Chapter 05 – How to Form a Business
5-81
Finley is a limited partner in Gettout & Associates. Heywood U. Gettout, one of the
general partners in the company, must temporarily leave the company to attend to some
personal matters. Heywood has asked Finley to perform his managerial duties while he is
gone. As a limited partner, Finley:
A. Can fill in as a manager whenever necessary, as long as it is for only a limited time.
B. Can make managerial decisions as long as they do not involve the payment of money.
C. Cannot participate in the management of the partnership.
D. Can manage the firm as long as he gets approval from the company’s other general
partners.
Feedback: A limited partner invests money in a partnership but cannot legally take an active
role in its management.
233. Kristen and her brothers and sisters decided to form a partnership that specializes in
home design of all types. One their goals is to maintain the loving relationship they
currently enjoy so they are following the Model Business Corporation Act
recommendations as they write the partnership agreement. Which of the following is an
accurate recommendation of the Act?
A. The business should be actively operating for an extended period before the partners
decide who is responsible for what business functions.
B. Family businesses never take on outside partners, so no discussion of this need take
place.
C. There should be discussion and well-understood ways that the partners will handle
disagreements.
D. Due to the fact that they are all under 40 years old and expect to work until they are 65
there is no need to decide what will happen to the partnership if one decides to leave the
business, retire, or die.
Feedback: The Model Business Corporation Act recommends including a number of specifics
in the written partnership agreement including how disagreements will be handled.
234.
Chapter 05 – How to Form a Business
5-82
Maya plans to open a shop specializing in foods and cultural items from the Middle East.
She wants to be the firm’s only general partner, but she is trying to get several friends to
participate as limited partners. Apparently Maya wants to:
A. Limit her personal liability to the amount she personally invests in the company.
B. Keep all of the firm’s profits.
C. Obtain a strong financial base for the firm while maintaining personal control over the
firm’s management.
D. Meet the legal requirements of the Uniform Partnership Act.
Feedback: Limited partners invest money in a business and share in the profits, but are not
allowed to assume any management responsibilities. Since Maya plans to be the only general
partner, she will be the only owner who has a direct role in managing the company.
235. Zach and Mac own an auto repair business which they operate as co-owners. Both take
an active role in the management of the business, and each accepts unlimited liability.
Zach and Mac operate as a __________.
A. joint venture
B. general partnership
C. limited partnership
D. cooperative
Feedback: Since Zach and Mac operate the business as co-owners, they have formed a
general partnership. Since both will manage the firm and accept unlimited liability, they are
both general partners.
236.
Chapter 05 – How to Form a Business
Mel, Tim, and Bill agreed to partner in a small rehab business. Initially, they were
enthusiastic contributors until their first project took more work than Mel initially
estimated; Tim wanted morning meetings and long lunch hours; and, Bill decided to go on
vacation even though the project was not complete and ready to sell. As the Spotlight on
Small Business box, titled, “The Ties That Bind” indicates,
A. It’s smart to begin the partnership with honest communication of what each partner
expects to give and get from the partnership.
B. Organize the business as a limited liability company to reduce the financial risks that
put pressure on members of the partnership.
C. Designate one of the partners as the primary partner with final authority to call all the
shots.
D. Enter into partnerships with people who have similar educational and cultural
backgrounds and similar personalities.
Feedback: This question is based on the material in the Spotlight on Small Business box in
Chapter 5. This box provides advice on how to choose a partner. A key point made in the box
is that “Just like most good marriages, the best way to avoid major conflicts is to begin with
an honest communication of what each partner expects to give and get from the partnership.”
237. Jamie and Maria invested all their savings in a small pizzeria they opened outside the
University of Western Kentucky. They operated the business as a general partnership.
After 11 months, the business went broke and Jamie and Maria were left with outstanding
bills of $37,500, which was more than their initial investment in the company. Jamie and
Maria can:
A. Lose their personal assets as the result of their company’s financial problems.
B. Lose only the funds they originally invested in their company.
C. Lose only the total value of the assets actually used to operate the business.
D. Avoid any liability for these debts since a partnership is considered to be a business
entity that is separate and distinct from the partners who own it.
Feedback: General partners have unlimited liability for the debts of their business. This
means their personal assets are at risk.
5-95
266. The S corporation is likely to be less popular in the future because:
A. Congress repealed the limited liability protection of S corporations and limited them to
companies with earnings of less than $3 million per year.
B. Limited liability companies, which do not have the restrictive eligibility requirements
of S corporations and offer greater flexibility in the choice of tax treatment, are now legal
in all 50 states.
C. Many states significantly increased the annual fee that S corporations must pay to
maintain their tax status, thus eliminating the financial advantages of this form of
ownership.
D. S corporations have been made illegal in several states as a reaction to widespread
abuse of the special benefits available to this type of business.
Feedback: Limited liability companies allow firms great flexibility to choose the most
advantageous tax treatment, and avoid the special eligibility requirements that characterize S
corporations. In 1995 the National Conference of Commissioners on Uniform State Laws
approved the final version of the Uniform Limited Liability Company Act. By 1996, all 50
states and the District of Columbia recognized LLCs. Today more than half of new business
registrations in some states are LLCs.
267.
Chapter 05 – How to Form a Business
5-96
Compared to the C-corporation, the limited liability company is an attractive form of
business ownership because:
A. Even though it is a little more expensive to form, it has a longer life than the C-
corporation.
