Mod 3 Business Basics

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Module 3: Business Law

BasicsPart 1: Different Business Entities


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Types of Legal Entities

Sole proprietorship- 1 person in usiness to !a"e!oney# unli!ited authority# does not sur$i$e death#

%ssociations- & or !ore people in usiness to !a"e!oney Partnership- 'eneral ( Li!ited) Li!ited Liaility Li!ited Liaility *o!pany-hyrid corp+pship

Manager or !e!er !anaged

*orporations- ,euires intent) for!ality and agree!ent *losely-held---s!all us.) fa!ily) few people# pulic--!in. / of people) 0 assets Professional corporation-licensed professionals


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*ritical actors

Li!ited Liaility

Manage!ent

Ta2-free con$ersion Eligiility

Transferaility of nterest

Dissolution Ta2ation


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Module 3: Business Basics

Part &: 4nderstanding the Deal


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inancing a Business

1. Det $s. euity- ,eflects the characteri5ation of the contriution ofan in$estor. %ffects priority in getting return) i.e. det-repaid eforereturn contriution or distriute profits ut li!ited to a!ount owedplus interest# or euity-return on contriution plus a pro rata share ofprofits.

&. ,etaining control $s. !a2i!i5ing return $ia Preferences 6priority indistriution7) and Pree!pti$e- right of first refusal. Preferences gi$ethe in$estor priority in distriution or first in line) e.g preferredshares. Pree!ptions allow the in$estor to restrict rights of other andprotect against dilution. E.g. right of first refusal.

3. Le$erage- use of other people8s !oney to purchase or in$est. *ostof orrowing !ust e lower than interest earned in in$esting.

9. Marginal 6ta2 rate fro! chart7 $s. Effecti$e ta2 6actual rate applied7


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*ontriution of *apital

Partnerships: %ny or no consideration is reuired

LL*: wners can contriute 0) property) ser$ices rendered orinding oligation to contriute these so future ser$ices with acontract is ;.

*losely corporation: *apital for a corp can e 0) property) pastser$ices) det securities. n *alif. no future ser$ices or pro!issorynotes. There !ust e so!e consideration. *alif *orp. 9.&167 allows d to authori5e shares for cash)

pro!issory note) ser$ices perfor!ed) contracts for future ser$ices.-Bd. %ssigns reasonale $alue to the noncash contriution.


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*haracteri5ation of *ontriution

*o. has interests different fro! indi$idualowners:

-*o!pany usu. prefers !ore capital and lessdetno oligation to repay so don8t spendyour !oney on det ser$ice# easier to le$erage?cause it is not encu!ered# etter financialcondition for lenders.

ndi$idual owners:

-Based upon ris" tolerance) need to get!oney ac") ta2 treat!ent) so !ay want !oredet than capital ?cause greater assurance forrepay!ent) ut low upside.


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Module 3: Business Basics

Part 3: Ta2 Planning


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Ta2 Ter!s-Basis

1) Basis: The cost or purchase price of an asset.Example: If Harry buys a car for $20000 the basis in the car is $20000.

2) !"#uste" basis: Basis impro%ements & "e"uctions from "epreciation of certainimpro%ements.

Example: If Harry buys a house for $100000 an" puts an a""itional $2'000 inimpro%ements an" up(ra"es to the house then the a"#uste" basis euals$12'000. *ome up(ra"es such as a furnace or boiler is amorti+e" or"epreciate" o%er a perio" of time meanin( that a portion of the cost is"e"ucte" o%er the useful life of the buil"in(.

,) *teppe"&up basis: Euals the fair mar-et %alue of property at the "eath of aperson that becomes the basis of the beneficiary. This means hen someone

"ies an" the beneficiaries recei%e property as part of a beuest the basis in theproperty for tax purposes ill be the current %alue of the property not theori(inal purchase price to the "ece"ent.Example: Harry buys some stoc- in 1/0 for $10000 an" hol"s it until his"eath an" beueaths the stoc- to oe. The current %alue of the stoc- is$'0000. !t the time of Harrys "eath oes steppe" up basis in the stoc- is$'0000.


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Profits ( Losses

97 !mount reali+e" 3ain or 4rofit: The cash recei$ed-ad@usted asisupon sale or disposition of property# otherwise considered what ista2ale as gain or profit.E2a!ple: n our pre$ious e2a!ple) if Aarry has an ad@usted asis ina house for 01&)


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Treat!ent of %ssets+nco!e

>7 6apital asset: %n asset held for use in a usiness for !ore than 1year) depending upon inco!e) the !a2i!u! ta2 is 1.

