealings by creating and operating a professional
corporation together.
Answer: False
7. A partnership is a taxable entity, separate from the partners.
Answer: False
8. Corporations have a distinct advantage over other forms of business organization in the
area of taxation.
Answer: False
9. Franchise fees can be costly, but they are usually payable over a number of years, after
profits are generated from the business.
Answer: False
10. A limited liability company, unlike a Subchapter S corporation, can have members that
are corporations, partnerships, or nonresident aliens.
Answer: True
11. To form an LLC, a charter and an operating agreement must be filed with the Secretary of
State in the jurisdiction where the business will operate.
Answer: False
12. Filings are required to form and operate a limited liability partnership.
Answer: True
13. Nicholas and Holly are partners in a toymaking shop. If Rudolph obtains a judgment
against Nicholas for injuring Rudolph while Nicholas was on partnership business, Rudolph
must try to collect from the partnership before going after Nicholas’ personal assets.
Answer: True
14. Alicia and Ted have a written agreement wherein they will share the losses of their joint
business. This agreement is strong evidence they are partners.
Answer: True
15. The dissolution of a partnership means the same as its termination.
Answer: False
MULTIPLE CHOICE
1. Debra and Lawrence have an equal partnership. This year, after expenses, the partnership
had a profit of $200,000. Debra and Lawrence will each pay taxes on:
a. whatever they receive from the partnership.
b. $50,000.
c. $100,000.
d. None of the above. The partnership itself will pay the taxes on the business’s profit.
Answer: C
2. All the business forms listed below have limited liability except the:
a. limited liability company.
b. general partnership.
c. Subchapter "S" corporation.
d. corporation.
Answer: B
3. Rachel and Cyndi started a retail business called Zebra Toy Company. The business is
operated as a partnership. Under partnership law:
a. Rachel is personally liable for any business contracts entered into by Cyndi.
b. Rachel is personally liable for any business debts, regardless of whether she or Cyndi
created the obligation.
c. Rachel is personally liable for any negligent act committed by Cyndi in the scope of the
business activity.
d. All the above.
Answer: D
4. Seventy farmers in Morgan County joined together to gain the advantages of purchasing
seed and fertilizer in bulk and of obtaining better prices when distributing and selling their
crops. These farmers have formed a:
a. business trust.
b. cooperative.
c. franchise.
d. joint venture.
Answer: B
5. The importance of a Subchapter S corporation is:
a. its organizational structure.
b. its treatment of shareholders for income taxation purposes.
c. its requirement of restrictive transfer rights of the shares.
d. its small cost of formation.
Answer: B
6. The business form that is taxed as a partnership and gives all owners limited liability, is:
a. a close corporation.
b. a limited partnership.
c. a limited liability company.
d. a general partnership.
Answer: C
7. Which of the following transactions would be considered by the IRS to be a taxable sale of
assets? Changing the form of business from:
a. a corporation to an LLC.
b. a partnership to an LLC.
c. an LLC to a corporation.
d. All of the above.
Answer: A
8. All of the following are characteristics of a closely held corporation EXCEPT:
a. the shares are publicly traded.
b. the corporation can typically operate without a board of directors.
c. the shareholders usually restrict share transfer.
d. minority shareholders are provided more protection than in regular corporations.
Answer: A
9. Which of the following would not be personally liable for the debts of the business?
a. A sole proprietor.
b. A partner in a general partnership.
c. A general partner in a limited liability limited partnership.
d. A general partner in a limited partnership.
Answer: C
10. James was a partner in a large firm. He died unexpectedly. His son, Frank, wanted to take
over for his father in the partnership and was well qualified to do the work his father had
done. Which statement best describes Frank's rights in the partnership if he inherits the
interest?
a. Frank has a right to take over for his father in the partnership.
b. Frank is entitled to the value in the partnership, but not to become a full partner.
c. Frank has no rights to his father's partnership interest.
d. None of the above.
Answer: B
11. Jill was a limited partner in a retail business that was sued by a customer who fell in the
store. The customer claimed the business was negligent in caring for its floors. Which
statement best describes Jill's potential liability?
a. Jill has no potential liability to the customer.
b. Jill can be held personally liable to the customer since she is a partner.
c. Jill can only be liable to the amount of her investment.
d. Jill is personally liable, but the woman must first collect from the general partners before
collecting from Jill.
Answer: C
12. The form of business ownership that is the most easily transferable is the:
a. general partnership.
b. corporation.
c. limited liability company.
d. limited partnership.
Answer: B
13. The corporate form of business:
a. was first known and used by the Greeks and then spread through the Romans to England.
b. was not known until about 1737 when Sir Francis LaRue developed the concept.
c. was first allowed in the State of New York around 1811 and is considered to be an
American creation.
d. None of the above.
Answer: A
14. The advantage of a corporation over a partnership is:
a. shares are easily transferable to another person.
b. perpetual existence.
c. it is easier to raise funds.
d. All the above.
