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2.1. Business Environment |
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Business Environment
& Concepts 1
Business Environment & Concepts 1
1. Sole proprietorship and joint venture................................................................................
3
2. General partnership .......................................................................................................
4
3. Limited liability partnership ...........................................................................................
19
4. Limited partnership......................................................................................................
20
5. Limited liability company ..............................................................................................
26
6. Corporation ................................................................................................................
30
7. Terminology ...............................................................................................................
57
8. Class questions ...........................................................................................................
59
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SOLE PROPRIETORSHIP AND JOINT VENTURE
I. ADVANTAGES, IMPLICATIONS AND CONSTRAINTS OF A SOLE PROPRIETORSHIP
A sole proprietorship is the simplest form of business ownership. One person owns the business
and manages all of its affairs, and the sole proprietor is not considered an entity separate from the
business. No formality is required to form a sole proprietorship, and nothing need be filed with the
state in which the business operates (unless the state or city requires a business license). If a
fictitious business name is used, then many states require publishing the true name of the business
owner.
A. PERSONAL LIABILITY
The sole proprietor is personally liable for all obligations of the business.
B. LIFE OF ENTITY
A sole proprietorship cannot exist beyond the life of the sole proprietor.
C. TAX TREATMENT
For tax purposes, profits and losses from the business flow through the business to the sole
proprietor.
D. TRANSFERABILITY
A sole proprietor is free to transfer his interest in the sole proprietorship at will.
E. BANKRUPTCY
A sole proprietorship is not considered an entity separate from the sole proprietor; therefore,
a sole proprietor would have to file for bankruptcy personally under the Bankruptcy Code.
II. CHOICE AS A BUSINESS ENTITY
The sole proprietorship may be a good choice of business entity when an individual wants to form a
business that he or she will manage, wants to claim the income or losses from the business on his
or her personal taxes, and does not want to bother with a lot of formality. On the other hand, the
individual risks all of his or her personal assets when this type of business entity is formed.
III. JOINT VENTURE DEFINED
A joint venture is an association of persons or entities with the intent of engaging in a single
business venture for profit.
IV. JOINT VENTURE COMPARED TO A PARTNERSHIP
Courts sometimes try to distinguish joint ventures from general partnerships, but the legal
requirements and consequences and advantages and disadvantages of forming a joint venture
generally are identical to those of a general partnership. For exam purposes, the key difference
between a joint venture and a general partnership is the fact that a joint venture is formed for a
single transaction or project or a related series of transactions or projects. Joint ventures are
treated as partnerships in most important legal aspects.
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GENERAL PARTNERSHIP
I. ADVANTAGES, IMPLICATIONS AND CONSTRAINTS OF A GENERAL PARTNERSHIP
A general partnership is similar to a sole proprietorship except that there are at least two owners of
a partnership. The right to manage a partnership is shared among all the partners. Little formality
is required to form a partnership, just an intention to carry on as co-owners a business for profit.
A. OWNERS ARE NOT ALWAYS DISTINCT FROM ENTITY
The law treats partnerships as entities distinct from their owners for some purposes (e.g.,
property may be held in the name of the partnership; suits can be maintained in the name of
the partnership), but not for others (e.g., partners are personally liable for obligations of the
partnership).
B. LIFE OF ENTITY
Like a sole proprietorship, partnerships often are not perpetual. A partnership may be
dissolved after a partner dies or otherwise dissociates from the partnership unless the
partners have agreed otherwise or vote to continue the partnership.
C. TAX TREATMENT
For tax purposes, profits and losses of a partnership flow through the partnership directly to
the partners. Partnerships are not recognized for federal income tax purposes as separate
taxable entities.
D. TRANSFERABILITY
A partner cannot transfer his partnership interest and confer partnership status on the
assignee without the unanimous consent of the other partners.
E. BANKRUPTCY
For purposes of filing for bankruptcy, a general partnership is considered an entity separate
from its owners and is eligible to file for bankruptcy under the Bankruptcy Code. However,
the partners remain personally liable for the partnership's debts.
F. CHOICE AS A BUSINESS ENTITY
If a person is interested in forming a business with more than one owner, does not want to
bother with a lot of formality, does not mind sharing management rights with co-owners, does
not mind putting personal assets at risk, etc., a general partnership might be an appropriate
entity to form.
II. NATURE, FORMATION, OPERATION AND TERMINATION OF A GENERAL PARTNERSHIP
A. NATURE OF A GENERAL PARTNERSHIP
A partnership is an association of two or more persons who agree to carry on as co-owners a
business for profit.
(e.g., transaction of limited duration).
Compare: A joint venture is similar, but it involves a single undertaking
1. Introduction to General Partnerships
All partnerships are assumed to be general partnerships unless otherwise stated.
Many of the items listed below will be covered in separate parts of this chapter, but
they are listed here together as an introduction. In a general partnership:
a. All partners are general partners.
b. All partners share in management.
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c. New general partners must be approved by all general partners.
d. All partners have unlimited personal liability for obligations of the partnership.
e. A general partner must give notice to creditors prior to withdrawal in order to
avoid liability for subsequent acts or events.
f. All partners (individually) have the apparent authority to bind the partnership with
respect to all normal partnership business transactions (except when a third
party knows the partner lacks actual authority).
g. All partners must approve all major business decisions (e.g., the sale of
goodwill).
h. Absent provisions to the contrary, profits and losses are shared equally among
the partners (even when capital contributions are not equal).
i. Each partner is jointly and severally liable for all partnership obligations (whether
arising from tort or contract) incurred within the scope of partnership business.
j. When a judgment is obtained against the partnership and the partners, the
partnership assets must be exhausted before any general partner's individual
assets can be attached.
2. Generally an Entity Except for Federal Income Tax Purposes
Although many states treat a partnership as an entity for most purposes (e.g., property
may be held in the name of the partnership, partnership may be sued in its own name,
etc.), partnerships are not treated as entities for purposes of federal income taxes.
This means that
losses flow through the partnership proportionately to the partners, who must report
their share of the partnership's gain or loss on their individual tax returns. Partnerships
are, however, considered to be separate entities for employment purposes (i.e.,
partnerships must pay FICA, FUTA, and Workers Compensation).
a partnership does not pay federal income tax; rather, profits and
3. Partnership May Be Sued
As a legal entity, a partnership may sue or be sued in its own name. However, unlike
corporations, partnerships are not completely separate from their owners (i.e., the
partners).
a. Full Personal Liability
As will be discussed later, partners are fully and personally liable for the debts of
their partnership, and partners may be sued along with their partnership in the
same action, provided they are properly served with process.
b. Judgment
To reach the personal assets of a partner, there must be a judgment against the
partner, which means that the partner must be individually named as a defendant
in the lawsuit. If only the partnership is named, a judgment against the
partnership will not be treated as a judgment against a partner, so only the
partnership's assets will be liable on the judgment.
