Business Entities Flashcards

Sole Proprietorships

• Definition: A sole proprietorship is a business owned by a single individual who is solely responsible for all debts and obligations.

• Formation:

  • There are no formal requirements for forming a sole proprietorship.

• Control:

  • The sole proprietor has complete control over the business and its decision-making processes.

• Taxation:

  • The business does not file a separate income tax return; instead, the proprietor reports profits and losses on their personal tax return.

• Liability:

  • The owner has unlimited personal liability for all business debts and obligations.

• Query:

  • Can a sole proprietorship be converted to another entity type?

    • Yes, it can be converted later, especially if the business grows or seeks limited liability protection.

  • When is it appropriate to convert?

    • When the business takes on more risk, seeks investment, or aims for enhanced credibility.

General Partnerships

• Definition: A general partnership is defined as two or more co-owners engaging in business for profit.

• Formation:

  • No formal requirements; written agreements are not mandatory but recommended for clarity.

• Taxation:

  • The partnership itself is not taxed. Instead, it files an informational tax return, and profits/losses flow through to partners who report them on their individual tax returns.

• Liability:

  • Each partner has joint and several liabilities for debts incurred in the ordinary course of business.

• Management:

  • Each general partner typically has equal rights to participate in the management and control of the business unless otherwise stated in a partnership agreement.

• Considerations:

  • Every partner acts as an agent of the partnership, meaning actions of one partner can bind the partnership.

Hypothetical Case Study: Doctor and Corporation

• Situation:

  • A doctor enters into a relationship with a corporation that manufactures cream.

  • The doctor could be held personally liable if a patient is harmed by the product (e.g., damages from cream).

• Legal Basis for Liability:

  • If the relationship qualifies as a general partnership (i.e., two persons running a business for profit), both partners share liabilities.

• Avoiding Liability:

  • The doctor could protect their personal assets by forming a separate entity (e.g., a corporation or LLC) for their dealings with the cream manufacturer.

Vohland Case Study

• Background:

  • Sweet worked at Vohland’s Nursery and was initially an hourly employee, later receiving a 20% share of the profits.

• Employment Structure:

  • Compensation was irregular, without tax withholdings or formal partnership returns.

  • Sweet described himself as self-employed on tax returns and maintained control over day-to-day operations, despite Vohland handling finances.

• Implications:

  • The lack of formal structure indicates potential challenges in categorizing the relationship legally.

Partnership Financial Overview

• General Partnership Example:

  • Gross Revenues: $100,000

  • Expenses: $50,000

  • Profit Allocation:

    • Each partner (A and B) owns 50%; Profit = $25,000 each.

    • The partnership does not pay taxes but submits an informational return.

Special Allocations in Partnerships (Applicable Only to LLCs and Partnerships)

• Capital Contributions:

  • Partner A contributes $100,000; Partner B contributes nothing.

• Profit and Loss Sharing:

  • Losses and profits can be allocated based on capital contributions, with a consideration for their agreement.

  • Projected Losses:

    • Year 1: ($50,000)

    • Year 2: ($50,000)

    • Year 3: $20,000

• Tax Rule for Losses:

  • A and B can offset other income with partnership losses to the extent of their capital contributions.