Taxation Quiz: LLCs and S-Corporations
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Questions and Answers

What is a significant drawback of Sub-S LLCs compared to S-corporations?

  • Several states do not recognize S-elections by LLCs for state tax purposes (correct)
  • Inability to pass through losses to owners
  • Higher tax rates at the federal level
  • Limited liability protection for owners

How are dividends from a Sub-C entity generally taxed?

  • At the corporate income tax rate
  • At the ordinary income tax rate only
  • At capital gains rates, depending on the owner's taxable income (correct)
  • They are not taxed if distributed

What defines a disregarded entity for tax purposes?

  • It is treated as an entity separate from its owner
  • It is treated as not separate from its single owner (correct)
  • It is a separate taxpayer for tax purposes
  • It must file Form 1120 annually

Which entity type must file an annual income tax return reporting its income?

<p>Sub-C entity (D)</p> Signup and view all the answers

Which taxation option is not available for a single-member LLC?

<p>Sub-K taxation (A)</p> Signup and view all the answers

What happens to passed-through losses for tax purposes?

<p>They reduce tax burden only to the extent of income available to offset (B)</p> Signup and view all the answers

Which duty prevents agents from profiting from third parties while conducting transactions for the principal?

<p>Duty of loyalty (C)</p> Signup and view all the answers

What must an agent avoid doing in their dealings with the principal according to their fiduciary duties?

<p>Acting on behalf of an adverse party (D)</p> Signup and view all the answers

For multi-owner businesses, which two tax structures are typically considered?

<p>Sub-S and Sub-K (C)</p> Signup and view all the answers

Which of the following best describes the agent's duty to the principal regarding information sharing?

<p>Duty to provide facts that are material to the principal (B)</p> Signup and view all the answers

In which scenario is a Sub-C entity considered the least favorable?

<p>Due to high tax rates and double taxation (D)</p> Signup and view all the answers

What characteristic of the employee is NOT considered when evaluating the potential breach of fiduciary duty?

<p>Employee's level of professional training (D)</p> Signup and view all the answers

Which action signifies a breach of the agent's fiduciary duty concerning competition?

<p>Assisting the principal's competitors (B)</p> Signup and view all the answers

What is the effect of moral and cultural values on agency law fiduciary duties?

<p>They mitigate the consequences of fiduciary breaches. (C)</p> Signup and view all the answers

What does the duty of confidentiality require from an agent?

<p>Not using or communicating confidential information for personal purposes (B)</p> Signup and view all the answers

What is primarily at stake that triggers a breach of fiduciary duty legal action?

<p>Substantial money (A)</p> Signup and view all the answers

What is the primary basis for selecting managers in an LLC?

<p>Percentage ownership in the LLC (D)</p> Signup and view all the answers

Which of the following best describes the duty of loyalty?

<p>Avoid competing with the LLC while it is active (B)</p> Signup and view all the answers

What must members of a member-managed LLC in Delaware do with regard to fiduciary duties?

<p>They owe fiduciary duties to each other and the LLC (A)</p> Signup and view all the answers

How can a fiduciary party demonstrate entire fairness in a transaction?

<p>By ensuring fair dealing and favorable timing (C)</p> Signup and view all the answers

What is the role of the business judgment rule in the duty of care?

<p>To protect managers from liability if they act in good faith (D)</p> Signup and view all the answers

Which of the following is NOT a component of fair dealing in a transaction?

<p>Public perception of the transaction (B)</p> Signup and view all the answers

In Delaware, what happens if the fiduciary duties of loyalty and care are not addressed in an operating agreement?

<p>Default fiduciary duties are assumed for all LLC members (D)</p> Signup and view all the answers

What is essential for demonstrating fair price in a fiduciary transaction?

<p>A comprehensive analysis of economic factors (C)</p> Signup and view all the answers

What characteristic makes a rule mandatory in corporate law?

<p>It is specified by a statutory provision as unalterable. (A)</p> Signup and view all the answers

Which of the following statements is true regarding default rules?

<p>Majority owners generally prefer to keep default rules unchanged. (A)</p> Signup and view all the answers

In which scenario would a minority owner typically seek to modify a default rule?