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B. FORMATION OF A GENERAL PARTNERSHIP
Under common law and the Revised Uniform Partnership Act (which has been adopted by a
majority of the states) all that is necessary to form a general partnership is: (i) an agreement
(ii) between at least two competent persons (iii) to carry on as co-owners a business for
profit. There is no requirement for a general partnership to file with the state.
EXAMPLE
Alex and Becky inherit Blackacre, an apartment building, as tenants in common (a form of joint ownership). They are
not automatically deemed partners. Mere joint ownership of property is not enough to establish a partnership
relationship.
1. Capacity to be a Partner
Generally any party competent to make a contract can be a partner. Thus, an
individual, a corporation or a partnership can be a partner. Even a minor can be a
partner, but the partnership would be voidable at the option of the minor.
2. Intent to Form a General Partnership
Intent to form a partnership is the key to general partnership formation.
agreement is necessary
enter into a business for profit together.
No express. An agreement can be implied from conduct showing intent to
EXAMPLE
Steve and Barb decide to operate a hot dog cart together. Steve agrees to pay for the cart, and Barb agrees to make
and sell the hot dogs. The two also agree to split the profits. A partnership has been formed even though Steve and
Barb never expressly agreed to form a partnership.
a. When Intent Unclear—Sharing of Profits
If it is unclear whether the parties intended to enter into a partnership, the courts
will look at a number of factors to determine the parties' intent, the most
important of which is whether the parties have agreed to share profits (which
gives rise to a presumption of partnership).
b. Exception Possible
Although an agreement to share profits generally indicates an intent to form a
partnership, no such inference will be drawn where the agreement to share
profits was merely to repay a debt, interest on a loan, to pay an employee
wages, to pay a landlord rent, etc.
EXAMPLE
Alex owns a piece of land. Becky desires to rent it and to build and operate a hotel on it. Alex leases the land to
Becky, who agrees to pay Alex 10% of the net profits earned from the operation of the hotel. Cindy, who delivers
goods to Becky for the hotel, seeks to hold Alex liable for the goods as Becky's partner when Becky fails to pay for the
goods. Cindy cannot recover from Alex. The 10% payments are rent—there is no partnership.
c. Other Factors Considered
The courts will also consider (i) whether title to property is in a partnership name,
(ii) whether the parties call the arrangement a partnership, and (iii) the amount of
activity involved (e.g., did the parties merely purchase a piece of property
together, or did they purchase the property, build apartments, manage the
development, etc.).
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3. Generally Writing Not Necessary
As a general rule, a general partnership agreement need not be in writing, even if the
partnership is to own land. However, if the partners want to enforce an agreement to
remain partners for
Frauds.
longer than one year, a writing is required under the Statute of
PASS KEY
The examiners often ask what is necessary to form a general partnership. The key is to remember three simple elements: (i)
two or more persons, (ii) who agree (expressly or impliedly) (iii) to carry on as co-owners a business for profit. There is no
requirement of a writing, even if the partnership is to own land, unless the partnership is to last for more than one year.
4. Fictitious Name Statutes
In almost all states, partnerships doing business under a fictitious name are required to
register with the state. This registration must set forth the name under which the
business is conducted and the real names and addresses of all persons conducting the
business. Failure to comply with a "fictitious name" statute will not invalidate the
partnership, but may result in a fine.
C. OPERATION OF A GENERAL PARTNERSHIP
Absent an agreement to the contrary, all partners have
partnership business.
equal rights to manage the
EXAMPLE
Alex, Becky, Cindy, Deanna, and Elias form a general partnership—Glorious Jeans—to manufacture coffee-colored
clothing. Alex contributes 40% of the capital, Becky contributes 30% of the capital, Cindy contributes 20% of the
capital, Deanna contributes 10% of the capital, and Elias agrees to design all the clothes. Each partner has an equal
right to participate in management of the partnership.
1. Required Approval
Decisions regarding matters within the ordinary course of the partnership's business
may be controlled by majority vote unless the partnership agreement provides
otherwise. Matters outside the ordinary course of the partnership's business (e.g., sale
of the partnership's goodwill) require consent of
requiring unanimous consent of all partners include:
a. Admitting new partners;
b. Confessing a judgment (admitting liability in a lawsuit) or submitting a claim to
arbitration;
c. Making a fundamental change in the partnership business (e.g., the sale of a
partnership's goodwill);
d. Changing the partnership agreement; and
e. Assigning partnership property to others.
all the partners. Examples of areas
EXAMPLE
In the partnership described in the previous example, the decision whether to buy cloth from Supplier may be approved
by any three partners, but a decision to shift production from the manufacture of clothing to the manufacture of small
appliances would have to be approved by all the partners.
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2. Agency Law Governs
The authority of a partner to bind the partnership when dealing with third parties is
governed by the law of agency. Every partner is an agent of the partnership for the
purpose of its business. Under Agency law, a principal (in the context of partnerships,
the partnership) can be bound by the acts of its agent (in contract or tort) if the agent
(in the context of partnerships, a partner) acted with actual or apparent authority. The
partnership may also ratify previously unauthorized acts, either expressly or by
accepting the benefits of a partner's unauthorized action with knowledge of all material
facts regarding the action.
a. Actual Authority
Actual authority includes all authority that a principal expressly gives to an agent
plus any authority that can reasonably be implied from the express grant (e.g., if
a partner is appointed to manage a store, it would be reasonable to imply the
authority to hire employees, buy merchandise, etc.). A partner, therefore, has
whatever actual authority is granted to him in the partnership agreement plus
whatever authority the partners subsequently agree that the partner has.
b. Apparent Authority
Apparent authority is the authority that a third party reasonably believes an agent
has based on the principal's holding the agent out as being the principal's agent.
A partner has broad apparent authority. Any act of any partner for apparently
carrying on in the ordinary course of the partnership business, or business of the
kind carried out by the partnership, will bind the partnership through apparent
authority. It is important to remember that this authority cannot be limited by
resolutions or instructions of which the third party is unaware.
