What are the six requirements that must be met to be considered an S Corporation?

Assignment Content
Chapter 19: Corporations – Assignment

The most common forms of business organization are the sole proprietorship, the partnership, and the corporation (with the limited liability company quickly becoming popular). In this chapter, we will review the basic features of corporations.

Corporations (read pp 535 – 537; pp 551 – 553)
Question 1
2 Points
A corporation is a creature of statute. Generally, corporations exist only under Blank 1 law, which can differ from state to state. The Blank 2 (MBCA), first published in 1946 and revised every few years, is a codification of corporation law. Most state statutes are versions of a recent major revision of the MBCA.
Blank 1
Blank 2
Question 2
3 Points
One of the key advantages of the corporate form of business is:

Question 3
3 Points
A corporation is a legal entity, separate from the natural persons that own it. Thus, a corporation is recognized as a “_____________________”. Explain what rights and constitutional guaranteed we have as an individual, thus also apply to a corporation:

In Citizens United v. FEC (2010) the U.S. Supreme Court held that corporations hold a 1St Amendment right of political speech, and thus could use corporate funding to broadcast “electioneering communications,” meaning they could spend corporate monies to make broadcasts expressly advocating a political candidate or political position. Although federal law still prohibits corporations and unions from giving funds directly to political campaigns, a corporation can fund advertising and other actions to persuade the voting public.

Corporate Personnel
Question 4
2 Points
The responsibility for the overall management of the corporation belongs to Blank 1, whose members are elected by the shareholders. This management group then hires Blank 2 and other employees who run the corporation’s daily business operations.
Blank 1
Blank 2
One of the most valued advantages of incorporation is that it limits the personal liability of its shareholders. Shareholders are typically not personally liable for the obligations of the corporation beyond the extent of their investments. In some rare situations a court may “pierce the corporate veil” and impose liability on the individual corporate owners – we will look at that later in this chapter.
Corporate Earnings and Taxation
Question 5
2 Points
When a corporation earns profits, they can either pass them on to the shareholders in the form of Blank 1, or retain the profits as Blank 2 which will be reinvested in the corporation to hopefully yield higher company profits, resulting in the value of the corporation stock to rise. Shareholders can then reap the benefits of these long term profits, called Blank 3, when they sell their stock.
Blank 1
Blank 2
Blank 3
One of the major disadvantages of a corporation is that it is double taxed on its profits. The corporation must may taxes on its profits, and then when it passes these profits to the shareholder through dividends, the shareholders must now also pay taxes on them
Corporation’s Liability for Torts and Crimes
Question 6
2 Points
When can a corporation can be held liable for the torts committed by its agents or employees? What is the name of the doctrine?

Additionally, today a corporation can be held criminally liable for the acts of its agents and employees. We cannot imprison a corporation, but we can criminally fine them.
Classification of Corporations (read pp 538 – 541; pp 553- 557)
Question 7
3 Points
Explain the following:
a) Domestic Corporation
b) Foreign Corporation
c) Alien Corporation

Question 8
2 Points
Typically, a corporation does not have a right to do business in a state other than the one in which it is incorporated. Thus, to do business in other states, it must first obtain a Blank 1 in any other state it wants to do business. However, this is not required if the corporation is only selling goods or services via the internet or by mail.
Blank 1
Question 9
3 Points
Explain the following:
a) Public Corporation
b) Publicly Held Corporation
c) Private Corporation.
d) Nonprofit Corporations

Question 10
2 Points
Close Corporations

Most corporations in the U.S are Close Corporations. These are corporations whose shares are held by member of a family or by just a few persons. These are also referred to as _________, _____________, or ________________ corporations. In these there is no public trading of the shares.

Question 11
3 Points
However, control of who owns the shares in a close corporation is critical to the management of the corporation. Thus, it is typical for a close corporation to control the transfer of its shares through a shareholder agreement. Explain how the corporation can restrict the transferability of shares to outside persons:

Question 12
3 Points
S Corporations

A Close Corporation may meet the qualifying requirements in Subchapter S of the Internal Revenue Code and can operate as an S corporation. What is the advantage of being an S Corporation (read the entire section before attempting to answer this question)?

Question 13
3 Points
What are the six requirements that must be met to be considered an S Corporation?