<p>To gain more control over the company's operations. (B)</p> Signup and view all the answers

Which of the following describes a public company?

<p>Its shares are traded on public secondary markets. (D)</p> Signup and view all the answers

How do default rules that can only be altered in a corporation's charter differ from those in bylaws?

<p>They provide more stability and commitment. (D)</p> Signup and view all the answers

What is a fundamental difference between public and private companies?

<p>Private companies' shares are not publicly traded. (A)</p> Signup and view all the answers

What is a likely reason for a majority owner to consider changing a default rule?

<p>To encourage investments from minority shareholders. (D)</p> Signup and view all the answers

What factor primarily determines whether a rule is a default rule or a mandatory rule?

<p>The clarity of the rule's language. (A)</p> Signup and view all the answers

Which of the following statements about private company shares is correct?

<p>They are considered illiquid. (B)</p> Signup and view all the answers

What is the most common way an agency relationship is established?

<p>When a business hires an individual as an employee. (D)</p> Signup and view all the answers

What must be true for a principal to be bound by a contract with a third party?

<p>Either actual authority or apparent authority must exist. (A)</p> Signup and view all the answers

Which of the following describes actual authority?

<p>Express or implied authority communicated by the principal. (D)</p> Signup and view all the answers

Which of the following statements regarding agency law is false?

<p>Agency law is primarily governed by federal statutes. (D)</p> Signup and view all the answers

What is implied actual authority?

<p>Authority to perform acts incidental to achieve the principal's objectives. (A)</p> Signup and view all the answers

When might apparent authority and actual authority coincide?

<p>When they are established through various means simultaneously. (C)</p> Signup and view all the answers

Which condition does NOT create an agency relationship?

<p>A contract explicitly states no agency relationship exists. (A)</p> Signup and view all the answers

What type of business structure offers no liability shield for its owners?

<p>General Partnerships (B)</p> Signup and view all the answers

Which business structure provides full liability shields to limited partners?

<p>Limited Partnership (D)</p> Signup and view all the answers

In which states do Limited Liability Partnerships (LLPs) provide only partial liability shields?

<p>Louisiana and South Carolina (A)</p> Signup and view all the answers

Which of the following is NOT a reason why some business owners may eliminate general partnerships from consideration?

<p>High formation fees (C)</p> Signup and view all the answers

If a general partner in a Limited Partnership (LP) is an individual, what is the liability status?

<p>Liable for LP debts (B)</p> Signup and view all the answers

Which business structure is often preferred today over Limited Partnerships due to better liability protection?

<p>Limited Liability Companies (B)</p> Signup and view all the answers

Under what condition can limited partners in an LP lose their liability shield?

<p>If they take on management roles (A)</p> Signup and view all the answers

For professional practices in states that only allow LLPs for them, what is the consequence of operating an LLP as a non-professional?

<p>They may be treated as a general partnership (A)</p> Signup and view all the answers

Flashcards

Mandatory Rule

A rule that cannot be changed by contract or agreement, reflecting an important public policy reason.

Default Rule

A rule that can be changed by agreement or a specific provision in the governing documents, usually found in statutes like RUPA.

Corporate Law Statutes

These statutes, such as MBCA, regulate the formation, operation, and governance of corporations.

Charter vs. Bylaws

Charter: The fundamental document that establishes a corporation. Bylaws: Internal rules that govern the day-to-day operations of a corporation.

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Majority Owner

A shareholder or group of shareholders who have a controlling interest in a company.

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Minority Owner

A shareholder or group of shareholders who have less than a controlling interest in a company.

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Public Company

A company whose shares are traded on a public market like the stock market.

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Private Company

A company whose shares are not publicly traded.

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Illiquidity of Private Company Shares

Shares of private companies are difficult to buy or sell, making it challenging to convert them into cash quickly.

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Going Public

When a private company offers its shares to the public for the first time, it's called going public. This involves listing on a stock exchange and raising funds from investors.

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Agency Law: Binding Contracts

Agency law determines when a company is legally obligated to a contract entered into by someone acting on its behalf.