EXAMPLE
Ann and Bob form Kappa Associates, a partnership to sell kitchen equipment. The partnership agreement requires
each partner to get the approval of the other for purchases over $500. Thus, Ann and Bob each have actual authority
to purchase $500 in equipment. If Bob wants to purchase $1,000 of inventory from XYZ Kitchen Supply, and he asks
Ann for approval and she agrees, he has actual authority to purchase the $1,000 of equipment. If Bob does this three
times and on a fourth occasion decides not to seek Ann's pre-approval, he lacks actual authority to make the fourth
$1,000 purchase, but Kappa Associates nevertheless would be bound on the $1,000 purchase because Bob would
have apparent authority, as the purchase was apparently for carrying on the partnership's business.
c. Limitations—Transactions Outside Ordinary Course of Business
A partner has no apparent authority to bind the partnership to transactions
apparently outside the regular course of the partnership's business. Thus, in the
example above, if Bob had purchased a lawn tractor purportedly on behalf of the
partnership, the partnership would not be bound. Note that the following are
generally outside the scope of partnership business and so do not come within a
partner's apparent authority:
(1) Confessing a judgment against the partnership (i.e., admitting partnership
liability in court);
(2) Selling the partnership's goodwill (e.g., selling use of the company's
name);
(3) Submitting an issue to arbitration on behalf of the partnership;
(4) Committing an act that would prevent the partnership from continuing in
business; and
(5) Changing the partnership agreement.
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d. Partner Liable for Damages
A partner who acts outside the scope of his actual authority will be liable to the
partnership for any damages caused by the unauthorized act.
3. Expanding and Limiting Authority—Statement of Authority
The general rule is that a partnership may expand or curtail a partner's authority to
enter into transactions on behalf of the partnership by filing a statement of authority
with the secretary of state.
a. Personal Property Transfers
(1) Grant of Authority
If a statement of authority filed with the secretary of state
authority to enter into transactions on behalf of the partnership, other than
transfers of real property, the partner will generally be treated as having
the authority granted, even if the partners later agree that the partner
should not have the authority.
grants a partner
EXAMPLE
Alex, Becky, and Cindy are partners in Glorious Jeans Clothing Company, which manufactures jeans using a special
patented process. The company falls on hard times, and the partners file a Statement of Authority with the secretary of
state giving Cindy the power to sell the company's patent. Before Cindy can find a buyer, business turns around, the
company is once again running at a profit, and the partners agree that a sale is no longer needed. Six months later, a
Starbacks Jeans representative gives Cindy a large sum of money to purchase the patent. Glorious Jeans will be
bound because it never canceled the Statement of Authority, unless it can show that Starbacks actually knew that
Cindy lacked authority to sell the patent.
(2) Limitation on Authority
The rule is different for limitations on authority. A person is not considered
to know of a limitation on a partner's authority to enter into transactions not
involving real estate transfers merely because the limitation is filed with the
secretary of state. In other words,
third parties constructive knowledge of the limitation
the filing of a limitation does not give.
EXAMPLE
In the previous example, if the Statement of Authority filed by Glorious Jeans also contained a provision that Alex does
not have authority to purchase cloth on behalf of the partnership, and Alex purchased cloth from Supplier, the limitation
is not effective against Supplier unless Supplier actually knows of it.
b. Transfers of Real Property
If a Statement of Authority either grants
partnership's real property, the grant or limitation is conclusive if: (i) it is filed with
both the secretary of state and the county recording office and (ii) the buyer gives
value for the real property without knowledge that the partner lacked authority.
Thus, unlike the rule for personal property, a person will be considered to know
of a properly filed limitation on a partner's authority to transfer real property. In
other words,
or limits power of a partner to sell thethe filing here serves as constructive knowledge of the limitation.
c. Statement of Denial
A partner listed in a filed statement of partnership authority may effectively deny
her authority by filing a statement of denial with the secretary of state.
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D. TERMINATION—DISSOCIATION AND DISSOLUTION OF A GENERAL PARTNERSHIP
1. Dissociation
Dissociation is a change in the relationship of the partners caused by any partner
ceasing to be associated in the carrying on of the business. Dissociation of a partner
does not necessarily cause a dissolution and winding up of the business of the
partnership.
a. Events of Dissociation
A partner is dissociated from the partnership when:
(1) The partner notifies the partnership that he or she wants to withdraw (the
notice does not have to be in writing);
(2) An event occurs that was set out in the partnership agreement as an event
that would cause a dissociation;
(3) The partner is expelled from the partnership by unanimous vote or as
provided in the partnership agreement or by judicial decree;
(4) The partner becomes a debtor in bankruptcy or the like; or
(5) The partner dies (or if the partner is not a natural person, such as a
corporation, its existence is terminated).
b. Wrongful Dissociation
A partner will be deemed to have wrongfully dissociated if the dissociation is a
breach of an express term of the partnership. The dissociation is also wrongful if
the partnership is for a definite term or a particular undertaking and the partner
withdraws, is expelled, or becomes bankrupt before the end of the term or
undertaking.
(1) Wrongful Partner is Liable for Damages
A partner who wrongfully dissociates is liable for the damages caused by
the dissociation.
(2) Compare—Rightful Dissociation
If the partnership is "at will," partners are free to quit at any time. A
partnership is presumed to be at will unless the partners specifically agree
otherwise.
c. Consequences
When a partner dissociates, the partner's right to participate in management
ceases.
(1) Purchase of Partner's Interest
If the partnership business continues after a partner dissociates, the
partnership must purchase the dissociated partner's interest based on the
greater of (i) the partnership's liquidation value or (ii) the value of the
partnership business as a going concern without the dissociated partner.
Damages for wrongful dissociation reduce the amount due to the
dissociated partner.
(2) Deferred Payment if Premature Dissociation
If a partner wrongfully dissociates before expiration of a definite term, the
partner is not entitled to payment or interest until the expiration of the term.
However, the deferred payment must be adequately secured and bear
interest.
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(3) Dissociated Partner's Power to Bind Partnership
If a partner dissociates and the partnership does not dissolve and wind up
its affairs, the dissociated partner will have power to bind the partnership
for two years if the other party to the transaction (i) reasonably believed the
dissociated partner was a partner and (ii) did not have notice or knowledge
of the dissociation.
d. Dissociated Partner's Liability to Other Parties
(1) For Debts Incurred Prior to Dissociation
Generally, a dissociated partner remains liable for the debts incurred by
the partnership before the partner's dissociation unless there has been a
release by the creditor or a novation (i.e., a substitution of a third party for
the retiring partner agreed to by the creditor). A release by the partners of
a dissociated partner (called a
relieve the dissociating partner from liability to outside creditors.
hold harmless agreement) alone does not
(2) For Debts Incurred After Dissociation
A dissociated partner may be liable for debts arising within two years after
the date of dissociation if the other party to the transaction (i) reasonably
believed when entering the transaction that the dissociated partner was still
a partner and (ii) did not have notice of the partner's dissociation.