S Corporations have lost much of their significance recently, in light of the creation of the limited liability company and limited liability partnerships, which now offer similar tax advantages as the S Corporations, while providing even more business flexibility than corporate existence.
Formation and Powers (read pp 542 – 544; 557 – 559)
The formation of a corporation can be divided into two steps: (1) organizational and promotional efforts, and (2) the legal process of incorporation.
In the past, creating a corporation was very time consuming and complicated. Things have changes, and today many businesses incorporate via the internet. The actual process to incorporate will differ from state to state, but there are a few basic steps that must be followed. Let’s look at four of these steps.
Selecting the State of Incorporation. You would think a business would simply incorporate in the state in which it intends to have its primary business offices. Close hold corporations will generally incorporate in the state where its principle shareholders live and work, but sometimes larger businesses will look at the states to decide where to incorporate.
Question 14
2 Points
Name some of the factors a business will look at in choosing which state in which to incorporate:

Secure the Corporate Name: The Corporation’s name is subject to state approval. The state will typically run a check to make sure the name the new business has chosen is not being used and not close enough to another corporate name that could result in confusion or deception.
Question 15
2 Points
All state corporate statutes requires the corporate name to include the word(s) _______________________________,or abbreviations of these terms.
Additionally, when selecting a corporation name, the business is going to need an online presence, thus it is important to check what domain names are available before securing a corporate name.

Prepare the Articles of Incorporation. The Articles of Incorporation is a document that is the primary document needed to incorporate. It provides the basic information about the corporation and serves as the primary source of authority for its future business functions.
Question 16
3 Points
The persons who execute the articles are called incorporators. Generally, the articles of incorporation must include the following information:
1.
2.
3.
4.

File the Articles with the State: Once the Articles are prepared, signed and authenticated by the incorporators, they are sent to the appropriate state official, typically the secretary of state, along with the filing fee.
Question 17
2 Points
Which state is the most popular when it comes to incorporation?

Question 18
2 Points
Although the Articles of Incorporation cover much about the business, the Blank 1 normally describe the internal structure and rules of management for the new corporation, which are adopted by the corporation at its first organizational meeting.
Blank 1
Improper Corporation
If the procedures for incorporation are not followed precisely, others may be able to challenge the existence of the corporation. On the basis of improper incorporation, a plaintiff might successfully hold the would-be shareholders personally liable.
Question 19
2 Points
If there is substantial compliance with all conditions precedent to incorporation, the corporation is said to have _______________________ (rightful and lawful) existence. In most states, the certificate of incorporation is issued even if there are minor errors in an incorporation, and thus, it constitutes evidence that all conditions have been met.

However, if a defect in formation is substantial, such as its failure to hold an organizational meeting to adopt bylaws, the corporation may not legally exist and now the incorporators can be held personally liable.

Corporate Financing: (read pp 544 – 546; pp 559 – 561)
An important process of corporate formation involves corporate financing. So how, exactly, does a corporation obtain its money to now do business? Typically this is accomplished by the issuance and sale of corporate securities – stocks and bonds.

By purchasing interests through stocks and bonds, the owners gain the right to now participate in the earnings and the distribution of corporate property. Let’s take a closer look at each of these.

Bonds: A bond is a security that evidences a corporate debt. In this debt financing, a person purchases a bond from the corporation, through what is called a bond indenture or agreement between the corporate issuer and the bondholder, setting out the terms of the bond. Normally there will be a designated maturity date when the principal, or fame amount of the bond, will be returned to the investor. These are sometimes called fixed-income securities, because the owners (the creditors) receive fixed-dollar interest payments during the time before maturity.
Stocks: Unlike a bond, stocks are an equity interest and represent ownership in the corporation. There are two types of stock: Common Stock and Preferred Stock.
Question 20
3 Points
Common Stock: Common Stock provides a _____________________________________.

A shareholder’s interest is generally proportionate to the number of shares he owns out of the total number of shares issued by the corporation.

What do we mean by “control” of the corporation? Understand that shareholders are virtually never involved in the day-to-day operations of a corporation. However, common stock owners have “control” of the corporation because they have Voting Rights. They elect the board of directors. Additionally, a merger or sale of substantially all of the corporation’s assets, must be voted upon by the shareholders.

As to “earnings,” holders of common stock are in a residual position in the overall financial structure – that means they get a share of the profits LAST, behind preferred shareholders, bondholders, employees, creditors, etc. Once those groups have been paid, the common stock owners are entitled to all remaining earnings as dividends.
Question 21
3 Points
Preferred Stock. This is stock with preferences, meaning:

However, even though preferred shareholders have a stronger position than common shareholder with respect to dividends, they only receive fixed percentage of the face value of the stock, and thus may not share in the full prosperity of the corporations as the common shareholders could over time. Additionally, because of their rather cautious position in their relationship with the corporation, the preferred shareholders normally do not have voting rights in the corporation.
Be sure you know the differences between common stock and preferred stock. You will be responsible for this information on the next exam.
Corporate Powers: (read pp 546 – 549; 561 – 563)

When a corporation is created express and implied powers necessary to achieve its purpose also come into existence. Corporations cannot engage in acts that are beyond their powers, nor can a corporation’s owners (the shareholders) avoid personal liability if they misuse the corporate entity for their own personal benefits.
Question 22
3 Points
What are the express powers of a corporation?

Question 23
3 Points
What are the implied powers of a corporation?