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Actual Authority

The explicit or implied power given to an agent by the principal to act on their behalf.

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Express Actual Authority

The principal directly and explicitly communicates the authority to the agent.

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Implied Actual Authority

The authority that's reasonably inferred from the principal's actions or from the agent's role and responsibilities.

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Apparent Authority

When a third party reasonably believes, based on the principal's actions, that the agent has the authority to act on their behalf, even if the agent doesn't have actual authority.

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When is a Principal Bound?

A principal is bound to a contract entered into by an agent when either actual authority or apparent authority exists.

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Fiduciary Duty

A legal obligation of an agent to act in the best interests of their principal and avoid conflicts of interest.

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Duty Not to Acquire Material Benefit

An agent cannot gain personal benefit from third parties through transactions related to their principal's business.

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Duty Not to Deal with Principal Adversely

An agent cannot act against their principal's interests in a transaction related to the agency.

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Duty to Refrain from Competition

An agent cannot compete with their principal or help competitors.

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Duty to Use Principal's Property Appropriately

An agent cannot use the principal's property for their own purposes or those of a third party.

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Duty to Act with Care and Diligence

An agent must act with the same level of care and skill as other agents in similar situations.

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Duty to Act Within Scope of Authority

An agent must only act within the authority given by the principal.

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Duty to Provide Material Information

An agent must disclose relevant information that the principal would want to know.

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Liability Shield

A legal protection that shields business owners from personal liability for their business's debts.

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Sole Proprietorship Liability

Sole proprietors have NO liability shield, meaning they are personally liable for all business debts.

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General Partnership Liability

General partners have NO liability shield, meaning they're personally liable for business debts.

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Limited Partnership (LP) Liability

Limited partners in an LP have a liability shield, protecting them from personal liability, unless they exert control. General partners have NO shield.

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LP Liability Shield for General Partners

By incorporating the general partner, LPs can gain a liability shield for all owners. This shields the individual from personal liability.

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LLP Liability

Most LLPs offer full liability shields to partners. However, LLPs in LA and SC provide only partial shields.

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LLP Professional Practice Restrictions

In some states, including NY, LLPs are limited to professional practices (law, medicine, accounting). Non-professional businesses may be treated as general partnerships

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Weakened LLP Liability Shield

The liability shield of an LLP can be weakened in certain states (LA and SC) where only partial shields are provided.

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Sub-S vs. Sub-K

For multi-owner businesses, owners choose between Sub-K (partnership) and Sub-S (corporation) tax treatment, depending on which offers lower liability.

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Disregarded Entity

A single-member LLC is treated as NOT separate from its owner for tax purposes, meaning income is reported on the owner's personal return.

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Sub-S Corporation Tax

Owners pay taxes on business income allocated to them, even if the business doesn't distribute any money.

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Sub-C Corporation Tax

The business is taxed separately from its owners. Profits are taxed twice: once when earned by the business and again when distributed to owners.

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Passed-Through Losses

Losses from a Sub-S business can reduce the owner's tax liability, but only to the extent of their overall taxable income.

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Allocating Losses Strategically

When allocating Sub-S losses, aim to put them with the owner who has the most income and is in a higher tax bracket to maximize reduction.

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Single-Member LLC Tax Options

A single-owner LLC can choose disregarded entity (like a sole proprietorship), Sub-S (if it meets the requirements), or Sub-C.

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Sub-K Taxation

Only available for unincorporated businesses with 2 or more owners, Sub-K offers a pass-through tax structure.

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LLC Manager Selection

In most LLCs, managers are chosen by members based on their percentage ownership. This means members with a larger stake have more influence in selecting managers.

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LLC Board of Managers

Some LLCs mirror corporate governance structures, opting for a board of managers elected annually by members. The board holds ultimate authority within the LLC.

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Duty of Loyalty

A fiduciary responsibility that prevents managers from competing with or harming the LLC's interests. It includes avoiding conflicts of interest and refraining from competing with the LLC.

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Duty of Care

A fiduciary responsibility requiring managers to act reasonably and in the best interests of the LLC, similar to how a prudent person would act in similar circumstances.