However, a dissociating partner can limit his liability by filing a notice of
dissociation with the state. Persons are considered to have notice of a
partner's dissociation 90 days after the dissociated partner or the
partnership files notice of dissociation with the secretary of state.
(3) Liability of Incoming Partner
It is common (at least on the CPA exam) to have a new partner admitted
when an old partner retires. An incoming partner is not personally liable for
debts incurred by the partnership before he became a partner, but any
financial contribution the incoming partner made to partnership property
may be used to satisfy old debts. Of course, an incoming partner is
personally liable for all debts incurred by the partnership after he becomes
a partner.
2. Dissolution
a. Events Causing Dissolution
Generally, a partnership is dissolved and its business must be wound up when
any of the following occur:
(1) A partner in a partnership at will (i.e., a partnership without a specified
duration) gives notice of intent to withdraw;
(2) In a partnership for a definite term: (i) all partners consent to dissolution; (ii)
the term has expired; or (iii) 90 days have passed since a partner has died,
been declared bankrupt, or has wrongfully dissociated
interest of the remaining partners do not wish to continue;
(3) The happening of an event agreed to by the partners in the partnership
agreement, that will trigger dissolution or that makes it unlawful for the
partnership to continue;
(4) Issuance of a judicial decree
economic purpose of the partnership is likely to be frustrated, (ii) a partner
has engaged in conduct making it not reasonably practicable to carry on
the business, or (iii) the business cannot practicably be carried on in
conformity with the partnership agreement; or
and a majority inon application of a partner that (i) the
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(5) Issuance of a judicial decree
interest that it is equitable (i.e., fair) to wind up the partnership because its
term has expired or it was a partnership at will.
on application of a transferee of a partner's
PASS KEY
The examiners often ask about the basic characteristics of a partnership. One characteristic that has been key to several past
questions is that a partnership is not of unlimited duration—because any one of the above events can trigger a dissolution.
b. Partner's Power to Bind Partnership after Dissolution
A partnership will be bound by a partner's act after dissolution if the act is
appropriate for winding up the partnership (e.g., settling claims, selling
partnership assets, collecting debts, paying creditors, etc.). A partnership also
will be bound by a partner's post-dissolution acts if the party with whom the
partner dealt did not have notice of the dissolution.
(1) Timing of Notice to Third Parties
As noted above, the partnership can give third parties notice by filing a
statement of dissolution with the secretary of state. Such a notice gives
third parties constructive notice of the dissolution 90 days after the
statement is filed.
(2) Partner's Liability to Partnership
If a partner knows of the dissolution and enters into a transaction not
appropriate for winding up the partnership's business, the partner will be
liable to the partnership for any damage caused.
c. Partnership Continues After Dissolution
A partnership continues to exist after dissolution until its business is wound up, at
which time the partnership is terminated.
d. Who May Wind Up
(1) All Partners
If all partners agree to a dissolution or the partnership term expires,
partners have the right to wind up the affairs of the partnership. A partner
who has wrongfully caused a dissociation may not participate.
all the
(2) Remaining Partners
If a partner dissolves the partnership by bankruptcy, then the remaining
partner(s) have the right to wind up the partnership's affairs.
(3) Surviving Partners
If a partnership is dissolved by the death of a partner, then the surviving
partner(s) have the right to wind up partnership affairs.
(4) Executor
If the partnership's affairs have not been wound up when the last surviving
partner dies, that partner's executor or administrator has the right to wind
up the partnership's affairs.
(5) Partner Wrongfully Dissolving Partnership—Cannot Wind Up
A partner who wrongfully dissolves a partnership is not entitled to wind up
the affairs of the partnership.
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e. Partners May Waive Dissolution and Continue the Business
Any time after the dissolution of a partnership and before the winding up of the
partnership's business is completed, the partners (excluding any wrongfully
dissolving partners) may decide by
business. If they do so, the dissolution is retroactively nullified and liabilities are
determined as if the dissolution never occurred.
unanimous vote to continue the partnership
3. Distribution of Assets—Final Accounting
a. Order of Distribution
Where a solvent partnership is dissolved and its assets are reduced to cash, the
cash must be used to pay the partnership's liabilities in the following order:
(1) Creditors
Creditors, including partners who are creditors, must be paid before the
non-creditor partners receive any payments.
(2) Partners
After obligations to creditors are satisfied, each partner is entitled to
payment. Under the Revised Uniform Partnership Act, each partner is
deemed to have an account that is credited or charged, as the case may
be, with a net amount equal to the partner's contribution, plus or minus the
partner's share of any profits or losses. If the account balance is positive
on dissolution, that amount is distributed to the partner. If the account
balance is negative, the partner must contribute that amount to the
partnership.
b. Application
It is doubtful that the facts of a CPA exam question will give you the balances of
the partners' accounts, because determining the amount each partner should
receive would then be too easy. Historically, questions in this area state the
contributions of each partner and the amount of cash the partnership has left and
then require you to figure out the amounts owed to or owed by each of the
partners.
(1) Amounts Due or Owed
To determine the amounts due or owed, deduct from the assets left upon
dissolution any amounts still owing to creditors (including partners who are
creditors) and then deduct the amounts that would be needed to return the
partners' contributions (if these have not already been repaid).
(2) Divide Remaining Profit (if Any) Equally
If money still remains, it is profit that must be divided among the partners.
If the assets at dissolution are less than what is needed to pay the
creditors and return contributions, then there is a loss that must be divided
among the partners. In either case, remember that unless the partnership
agreement provides otherwise, profits are divided equally among partners,
and losses are divided the same as profits.
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EXAMPLE
Alex, Becky, and Cindy contributed money ($30,000, $15,000, and $5,000, respectively) to the ABC Partnership. Upon
dissolution, after paying all creditors, $20,000 remains. The partnership has suffered a $30,000 loss because $50,000
was contributed to capital and only $20,000 remains. The partnership agreement is silent as to how losses are to be
divided, but provides that profits are to be allocated as follows: 40% to Alex, 25% to Becky, and 35% to Cindy.