Piercing the Corporate Veil

As we have learned, the advantage of incorporation is that the owners (shareholders) are now personally protected from being held personally liable for the debts of the corporation, at least beyond the value of the shareholder’s investment in the corporation. However, in some situations, the courts might ignore the corporate structure and expose the shareholders to personal liability for the debts of the corporation. This is referred to as piercing the corporate veil.

The most common situations in which this might occur are

1) if the corporation is set up never to make a profits or always to be insolvent, or it was too “thinly” capitalized- meaning it had insufficient capital at the time of formation to meet its prospective debts or foreseeable liabilities.

For example, assume a new corporation is formed to build airplanes, an activity that requires large expenditures and entails substantial risks of liability for third-party injury. The corporation only raised $5000 in capital. It is obvious that the corporation will run out of money quickly and be unable to pay its bills. It will not have money to buy adequate product liability insurance or protect itself from defective airplanes. Because of this undercapitalization, a court may ignore the corporate form and hold the owners of the corporation personally liable for its debts and liabilities.

2) If the shareholders commingle the corporate monies and interests with their personal monies and interest, so that the corporation has no real separate identity from the owners. This is referred to as the alter ego theory- as instead of the corporation being a separate entity, it is really only the alter ego of the owners. Thus the courts might look past the corporate entity and hold the owners personally liable for the debts and liabilities of the business.
Directors and Officers (read pp 549 – 554; 563 – 568)

Directors: The board of directors is the ultimate authority in a corporation.
Question 24
3 Points
What responsibilities do the directors have?

Question 25
2 Points
Who appoints the first board of directors?

Question 26
2 Points
For how long must a director serve?

Compensation of Directors

There is no inherent right to compensation, but many states permit the articles or bylaws to authorize it, and in some cases the board can set its own. Directors may set their own compensation.
Question 27
3 Points
What is an outside director?

Question 28
3 Points
What is an inside director?

Board of Directors’ Meetings

The board of directors conducts business by holding formal meetings. A majority of the board normally constitutes a quorum – the minimum number of members that must be present before business can be transacted.
A corporate director must have certain rights to function properly and make informed policy decision for the company. One such right is the right to inspect all the corporation’s books and records, facilities and premises. This is an absolute right and cannot be restricted by the articles or bylaws.

The Role of Corporate Officers and Executives:
Question 29
3 Points
How are corporate officers and other executives hired?

The officers and other high-level managers are employees of the company so their rights are defined by their employment contract

Duties and Liabilities of Directors and Officers:
The duties are the same for both directors and officers. All are considered fiduciaries of the corporation and thus owe ethical and legal duties to the corporation and to the shareholders as a whole.
Question 30
3 Points
Duty of Care. Briefly explain a director’s and executive officer’s duty of care:

Question 31
3 Points
What is the Business Judgment Rule? Be sure to explain the three things that must apply in order for the courts to apply this rule to the decisions of the directors and executive officers.

Question 32
3 Points
Duty of Loyalty. Briefly explain the duty of loyalty.

This duty of loyalty includes the duty to disclose any possible conflicts of interest the director or officer may have. For example, if the corporation enters into a contract to engage with a business in which the director has a personal interest, he or she must fully disclose this and abstain from voting on that proposed transaction.
Question 33
2 Points
The Directors and Officers may be held liable for torts or crimes committed by them or by the employees under their supervision. Additionally, if the shareholders believe directors are not acting in the best interest of the corporation, they can sue them in what is called a ______________________________.

Shareholders (read pp 555 – 560; 568 – 574)

Shareholders own the company by their acquisition of shares of stock. However, as a general rule, they have no responsibility for the daily management of the corporation. They only elect the directors who do have such control and responsibility.
Question 34
3 Points
Shareholders do hold important powers. Beyond electing the directors, what powers do the shareholders have?

Question 35
3 Points
Shareholders exercise these powers through their power to vote. This occurs at a shareholders’ meeting. Shareholders must have at least one meeting per year. All shareholders must be notified prior to the meeting, at least [A] , but not more than [B] before the meeting date. If a shareholder cannot attend, he can sign a [C] , in which he authorizes another person as his agent to vote at the shareholders’ meeting.
Prompts
Submitted Answers
Question 56
A
Choose a match
Question 56
B
Choose a match
Question 56
C
Choose a match
Other Rights of Shareholders:
Question 36
3 Points
Stock Certificates: In the past, corporations issued stock certificates that evidence ownership of a specified number of shares in the corporation. Today, the board of directors can choose that share of stock will be uncertificated, which means:

Dividends: As we have learned, the board of directors votes to distribute some of the corporate profits or income to be paid to the shareholders. However, sometimes the board decides not to pay out the profits but rather hold the profits to expand the corporation.
Question 37
3 Points
If the directors fail to declare a dividend, what can the shareholders do? To be successful, what must they prove?

Question 38
3 Points
Explain what a shareholders derivative suit is and how shareholders can bring such a suit.

This completes our study of Corporations. I know it was long, but hopefully you found is pretty straight forward and interesting. We will look at other issues involved in corporations in our next chapter.

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