Answer: D
15. What federal agency requires that the seller of a franchise give the potential buyer an
offering circular and audited financial statements?
a. The Securities and Exchange Commission (SEC).
b. The Interstate Commerce Commission (ICC).
c. The Federal Trade Commission (FTC).
d. The Franchise Sales Commission (FSC).
Answer: C
16. Which of the following forms of organization is a compromise between starting one's own
business as an entrepreneur and working for someone else as an employee?
a. Limited liability company.
b. Business trust.
c. Close corporation.
d. Franchise.
Answer: D
17. Harold and Zack have pooled their money together to buy real estate but have filed no
formal papers to form a business. Harold, a lawyer, handles all the legal matters and Zack, a
real estate broker, finds buyers for the property they have subdivided. Harold and Zack are
engaged in a:
a. partnership.
b. close corporation.
c. limited liability company.
d. business trust.
Answer: A
18. Charles and Ellen, an unmarried couple, run an ice cream store. The business is not
incorporated and they have filed no formation papers with the state. Their business is a:
a. sole proprietorship.
b. partnership.
c. joint venture.
d. limited liability company.
Answer: B
19. E. I. James is a writer with a best selling novel. He wishes to create a corporation called
“James, Inc.” He will be the only shareholder. Can James incorporate his business of writing?
a. Yes, this would be the incorporation of a sole proprietorship.
b. No, the law requires at least two people to be shareholders of a corporation.
c. No, the law does not permit a person to, in effect, incorporate himself.
d. Only if he forms an S Corporation.
Answer: A
20. Daniel, his parents, and three brothers own all the stock of their family farm corporation.
This corporation, which is taxed as a corporation, is probably:
a. an S corporation.
b. a C corporation.
c. a closely held corporation.
d. an LLC.
Answer: C
21. An S Corporation cannot have more than ____ shareholders.
a. 100
b. 75
c. 50
d. 25
Answer: A
22. The term "S Corporation" comes from:
a. the Internal Revenue Code.
b. the FTC rules.
c. the U.S. Constitution.
d. state corporation law.
Answer: A
23. Martin, Leah, and Pablo are considering forming a business. What factors should they
consider in making a choice of organization?
a. Ease of creation and operation.
b. Whether there is personal liability for the owners.
c. How the owners will be taxed.
d. All of the above.
Answer: D
24. Jackie and Robert own an apartment building as partners. Cyndi, one of their tenants,
gives Robert written notice she will be moving out at the end of the following month. Robert
did not tell Jackie that Cyndi was moving. Has Cyndi properly given notice to the
partnership?
a. Yes. Notice to Robert was notice to the partnership.
b. Yes, if it is determined that Robert acted negligently in failing to notify Jackie.
c. No. Cyndi has an obligation to notify both Robert and Jackie.
d. No. Jackie was not notified since Robert never told her Cyndi was moving.
Answer: A
25. At what stage are the partnership debts paid and the proceeds distributed to the partners?
a. During dissolution.
b. During winding up.
c. During termination.
d. During dissociation.
Answer: B
ESSAY
1. What is a limited liability company? Explain the advantages and disadvantages of this type
of business ownership?
Answer: A limited liability company (LLC) is a relatively new form of organization. Its
existence must be in compliance with state law. LLC's are taxed as partnerships. Income
flows through the company directly to the owners, who are called members rather than
shareholders. None of the limitations associated with S Corps exist for an LLC (one class of
stock, 100 or fewer owners, etc.). Members are not personally liable for debts of the
company.
Disadvantages of a LLC include inconsistencies among state statutes and lack of wellestablished case law. Formerly, LLCs automatically terminated upon the death, bankruptcy,
etc. of any member unless the majority of remaining members agreed to keep the business
going. Now, however, there is a trend to permit continuation after withdrawal of a member. A
sale of a member's interest must be unanimously approved by the other members unless the
operating agreement states otherwise. There are no standardized forms to make formation of
the business easy and inexpensive.
2. Compare and contrast the following forms of business organization: sole proprietorship,
general partnership, limited partnership, limited liability company, and corporation as to ease
of formation, liability of owners, management, and tax implications.
Answer: A sole proprietorship is an unincorporated business owned by one person. It is easy
and inexpensive to create and operate. However, the owner has unlimited personal liability
for the debts of the business. The owner has the right to manage the business. Business
income is taxed on the owner’s personal income tax return; the company does not have to file
a separate tax return. A general partnership is an association of two or more co-owners to
operate a business for profit. Partnerships are easy to form and do not require filings with the
government, although a written partnership agreement for use between the parties is
recommended. A disadvantage of general partnerships is the unlimited liability of partners.