Because the partnership agreement is silent as to allocation of losses, the loss will be allocated in the same
proportions as profits: 40% to Alex=$12,000 (i.e., 40% of $30,000); 25% to Becky=$7,500; and 35% to Cindy=$10,500.
Thus, Alex is entitled to receive $18,000 ($30,000 capital contribution less $12,000 share of loss); Becky is entitled to
receive $7,500 ($15,000 capital contribution less $7,500 share of loss), and Cindy owes $5,500 ($5,000 capital
contribution less $10,500 share of loss).
EXAMPLE
Note:
jurisdiction), or are insolvent, the remaining partners must share the extra loss proportionally. Thus, in the example
above, if Cindy refused to pay anything else, Alex and Becky would have to share the $5,500 loss that Cindy owes on
a 4 to 2.5 basis (Alex would have to deduct an extra $3,385 from his capital and Becky would have to deduct an extra
$2,115 from her capital). Of course, if Cindy is solvent, Alex and Becky can seek to recover the $5,500 from Cindy in
an action for indemnification.
If there is a loss and some partners refuse to contribute, are not subject to process (i.e., are not within a court's
III. FINANCIAL STRUCTURE, CAPITALIZATION, PROFIT AND LOSS ALLOCATION AND
DISTRIBUTIONS
A. FINANCIAL STRUCTURE AND CAPITALIZATION
Partners are not required to make any particular contribution to their partnership, and the law
does not specify any particular financial structure for general partnerships. However, as
mentioned previously, each partner is deemed to have an account that is credited or charged,
as the case may be, with a net amount equal to the partner's contribution, plus or minus the
partner's share of any profits or losses.
B. PROFIT AND LOSS ALLOCATION
1. Profits
Absent an agreement to the contrary, all partners have
profits of the partnership.
equal rights to share in the
EXAMPLE
Alex, Becky, Cindy, Deanna, and Elias form a general partnership—Glorious Jeans—to manufacture coffee-colored
clothing. Alex contributes 40% of the capital, Becky contributes 30% of the capital, Cindy contributes 20% of the
capital, Deanna contributes 10% of the capital, and Elias agrees to design all the clothes. Alex, Becky, Cindy, Deanna,
and Ethan will share profits equally absent an agreement to the contrary.
2. Losses
Unless the partners agree otherwise, they share losses in the same manner as they
share profits.
EXAMPLE
Assume the same facts as in the previous example. If there is a $100,000 loss, absent an agreement to the
contrary, Alex, Becky, Cindy, Deanna, and Elias will each be responsible for $20,000 of the loss.
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PASS KEY
The examiners often ask how partners will share profits and/or losses. The key is to remember that, like partners'
management powers, unless the partners provide otherwise,
contributions. If a partner cannot contribute his share of losses (e.g., because of bankruptcy or other refusal), the remaining
partners must make up the share on a pro rata basis.
profits and losses will be split equally, regardless of the partners'
C. DISTRIBUTIONS
1. No Inherent Right to Distribution
Partners have no specific rights to receive distributions from the partnership other than
as they agree. Indeed, unless agreed otherwise, although partners are bound to devote
themselves full-time to the partnership business, they are not entitled to remuneration
for services rendered to the partnership.
EXAMPLE
In the previous example, if Alex, Becky, and Cindy never did any work for Glorious Jeans, and Deanna and Elias
worked full-time to manufacture the clothes, Deanna and Elias would have no right to be paid for their services (unless
Alex, Becky, and Cindy breached an agreement to work).
2. Exception—Winding Up by Surviving Partner
A surviving partner is entitled to reasonable compensation for winding up the
partnership affairs.
IV. RIGHTS, DUTIES, LEGAL OBLIGATIONS, AND AUTHORITY OF GENERAL PARTNERS
A. RIGHTS OF PARTNERS
1. Rights in Partnership Property
A partnership is treated as owning all money and property contributed to the
partnership by the partners and all other property acquired by the partnership.
Partners are not treated as co-owners of partnership property. As a general rule,
partners have no right to possess or use a specific item of partnership property other
for partnership purposes.
EXAMPLE
Alex and Becky agree to form a partnership to sell antique cars. Alex contributes 10 antique cars from his collection
and Becky contributes $200,000. The cars and the cash are partnership property. Alex may no longer use the cars for
personal use—even if they are titled in his name—and Becky may no longer freely spend the $200,000. The cars and
cash can be used only for partnership purposes.
a. Not Assignable or Mortgageable by Partner Individually
A partner has no power to assign or transfer his rights in a specific item of
partnership property; neither may a single partner without authority mortgage an
item of partnership property.
b. Not Subject to Attachment by Individual Partner's Creditors or for Alimony
Because a partner has no right to possess partnership property individually, a
creditor of an individual partner has no right to attach partnership property to
satisfy an individual partner's obligation to the creditor, because the creditor can
have no greater rights than the individual partner. Partnership property is also
not subject to an individual partner's liability for alimony.
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c. Rights Vest in Surviving Partners upon Death
When a partner dies, his rights in specific partnership property vest in the
surviving partners; the deceased partner's rights in partnership property do not
pass on to his estate.
PASS KEY
The examiners often ask about a partner's interest in specific partnership property. The partner has
transfer
claims or alimony. However, it is subject to a surviving partner's survivorship interest.
no right to possess or(through sale, will, etc.) except for partnership purposes. Thus, the property is not subject to personal creditors'
2. Rights in Partnership Interest
A partner has a personal property interest in the partnership consisting of the partner's
right to his share of the profit and surplus.
a. Interest is Assignable
Because a partner's interest in his partnership is the partner's personal property,
he may assign his interest in the profits and surplus at any time. Be careful not
to confuse a partner's assignment of his interest in the partnership (which is
allowed) with a partner's assignment of his interest in partnership property (which
is prohibited).
b. Assignee Has Rights to Partner's Share of Profits
After assignment of a partner's interest in the partnership, the assignee has the
right to receive the partner's share of the profits and surplus, including the
partner's rights to profits and surplus upon dissolution.
c. Assignee Has No Management Rights
The assignment of a partner's interest in the partnership does not give the
assignee any right to participate in managing the partnership. Thus, the
assignee has no right to attend partnership meetings, inspect the partnership
books and records, vote, etc. An assignee can obtain such rights only if admitted
to the partnership as a partner, which generally requires the approval of all the
partners.
d. Judicial Dissolution
Although mere assignment of a partnership interest does not dissolve the
partnership, an assignee of a partner's interest may ask a court to dissolve the
partnership and wind up its affairs if, under the circumstances, that is the fair
thing to do and the partnership is at will or the term of the partnership has
expired.
e. Creditors May Attach a Partner's Interest – Called a "Charging Order"
A creditor of an individual partner may obtain from a court a
charging order
against an individual partner's share of profits.
a. A charging order does not cause a dissolution of the partnership.
b. A charging order does not make a creditor a partner or allow the creditor to
participate in partnership affairs.
