Chapter 05 – How to Form a Business
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In today’s economy, only large business enterprises should operate as corporations.
63. The owners of a corporation are known as general corporate partners.
64. A corporation can raise financial capital by selling shares of stock to interested investors.
65. Stockholders in a corporation accept unlimited liability for the corporation’s debts.
66. A disadvantage of corporations is that their charters are only valid for 99 years, so
corporations are less permanent than other types of businesses.
67.
Chapter 05 – How to Form a Business
When one of the owners of a corporation dies, the corporation legally ceases to exist.
68. Corporations are easy to start and easy to terminate.
69. A disadvantage of corporations is that they generally require extensive paperwork.
70. A disadvantage of corporations is that an owner must get the approval of all other owners
before selling his or her interest in the firm to another investor.
71. Stockholders in a corporation normally exert a significant degree of control over the
company’s daily operations.
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87.
Chapter 05 – How to Form a Business
A multinational corporation is a firm that operates in several countries.
88. To change ownership in a corporation you simply sell your stock to someone else.
89. Stock options are the right to purchase shares of the corporation for a fixed price.
90. An advantage of corporations is their ability to attract good talent by offering stock
options and other employee benefits.
91. It is said that corporations have perpetual life.
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108. If a corporation distributes after-tax profits to its stockholders in the form of dividends,
the government considers these distributions as part of each stockholder’s personal
income. Stockholders pay taxes on these distributions.
Feedback: A disadvantage of the corporate form of business ownership is double taxation. If
corporations distribute after-tax profits to stockholders, these individuals are required to pay
taxes on this income. Unfortunately, these amounts were already taxed once, when the
corporation paid taxes on them.
109. If a corporation has after-tax profits of $360,000, and elects to distribute this amount in
the form of dividends to its stockholders, these distributions are free and clear of taxes
because the corporation paid taxes on this amount prior to distribution.
Feedback: A disadvantage of the corporate form of business ownership is double taxation. If
corporations distribute after-tax profits to stockholders, these individuals are required to pay
taxes on dividend income. Unfortunately, these amounts were already taxed once, when the
corporation paid taxes on them, hence the term, double taxation.
110.
Chapter 05 – How to Form a Business
Double taxation means that a corporation pays twice the amount of taxes as a sole
proprietorship or partnership.
Feedback: A disadvantage of the corporate form of business ownership is double taxation. If
corporations distribute after-tax profits to stockholders, these individuals are required to pay
taxes on dividend income. Unfortunately, these amounts were already taxed once, when the
corporation paid taxes on them, hence the term, double taxation.
111. The major differences between an S-Corporation and a Limited Liability Company are
limits on the number of owners, and, the citizenship status of individuals who are owners.
Feedback: A limited liability company (LLC) is similar to an S corporation but without the
special eligibility requirements. S-Corporations require its owners to be U.S. citizens or the
estates of U.S. citizens. The LLC does not have these requirements.
112. The owners of a limited liability company (LLC) must pay self-employment taxes on
any profits they earn, even if they did not obtain a salary from the company.
Feedback: Although the LLC allows for profits to be distributed to owners and taxed at each
owner’s personal tax rate, the owners must also pay self-employment taxes on those earnings.
Self-employment taxes include Medicare and Social Security taxes.
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116. Mojo Motors is a small conventional corporation with only 212 stockholders. Eleven of
the stockholders are citizens of Mexico, and eight others are citizens of Canada. Due to its
size and diversity in ownership, you would recommend that Mojo Motors change to an S-
Corporation.
Feedback: Mojo Motors does not satisfy the requirements for an S corporation—it has more
than 100 stockholders, some of whom are not U.S. citizens or permanent residents of the
United States.
117. The owners of Idle Time Gaming Company would like to switch to an S corporation.
Unfortunately, their lawyer advised them that they do not meet some of the requirements
necessary to qualify as an S corporation. An alternative form of business that would give
them similar advantages is a limited liability company.
Feedback: Limited liability companies offer many of the same advantages as S corporations,
including limited liability and the possibility of taxation like a partnership, without the special
eligibility requirements required to qualify for S corporation status.
118.
Chapter 05 – How to Form a Business
The owners of California Canines, a firm that designs and manufactures coats, sweaters,
jackets, and rainwear for dogs want to organize as an LLC. Two members are college
students and two others are thirty something couples with young children. This is good
strategy because each member can choose to commit to limited or unlimited liability.
Feedback: All members of an LLC have limited liability. There is no choice in that matter.
The purpose of organizing as an LLC is to eliminate the risk of losing personal assets in an
unprofitable venture. In terms of taxes, a limited liability company offers the best of both
worlds, allowing the owners to choose to be taxed as a partnership or a corporation depending
on which tax rates would benefit them the most.
119. A few years back, your friends who are horse fanatics inherited several acres of land
that they turned into a retirement haven for racehorses. Peaceful Pastures was recently
incorporated as a limited liability company. The members are re-evaluating this form of
ownership. Unlike an S-corporation, they now pay self-employment taxes on all company
profits – not just on the salaries they pay themselves.
Feedback: While S-corporations have several restrictions, one advantage they have compared
to the Limited Liability Company is the self-employment tax requirements. Any profits
earned by the LLC are considered part of the owner’s wages/salary/income. These wages are
subject to self-employment taxes. The S-corporation only pays self-employment taxes on
those dollars designated as salary or wage expenses by the business. They do not pay self-
employment taxes on the profits of the business.
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120. According to the Legal Briefcase box, ” Virtual Companies”, a Vermont virtual LLC’s
profits are distributed to members according to their contribution of time, expertise, and
money.
Feedback: A virtual LLC is the newest form of business ownership in the state of Vermont.
Vermont hopes to attract companies who operate virtually. The company does not hire and
train employees in the traditional sense. Members of the LLC contribute their expertise and
time, virtually, and are paid according to the value and amount of their contribution(s).
121. After a successful five years, Peaceful Pastures, LLC (a retirement ranch for race
horses) thinks it may be able to attract donations from animal activist groups and even the
federal government if it becomes a non-profit corporation. As its business advisor, you
explain that as a non-profit corporation, the owner(s) may earn a salary but the business
should not seek after-tax profits.
Feedback: If Peaceful Pastures decides to change its form of business ownership to a non-
profit corporation, it will not seek personal profits for its owners. If the owner(s) works in the
business, he/she can expect a salary. By law, the firm cannot distribute any additional income
to owners. It must put all revenues and/or contributions back into the business.
122.
Chapter 05 – How to Form a Business
Chipper’s Golf Resort has the opportunity to buy 1000 acres of property adjacent to its 18-
hole golf course. After talking with her banker, the owner is encouraged to begin the
paperwork to change from a Limited Liability Company form of business ownership to a
corporation. You applaud this strategy because she will eliminate the problem of double
taxation.
Feedback: C-corporations (not LLCs) face the disadvantage of double taxation. A C-
corporation’s income is taxed twice. First the corporation pays tax on all income before it can
distribute any, as dividends, to stockholders. The stockholders pay income tax on the
dividends they receive.
123. When two firms join together to form one company, it is called a merger.
124. The three major types of mergers are acquisition, joint, and connective.
125. An acquisition is when one company buys the property and obligations of another
company.