E2a!ple: Aarry uys so!e euip!ent and holds it for 1 year. Aeacti$ely uses the euip!ent in his usiness. f he sells it after 1

year) it will e considered a capital asset.

C7 4assi%e income: nco!e earned fro! in$est!ents that are held for!ore than 1 year. Ta2ed at a !a2i!u! rate of 1. Does not applyto inco!e earned fro! an asset or acti$ity in which the ta2payer isacti$ely engaged in the usiness.

E2a!ple: Aarry owns so!e stoc" worth 01


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Ta2 Treat!ent

7 4assi%e 5oss: nco!e lost fro! in$est!ents that are held for !ore than 1 year. Foucan offset passi$e inco!e fro! passi$e losses to deter!ine net passi$e inco!e.

E2a!ple: Aarry owns so!e stoc" worth 01


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Ta2 Plan Guestions

17 'oal: Hhat is the ta2 liaility to the indi$idualI Hhat is the ta2 liaility ofco!panyI Must co!pute separately y running the nu!ers to deter!inepro@ected.

&7 @ecti$e: Hhat are all sources of inco!eI Hhat are deductile e2penses

and how will they e deductile) e.g. ordinary or capitali5ed o$er ter!I %ny

carry forward of deductionsI

37 ,esult: %t what rate will the in$estor e ta2edI Marginal 6schedule rate oninco!e7 $s effecti$e rate 6ased upon co!putation of actual ta27.

97 !pact: Aow should contriution of capital e characteri5edI Euity $s. DetHhat is the opti!al return on capital and how should it e characteri5edITa2 interest as ordinary inco!e $s di$idends ta2ed as capital gain.


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Ta2ation ,ules

ndi$idual ta2ation: Ta2ed on inco!e less allowaledeductions# Based upon Marginal rate or for!ula 6Seechart7

Partnership ta2ation: Partners ta2ed on pro rata share ofearnings 6profits7# Partnership does not pay separate ta2#%llocate according to Partnership agree!ent re percentof interest# not what actually distriuted#

*orporation: Ta2ed as entity and then salary anddistriutions ta2ed to indi$idual. Since indi$idual is ashareholder and e!ployee) sa!e pot of !oney is ta2edtwice) although the corporation can ta"e a deduction asa e2pense for the salary.


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or Each of the ollowing:

Hho will li"ely dri$e the ter!s of the dealI

Hho would e !ost interested in longter! goals of the co!panyI

Hhat type of entity should e createdI


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Module 3

Prole!s


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Hhat type of entity should ecreatedI17 Prescription Drug s a !anufacturer of PMS and !enopause-

related treat!ent. The industry is su@ect to hea$y go$ern!entregulation y the D%) including e2tensi$e trial tests) docu!entationand consu!er infor!ation) and strict liaility for negligence inhandling or dispensing the drug. *o!pany has 9 depart!ents anda hea$y in$est!ent in research and de$elop!ent. n$estors include

indi$idual che!ists and scientists who are leading e2perts in thisfield of research) uni$ersity and institutional in$estorsphar!aceutical co!panies.

&7 'roup of lawyers who ha$e a $aried corporate law practice inrelated and co!ple!entary fields. They propose to di$ide profits

and losses in accordance with $aluations assigned to client lists)cash in$est!ents. Their practice reuires that they issue opinionletters on the feasiility of deals. They will ha$e 9 associates on anindependent contract asis ased upon illale hours and an hourlyrate of 0C.


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Hhat type of entity should ecreatedI37 % group of four college roo!!ates decide to de$elop three lots: one

for co!!ercial and two residential !ulti-fa!ily dwellings. nly twoof the four roo!!ates ha$e any e2perience in real estatede$elop!ent) one as a !ar"eting agent and the other wor"ing foran engineering fir!. The other two ha$e e2perience in an"ing) andretail sales and 01


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Hhat allocation of interestI

Hhat is the le$el of ris" for % and B ineach of the following hypotheticals)assu!ing % is contriuting 01


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,is" and nterestI

a7. %LT 1: % is a retired !ilitary who is awidower. Ais contriution is his nest egg.Ae relies on social security and disaility

pay!ents) owns & apart!ent uildings.Ae is >< years of age and in fair health.

% ti


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%ssu!ptions% is contriuting 01


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,is" and nterestI

7 %LT &: % is a real estate attorney) with aprofitale practice fro! which he recei$esa salary of 01&


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%ssu!ptions:% is contriuting 01


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,is" and nterestI

c7 %LT 3: B is a recent college graduate with0>


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%ssu!ptions:% is contriuting 01

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Mod 3 Business Basics