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f. Upon Death, Heirs are Entitled to Deceased Partner's Share of Profits
When a partner dies, his right to profits vests in his heirs. As previously noted,
the right to partnership property vests in the surviving partners.
PASS KEY
The examiners like to ask about the effect of a partner transferring his interest in the partnership without the consent of the
other partners. The key is to remember that such a transfer does not make the assignee a partner (that can be done only with
the consent of all of the partners). Thus, the transferee has no power to manage the partnership, inspect the partnership's
books and records, vote, etc. Generally, the assignee's only right is to get whatever distribution the assignor would have
gotten. The same rule applies to a creditor with a charging order and an heir who receives a deceased partner's interest.
3. Right to Indemnification and Contribution
The partnership must indemnify every partner for expenses incurred by the partner on
behalf of the partnership. Similarly, where one partner is compelled to pay more than
his share of a partnership obligation, he has a right to seek contribution from the others
for their fair share of the debt.
4. Right to Inspect Books and Records
Every partner has the right to inspect and copy the books and records of the
partnership.
5. Right to Bring Legal Action Against Partnership
Under the old partnership act, partners could not sue their partnership except under
limited circumstances. Typically, the partnership would have to be dissolved and a
final accounting, considering all transactions between the partners, would be
performed. The Revised Uniform Partnership Act allows partners to bring legal actions
against their partnerships under most circumstances.
B. DUTIES AND LEGAL OBLIGATIONS OF PARTNERS
1. Fiduciary Duties Owed to Other Partners
Each partner owes a fiduciary duty to the general partnership and is bound to use
partnership property and his best efforts for the benefit of the partnership. Profits made
in the course of the partnership business belong to the partnership. If a partner usurps
partnership business or uses partnership property for his own benefit, he can be forced
to turn over his profits to the partnership.
2. Each Partner Personally Liable for All Partnership Obligations
a. Personal Liability for Acts of Other Partners
Partners are personally liable for all contracts entered into and all torts committed
by other partners within the scope of the partnership business or which are
otherwise authorized. The partners can even be personally liable for another
partner's fraud or breach of trust committed within the scope of partnership
business.
b. All Liability Joint and Several
The partners' liability is
or tort. (Under the older version of the partnership act, which may be reflected in
past CPA exam questions, contract liability was joint, while tort liability was joint
and several.) Under joint and several liability, each partner is personally and
individually liable for the entire amount of all partnership obligations.
joint and several, whether the obligations arise in contract
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(1) Action May Be Brought Against Any Partner and/or the Partnership
An action may be brought against any one or more of the partners or the
partnership. However, a judgment is not personally binding on a partner
unless that partner has been served with process in the suit.
(2) Must Exhaust Partnership Assets Prior to Individual Partner Liability
Most states require the judgment creditor to exhaust the partnership's
assets before enforcing a judgment against the individual assets of a
partner.
C. AUTHORITY OF PARTNERS
As previously covered, partners have whatever actual authority the partners agree that the
partners will have. They also have apparent authority to enter into any transaction that is
apparently within the scope of the partnership business.
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LIMITED LIABILITY PARTNERSHIP
I. LIMITED LIABILITY PARTNERSHIP (SIMILAR TO GENERAL PARTNERSHIP)
A limited liability partnership (LLP) is similar to a general partnership in most respects, including the
sharing of profits and losses, and generally all of the advantages and disadvantages of a general
partnership mentioned above apply to a limited liability partnership.
A. DIFFERENCE: PARTNER IN AN LLP NOT PERSONALLY LIABLE
1. Not Generally Personally Liable for Acts of Fellow Partners, Employees or
Agents
An LLP differs from a general partnership in that a partner in an LLP is not personally
liable for the obligations or liabilities of the partnership arising from errors, omissions,
negligence, malpractice, or the wrongful acts committed by another partner or by an
employee, agent, or representative of the LLP. Neither are the partners liable for
partnership contracts.
2. Liable for their Negligence and Negligence of those Under their Direct Control
LLP partners are, of course, liable for their own negligence or wrongful acts and for the
negligence and wrongful acts of those under their direct control.
3. Generally Not Personally Liable for Debts and Contractual Obligations
Generally partners in an LLP are NOT personally liable for the debts and contractual
obligations of the LLP. They are only liable to the extent of their capital contributions
and are personally liable for their own and their subordinates' negligence.
B. DIFFERENCE: FORMATION
1. LLP Must File with the State
Generally to become an LLP, the partnership must file a document with the state
(called a registration, statement of qualification, application for registration or certificate
of limited liability partnership). Some states restrict LLPs only to professionals.
2. Contents of Certificate of Limited Liability Partnership
Although registration requirements vary from state to state, generally the registration
must provide information such as the LLP's name, the name and location of its
registered office, the number of partners, a description of the partnership business, etc.
3. Partnerships May Convert to LLP
Most states permit an easy transition from a general partnership to an LLP.
4. A General Partner Who Is Personally Liable Is Not Usually Required
Generally in an LLP, there does not need to be a general partner who is personally
liable for all the debts and obligations. Most states allow LLPs for certain types of
professionals, and the states may require LLPs to carry negligence/malpractice
insurance to cover the negligent acts of the professionals and their subordinates.
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LIMITED PARTNERSHIP
I. ADVANTAGES, IMPLICATIONS, AND CONSTRAINTS OF LIMITED PARTNERSHIPS
A limited partnership is a partnership that provides for limited liability of some investors (called
"limited partners"), but it is otherwise similar to other partnerships. A limited partnership can be
formed only by compliance with the limited partnership statute.
A. GENERAL PARTNER HAS PERSONAL LIABILITY
There must be at least one general partner in a limited partnership, and that general partner
has full personal liability for all partnership debts. The general partner also has most
management rights. (Remember, there must also be at least one limited partner.)
B. UNANIMOUS CONSENT REQUIRED TO SELL
Like partners in other partnerships, neither a general partner nor a limited partner can sell the
right to be a partner in the limited partnership without the unanimous consent of the other
partners. However, a limited partner may sell or assign his partnership interest (share of
profits) without the consent of the other partners.