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Entire Fairness

A legal standard for evaluating transactions where a party with a fiduciary duty is on both sides. It requires fair dealing (process) and fair price (economics).

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Fiduciary Duties in DE LLCs

In Delaware, the default rule is unclear regarding fiduciary duties for managers of manager-managed LLCs, but members of member-managed LLCs and managers of manager-managed LLCs DO owe duties. The LLC agreement can specify the scope of these duties.

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Member Fiduciary Duties (Member-Managed LLC)

Members of member-managed LLCs in Delaware owe fiduciary duties to the other members and the LLC. These duties cannot be eliminated by the operating agreement. They are part of their legal obligation.

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Manager Fiduciary Duties (Manager-Managed LLC)

Managers of manager-managed LLCs in Delaware owe fiduciary duties to the other members and the LLC. These duties can be limited or eliminated by the operating agreement.

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Study Notes

Corps & P-Ships Outline

  • Six most common business forms: sole proprietorship, partnership/ general partnership, Limited Liability Partnership (LLP), Limited Partnership (LP), corporation, and Limited Liability Company (LLC)
  • Key purpose of starting a business is to avoid personal liability.

Sole Proprietorship

  • (a) Definition: A business owned by a single person (sole proprietor) who has not filed paperwork to operate in another legal form.
  • (b) NO Governing Law: There is no separate governing law for sole proprietorships.
  • (c) Management: The sole proprietor controls all business decisions and can delegate authority to employees.
  • (d) Liability Exposure: The sole proprietor is personally liable for business obligations. The owner’s personal obligations and business obligations are one and the same.
  • (e) Taxation: The sole proprietor is entitled to all income generated by the business and bears any losses. A sole proprietorship does NOT file a federal income tax return NOR does it pay federal income tax.

General Partnership

  • (a) Definition: A for-profit business with two or more owners who have not filed the paperwork for another legal form.
  • (b) Governing Law: Governed by the partnership statute of the state the partnership is organized in. If not clear which state was chosen, the jurisdiction where the contract was made governs.
  • (c) Partnership Agreement: Most general partnerships have a written agreement defining management structure, allocation of profits and losses, admissions and withdrawals of partners, and dissolution.
  • (d) Management: The governing law for partnerships is state law, and each partner has equal rights to manage the business; if unspecified in the agreement. Default rules typically are for all partners to agree on management matters.
  • (e) Liability Exposure: Partners are personally liable for partnership obligations.

Limited Liability Partnership (LLP)

  • (a) Definition: A for-profit business with two or more owners.

  • (b) Governing Law: Governed by the general partnership statute for that specific state.

  • (c) Partnership Agreement: Partnership agreements for this business structure are signed by each partner.

  • (d) Management: LLP management structure mirrors the general partnership structure.

  • (e) Liability Exposure: Partners in an LLP are not personally liable for the actions, and/or omissions of other partners. The partners are personally liable for their own wrongful conduct.

Limited Liability Company (LLC)

  • (a) Definition: An LLC is a for-profit business with two or more owners
  • (b) Governing Law: The members and/or managers of the LLC are governed by the state in which the LLC was established.
  • (c) Partnership Agreement: An LLC typically has a written partnership agreement, signed by each partner.
  • (d) Management: An LLC's management structure would mirror those of a general partnership.
  • (e) Liability Exposure: Members of an LLC are shielded from personal liability for the actions of the business. Members and managers are each responsible for their own conduct.

Corporations

  • (a) Definition: A business with shareholders who have filed articles of incorporation with a secretary of state.
  • (b) Governing Law: The state where the incorporation took place.
  • (c) Governing Documents: These govern internal affairs, such as establishing a board of directors.
  • (d) Management: A board of directors is elected by shareholders to manage the corporation.
  • (e) Liability Exposure: This type of entity provides shareholders with personal liability protection.

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Corps & P-Ships Outline PDF

Description

Test your knowledge on the taxation aspects of Sub-S LLCs and S-Corporations. This quiz covers key concepts such as entity types, taxation methods, fiduciary duties of agents, and more. Perfect for students and professionals interested in business structures and tax implications.

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