Partners have joint and several liability for partnership debts. Unless otherwise agreed,
partners have equal rights to manage the business. A partnership does not pay taxes itself; all
income and losses are passed through to the partners and reported on their personal income
tax returns. Limited partnerships have at least one general partner, who has unlimited liability
but the right to manage, and at least one limited partner, who has limited financial liability
but few management rights. A limited partnership must file a certificate of limited partnership
with its Secretary of State, so formation is not as easy as for sole proprietorships or general
partnerships. Limited partnerships, like general partnerships, are not taxable entities. Limited
liability companies generally require two documents: a charter and an operating agreement.
The charter must be filed with the Secretary of State. The operating agreement sets out the
rights and obligations of the owners/members. All members have limited liability, and the
business has the tax status of a partnership. Corporations are relatively expensive and difficult
to form, but owners have limited liability. Generally, the owners/shareholders are not
involved in the management of the company. Corporations are taxable entities, so they must
pay taxes and file returns. The owners/shareholders must also pay tax on dividends they
receive from corporations.
3. Andy wants to start his own business. He has decided to rent space in a "strip mall" and
open a pet shop. Additionally, he will provide dog grooming services. He figures he can do
almost everything himself, though he will need to hire a part-time employee on an "as
needed" basis. His friend, Lacy, has agreed to work when needed.
Andy is considering operating his business as a sole proprietorship. What are the primary
legal advantages and disadvantages to this form of business ownership for Andy's pet shop?
Answer: There are many advantages to operating the pet shop as a sole proprietorship. There
are no formal procedures required to create a this type of business ownership. Though he may
be required by local or state law to obtain a particular license, a retail sales tax number, etc.,
such requirements would exist no matter what form of business ownership he selected. A
proprietorship is not regarded as a separate tax entity, so Andy can report his earnings and
expenses on his individual income tax return (using Schedule C). Thus, he is not subject to
double taxation as is the corporate business. Additionally, as a small business, he is exempted
from a great deal of statutory law that applies to larger businesses. For example, he is not
subject to Title VII of the Civil Rights Act which only applies to companies with 15 or more
employees, nor is he subject to the Family and Medical Leave Act which applies to
companies with 50 or more employees.
Certainly, Andy faces some serious disadvantages as a sole proprietor. He is personally liable
for any debts or claims made against the company or his employees. As a proprietor, he will
have a difficult time raising capital, since the money can only come from savings or loans. If
the business is a failure, he may wind up losing all his savings and have serious debt
obligations that could drive him into bankruptcy. Also, since he is sole proprietor, he has no
one else to share the potential liability in the event of a claim not covered by insurance.
4. Briefly discuss the limitations on a corporation electing Subchapter "S" status.
Answer: For a corporation to elect Subchapter "S" status it must have:
• only one class of stock issued.
• 100 or fewer shareholders.
• no partnership or corporate shareholders.
• no nonresident alien shareholders.
• unanimous agreement of all shareholders that the company should be an S corporation.
5. In order to obtain limited liability, Tom and Doris formed an LLC to operate their catering
business. They sometimes deposited the proceeds from catering jobs into their personal
checking accounts and if they needed to pay personal bills and were short of funds, they used
the business account. If creditors of the business cannot get payment for their invoices, is
there anything a court can do to help the creditors?
Answer: It is common under corporate law for shareholders who do not comply with the
technicalities of the law to be held personally liable for the corporate debts. This is called
“piercing the corporate veil.” Similarly, the members of an LLC may be held liable if they do
not observe the formalities required for the business. Here, Tom and Doris were mingling
business and personal funds. Courts would be likely to disregard the LLC form and hold Tom
and Doris personally liable for the business debts.
6. Jack and Jill were living together. Jack wanted to start a small retail store, but did not have
good credit. Jill, whose credit was excellent, signed loan agreements with Jack so he could
borrow the money to start the business. Jack used business cards that stated he was the
"owner" of the business. He and Jill filed separate tax returns. Jack stated he was selfemployed and claimed the business was a sole proprietorship. The money that was earned
from the store was placed into a joint checking account owned and used by Jack and Jill.
When there were significant decisions to be made about the business, such as deciding to
franchise the business, the decision was made jointly by Jack and Jill.
Five years after the business was started, Jill left Jack. She claimed she was entitled to onehalf the business's profits since she and Jack were partners. Jack disagreed and claimed they
never had a partnership. Discuss Jill's claim.
Answer: Participants in an enterprise cannot be partners unless they share profits, but not all
profit sharers are partners. The courts also consider the following factors in deciding whether
there is a partnership:
a. Are the participants involved in the management? Partners share in the management of the
business, although not all managers are partners.
b. An agreement to share in losses is strong evidence of a partnership.
c. Referring to yourselves as partners is not enough to create a partnership, but in a close
case, it may sway a court.
Though it would be necessary to examine all the facts, it does appear that Jack and Jill had a
partnership and that she is entitled to one-half the net profits of the business as of the date the
partnership was dissolved. Of critical importance is that the money earned from the business
was deposited into the couple's joint bank account and that Jill was actively involved in the
management of the business.
Test Bank For Introduction to Business Law
Jeffrey F. Beatty, Susan S. Samuelson
9781133188155