C. CHOICE AS A BUSINESS ENTITY
This form of business entity offers limited liability to most investors, centralized management
(i.e., management by the general partner(s) rather than by all owners), and the flow-through
tax advantages of a partnership, without the limitation on number of investors that an S
corporation (discussed below) has. Its disadvantage, however, is that at least one person
must be personally liable for the debts of the business.
II. NATURE, FORMATION, OPERATION, AND TERMINATION OF LIMITED PARTNERSHIPS
A. NATURE OF A LIMITED PARTNERSHIP
A limited partnership is a partnership made up of one or more general partners (who have
personal liability for all partnership debts) and one or more limited partners (whose personal
liability for partnership debts generally is limited to their capital contributions). An introduction
to limited partnerships follows.
PASS KEY
Note that a limited partnership must have at least one general partner who will be personally liable for all partnership debts.
The examiners sometimes test this. They ask whether it's true that a limited partnership can be formed with limited liability for
all
partnership obligations.
partners. The answer, of course, is "no"—you need at least one general partner who has unlimited personal liability for all
1. Generally No Perpetual Life
Generally, a limited partnership does
agreement provides otherwise.
not have a perpetual life, unless the partnership
2. Similar to a Corporation
A limited partnership resembles a corporation in several ways. It can be formed only
pursuant to a state statute and only by filing a certificate with the state. Limited
partners are very much like shareholders. They contribute capital in exchange for an
interest in the partnership, but they do not participate in the management of the
partnership.
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3. General Partners
a. A general partner is personally liable for all partnership debts. If there is a loss,
only the general partner can be held personally liable.
b. A general partner may also be a limited partner at the same time.
c. A general partner may be a secured or unsecured creditor of the partnership (of
course, the advantages of being a secured creditor when partnership liabilities
exceed partnership assets are lost, because of the general partner's personal
liability for losses).
4. Limited Partners
a. A limited partner's liability is limited to his investment and unpaid capital
contributions. The price of the limited liability is a restriction on the power of the
limited partner to manage the partnership.
b. Limited partners' names cannot be identified with the business, or they might be
considered to be general partners and lose their limited liability status.
c. Limited partners must not participate in management, or they lose their limited
liability status (however, in some instances, such as approving of new general or
limited partners, the limited partners may vote).
d. If a limited partner is also a general partner (i.e., the general partner buys a
limited partnership interest in addition to his/her interest as a general partner),
the partner does not have the limited liability of a limited partner.
e. The owner of a limited partnership interest may assign his interest in the
partnership.
(1) The assignment of a limited partner's interest has the same effect as an
assignment of a general partner's interest in a general partnership—the
assignee has the limited partner's rights to profits.
(2) Unless otherwise agreed, the assignor ceases to be a limited partner upon
the assignment of all of his limited partnership interest.
f. A new partner can be added only upon the consent of all partners.
g. A limited partner does
general partners.
not owe a fiduciary duty to the limited partnership or to the
B. FORMATION OF A LIMITED PARTNERSHIP
1. Filing with the State is Required
Like an LLP and a corporation, a limited partnership can be formed only pursuant to a
state statute and only by filing a certificate with the state.
PASS KEY
The examiners often ask about the similarities between a limited partnership and a corporation. The correct answer usually is
that both are created under a state statute and require filing with the state for creation.
2. Contents of the Filing Document
Most states require the certificate of limited partnership to include the following:
a. A statement that the entity is a limited partnership. The name must contain the
words "limited partnership" or the abbreviation "Ltd.";
b. The name of the agent for service of process and the address of the office;
c. The name and business address of each general partner; and
d. The latest date upon which the limited partnership is to dissolve.
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C. OPERATION OF A LIMITED PARTNERSHIP
A limited partnership's day-to-day affairs are run by the limited partnership's general
partner(s), who have the same right to manage the partnership as partners in a general
partnership.
1. Limited Partner Does Not Manage
Limited partners have no right to take part in the day-to-day management of their
limited partnership.
2. Limited Partner is Not an Agent
A limited partner is not an agent of the partnership. Thus, a limited partner has no
authority to enter into contracts on behalf of the partnership. Neither may a limited
partner hire employees for the partnership; although, a limited partner may be
employed by the partnership.
D. TERMINATION OF A LIMITED PARTNERSHIP
1. Methods of Dissolution
A limited partnership may be dissolved by:
a. The occurrence of the time or event stated in the partnership agreement,
b. Written consent of all partners,
c. Withdrawal or death of a general partner, or
d. Judicial decree.
2. Death of a Limited Partner Does Not Cause Dissolution
Note that death of a limited partner will not dissolve the partnership—the representative
of the deceased limited partner takes the limited partner's rights for purposes of settling
the estate.
3. Order of Distribution of Assets
After dissolution, if the limited partnership is terminated, assets are distributed in the
following order:
a. Creditors
Creditors (secured and preferred creditors receiving payment before general
unsecured creditors), including partners who are creditors of the partnership, are
first in priority of payment.
b. Former Partners
Former partners are paid next in satisfaction of liabilities for distributions that
should have been made upon their withdrawal.
c. Partners
The partners are paid last, first to return their contributions, and then to distribute
profits.
4. Loss Situation
If there is a loss, general partners are personally liable for all partnership debts.
Limited partners have no personal liability, but rather risk only their capital contribution.
(Limited partners can be liable for unpaid contributions, however.)
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III. FINANCIAL STRUCTURE, CAPITALIZATION, PROFIT AND LOSS ALLOCATION, AND
DISTRIBUTIONS
A. FINANCIAL STRUCTURE AND CAPITALIZATION
The Revised Uniform Limited Partnership Act, like the Revised Uniform Partnership Act, does
not have detailed rules regarding the financial structure of a limited partnership. However,
the Act seems to contemplate that partners will make capital contributions of some kind, and
most states allow partners in a limited partnership to contribute cash, property, or services
already performed for the limited partnership. Many also permit promissory notes and
promises to perform services as well.
B. PROFIT AND LOSS ALLOCATIONS
If the partners have agreed on how they will share profits, that agreement will govern.
However, if there is no agreement as to how profits and losses will be shared, partners in a
limited partnership—whether they are general or limited partners—share profits and losses in
proportion to the value of each partners' contributions. (Recall that the rule for general
partnerships is different. In a general partnership, absent an agreement otherwise, partners
share profits and losses equally, regardless of their contributions.)