B. A limited liability company permits one owner to own all the stock of the company,
whereas a C-corporation requires several owners.
C. Once formed, the limited liability company is a legal form of business ownership,
worldwide, whereas the C-corporation must file for corporate status in each nation it
elects to do business.
D. Once formed, the limited liability company does not require the firm to hold annual
meetings, and has the option to avoid double taxation.
Feedback: The limited liability company can choose to be taxed as a partnership or a
corporation, giving it the option to avoid double taxation. This form of business ownership
files articles of organization, however it does not hold annual meetings, nor does it need to
file annually.
268.
Chapter 05 – How to Form a Business
5-97
“Double taxation” means:
A. If stockholders decide to sell their shares, they are subject to paying twice the amount
of taxes on any capital gains.
B. As the owner of the company, you pay twice the amount in employment taxes on
yourself, as you do on your employees.
C. Corporations pay taxes on their profits. If they distribute after-tax profits to the
stockholders, the stockholders also pay taxes on the distribution.
D. If the corporation doubles its profits from the previous year, the firm’s tax rate (the
percentage it pays in taxes) will also double.
Feedback: A corporation files a separate tax return from its owners. It pays taxes on all profits
earned after legitimate expenses are deducted. If any profits remain after taxes are paid, these
are considered after-tax-profits and they can be distributed to owners in the form of dividends.
These earnings are subject to double taxation because the government requires the recipient
(the owner/stockholder) to pay taxes on the dividends, even though they were already taxed
when they were part of the corporation’s earnings.
269. Trevor and Tyler own all the stock in the Double T Corporation. The stock of this
corporation is not sold to the general public. Trevor and Tyler own a:
A. Limited liability company.
B. Master limited partnership.
C. Alien corporation.
D. Closed corporation.
Feedback: A closed corporation is one whose stock is all owned by only a few investors (or
privately held), and isn’t available to the general public.
270.
Chapter 05 – How to Form a Business
5-98
Tess and Tijuana have considered starting their own business but are concerned about the
possibility of losing their personal assets if the business fails. One way for Tess and
Tijuana to avoid this risk would be to organize their firm as a(n):
A. General partnership.
B. Limited partnership.
C. Corporation.
D. Sole proprietorship.
Feedback: A corporation has the advantage of limited liability for all of its owners. Although
a limited partner also has limited liability, even a limited partnership must have at least one
general partner with unlimited liability.
271. Maria recently purchased 100 shares of stock in Idle Time Gaming, Inc. Maria is
a(n)_____________ of this company.
A. owner
B. manager
C. creditor
D. partner
Feedback: Stock represents shares of ownership in a corporation.
272.
Chapter 05 – How to Form a Business
5-99
Dane is a stockholder in SmallWorld, Inc., a C-corporation that manufactures amusement
park rides. The company recently lost a major court decision and will probably be forced
into bankruptcy. In fact, the damages awarded are so great that, even if all company assets
are sold and the proceeds are used to pay its debts, SmallWorld is likely to still owe
money to its creditors. If SmallWorld go bankrupt, Dane and the other stockholders will:
A. Be personally responsible for all remaining debts.
B. Lose their investment but nothing else.
C. Be entitled to full reimbursement of any investment losses.
D. Automatically qualify for federal reimbursement for any losses suffered by the firm.
Feedback: Owners of a corporation have limited liability. This means that the most they can
lose is the amount they invest in the corporation.
273. Ramon lives in Mexico City and is a Mexican citizen. He has several friends in the
United States who own shares in an S corporation. Ramon would like to invest in this
company. Ramon:
A. Can invest in this company, but must pay both U.S. and Mexican taxes.
B. Cannot become a shareholder since he is not a citizen or permanent resident of the U.S.
C. Can become a shareholder but cannot become a manager, and his income must be paid
in pesos.
D. Needs approval from the Mexican government before he can invest.
Feedback: S corporations are required to meet several special conditions that conventional
corporations do not have to satisfy. One requirement is that all of the owners of an S
corporation must be U.S. citizens or permanent residents of the United States.
274.
Chapter 05 – How to Form a Business
Although it is a small company, Zorn Enterprises owns a large number of inexpensive
rental housing units in Texas and Louisiana. Currently, the company is a chartered C-
corporation, but the owners are interested in switching to an S corporation. After
consulting a lawyer, they learned that Zorn Enterprises does not qualify to be designated
as an S corporation. Which of the following characteristics of Zorn Enterprises would
prevent it from becoming an S corporation?
A. The firm has fewer than 75 stockholders.
B. The firm is chartered in one state, but owns property in another.
C. The firm has only one class of stock, all owned by U.S. citizens.
D. The firm receives more than 70 percent of its income from rents and other passive
sources.
Feedback: An S corporation may earn no more than 25 percent of its income from passive
sources such as rents, royalties and interest.
275. Emily wants to open a chain of hair styling salons and hopes to attract investors to help
finance growth. She considered forming a C corporation, but wants to have more
flexibility about how the new business will be taxed. She also wants to offer
investors/owners limited liability. Emily can satisfy her objectives by setting up a(n):
A. Limited liability company.
B. S corporation.
C. Alien corporation.
D. General partnership.
Feedback: Limited liability companies offer limited liability protection while allowing the
company the choice of being taxed as a corporation or as a partnership. Although S
corporations also offer limited liability, they do not offer the tax flexibility. Moreover, an S
corporation has more stringent ownership rules.
276.