C. DISTRIBUTIONS
Like partners in a general partnership, partners in a limited partnership have no particular
right to receive a distribution except to the extent provided in the partnership agreement.
IV. RIGHTS, DUTIES, LEGAL OBLIGATIONS, AND AUTHORITY OF GENERAL AND LIMITED
PARTNERS
A. RIGHTS
1. Rights of Limited Partners
Limited partners do
not have general management rights in their partnership.
a. Rights are Similar to Those of Shareholders in a Corporation
The rights of limited partners are similar to the rights of shareholders of
corporations and include the following:
(1) Vote
Although a limited partner may not take part in the control of the limited
partnership without facing potential liability (as discussed below), the
Revised Limited Partnership Act does permit limited partners to
extraordinary matters without incurring liability, such as dissolution of the
limited partnership, amending the certificate of limited partnership,
admission or removal of a general or limited partner, sale of substantially
all of the limited partnership's assets, and any other fundamental change in
the nature of the limited partnership business.
vote on
(2) Inspect Partnership Books and Records
Limited partners have the right to inspect partnership books and records,
including tax returns.
(3) Transact Business with the Partnership
Limited partners have the right to transact business with the partnership,
including lending money to the partnership as either a secured or
unsecured creditor.
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(4) Bring a Derivative Action
Limited partners have the right to bring a derivative action if the general
partners improperly refuse to bring suit on the partnership's behalf.
(5) Withdraw from the Partnership
Limited partners have the right to withdraw from the partnership in
accordance with the partnership agreement or, absent such provision, on
six month's notice.
(6) Apply for Dissolution
Limited partners have the right to apply for dissolution when it is not
reasonably practicable to carry on business.
b. Assignment of Interest
Limited partners have a right to assign their interest in distributions in their
partnership. The assignment of a limited partner's interest has the same effect
as an assignment of a general partner's interest in a general partnership—the
assignee has the limited partner's rights to profits. An assignment does not
cause dissolution of the partnership. A new partner can be added only upon
consent of all partners.
2. Rights of a General Partner in a Limited Partnership
a. Same Rights and Duties as a Partner in a General Partnership
A general partner in a limited partnership has all the rights and powers of a
partner in a general partnership.
b. Can Lend Money to the Limited Partnership
A general partner can lend money to the limited partnership as either a secured
or unsecured creditor. Of course, the advantage of being a secured creditor is
lost because of the general partner's personal liability for losses.
c. Owe Fiduciary Duties to General and Limited Partners
A general partner owes fiduciary duties to all general and limited partners.
Limited partners do not owe fiduciary duties.
B. DUTIES AND LEGAL OBLIGATIONS
1. Duties and Legal Obligations of Limited Partners
a. Limited Liability
Limited partners are similar to shareholders of a corporation in that they do not
have personal liability for partnership obligations, but rather risk only their capital
contributions to the partnership.
b. Loss of Limited Liability
A limited partner can lose his limited liability by doing any one of the following
three things:
(1) Serving as a General Partner
A limited partner may also be a general partner in the same partnership at
the same time. Limited liability will be lost if the limited partner serves as a
general partner in addition to being a limited partner (in which case the
partner has all of the rights and liabilities of both a general partner and a
limited partner).
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(2) Allowing Name to Be Used in the Partnership Name
Limited liability will be lost if the limited partner allows his name to be used
in the partnership name (except under certain limited circumstances—such
as where the business had been carried on in that name before the limited
partnership was formed).
(3) Participating in Control
Limited liability will be lost if the limited partner participates in control of the
business such that a creditor who is dealing with the partnership
reasonably believes that the limited partner is a general partner. Note that
a limited partner may be hired by the partnership as an employee, and
even acting as a manager employee does not constitute "control."
2. Duties and Obligations of a General Partner in a Limited Partnership
If there is a loss, general partners are personally liable for all partnership debts.
Limited partners have no personal liability, but rather risk only their capital contribution.
Limited partners can be liable for unpaid contributions.
C. AUTHORITY
General partners in a limited partnership have the same authority as partners in a general
partnership. Limited partners have no apparent authority to act on behalf of the limited
partnership.
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LIMITED LIABILITY COMPANY
I. ADVANTAGES, IMPLICATIONS, AND CONSTRAINTS OF A LIMITED LIABILITY COMPANY
The limited liability company (LLC) is a form of business entity that offers its owners (called
"members") one of the main advantages of the corporate form of business (i.e., they are not
personally liable for the obligations of the company) and all of the tax advantages of a partnership
(i.e., profits and losses from an LLC flow through the company to its members unless the members
choose to have the LLC taxed like a corporation). Like a limited partnership and an LLP, an LLC
may be formed only by filing certain documents with the state.
A. CONSENT REQUIRED TO SELL
Under the statutory provisions that govern LLCs in most states, members may not sell their
ownership interest in the LLC without the consent of the other members.
B. MANAGEMENT
All members have a right to manage the LLC; however, the members may adopt operating
agreements changing this rule. When members choose to centralize management, it is
referred to as "manager managed."
C. CHOICE AS A BUSINESS ENTITY
The LLC is a very flexible business form that has attributes of a partnership and corporation.
D. BANKRUPTCY
As a hybrid entity, with features similar to a partnership and corporation, an LLC is eligible to
file for bankruptcy.
II. NATURE, FORMATION, OPERATION, AND TERMINATION OF A LIMITED LIABILITY
COMPANY
A. NATURE OF A LIMITED LIABILITY COMPANY
An LLC is a hybrid business organization that combines characteristics of corporations,
partnerships, and limited partnerships. In 1988, the Internal Revenue Service issued a ruling
treating such organizations like partnerships for tax purposes, provided certain conditions
were met. Since then, almost every state has adopted an LLC statute. Although there is
some variance among the states regarding LLCs, the basics generally are similar from stateto-
state and it is upon these basics that this outline will focus.
1. Basic Characteristics
a. Two Main Features
An LLC is tax-driven entity designed to provide its members with two main
features:
(1) Limited Liability of a Corporation
The limited liability that shareholders of a corporation enjoy (i.e., owners
are not personally liable for obligations of the business entity) is provided
to members of an LLC.
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(2) Taxation as a Partnership
An LLC has the ability to be taxed like a partnership (i.e., profits and losses
flow through the entity and are treated as the owners' personal profits and
losses, unlike profits of a corporation, which are taxed at the corporate
level and again when distributed to the shareholders). (
current tax laws, LLCs receive partnership-like tax treatment unless they
elect to be taxed as a corporation.)
Note: Under
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