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Pitt ECON 0110 - Three legal forms of business enterprise and the stock market

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ECON 0110 1st Edition Lecture 10THREE LEGAL FORMS OF BUSINESS ENTERPRISETHE THREE MOST IMPORTANT LEGAL FORMS OF BUSINESS ENTERPRISE1. SOLE PROPRIETOR2. PARTNERSHIP3. CORPORATIONDIFFERENT TREATMENT WITH RESPECT TO1. LIABILITYWho is liable (or responsible) for paying outstanding debts?2. TAXATIONHow are the profits taxed by the government?UNLIMITED LIABILITYSole proprietors and partnersThe business owners are personally liable for all business debtsEach partner is liable for all debtsBIG DISADVANTAGEExample: If your business borrowed, say, $1 million from a lender and your businesscould not repay the debt, the lender could sue you and take ownership of everythingyou own (checking accounts, savings, stock ownership, certificates of deposit, house, car,etc.)LIMITED LIABILITYApplies to corporate stockholdersYou sue a corporation as a separate legal entity.Personal assets of stockholders are safe.These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.Limits riskExample: Suppose you own stock in United Airlines. Suppose United Airlines borrowed $1billion to buy some new planes. Suppose United Airlines was unable to repay the lenders. Thelenders would sue United Airlines as a separate legal entity. The lenders could take possessionof all the assets owned by United Airlines, but the lenders could NOT sue you individually as apart owner and the lenders could NOT take possession of any of your individual assets.BIG ADVANTAGE FOR CORPORATIONSTAXATION OF PROFITSSOLE PROPRIETOR AND PARTNERSHIPSales revenue – business expenses = Business profitsBusiness profits are taxed as wage income on your individual income tax return2011: Top marginal tax rate = 35%CORPORATIONOWNERSHIP IS INDICATED BY SHARES OF STOCKRepresents partial ownership of a corporationOwnership of X% of the stock= Ownership of X% of the corporationSales revenue – business expenses = before tax profitsCorporations pay corporate taxes on its profitsMaximum corporate marginal tax rate is 35%Before tax profits – corporate taxes = after tax profitsAfter tax profits = Retained earnings + dividendsDIVIDENDS = Portion of after-tax profits that are distributed to stockholdersRETAINED EARNINGS = Portion of after-tax profits that are retained by thecorporation for later useOwnership of X% of the stock gives you X% of the corporation’s dividendsDividends are reported on the individual tax return of the stockholderCurrently dividends are taxed at a lower marginal rate than wage incomeDouble taxation of corporate profitsCorporations pay up to 35% of corporate profits as corporate income taxesThen, dividends are taxed on the stockholder’s tax return: (could be 35%)EXAMPLE:Assume total revenue = $10 millionAssume expenses = $9 millionThen before tax profits = $1 MILLIONAssume the corporate tax rate = 35%Then, CORPORATE INCOME TAXES = $350,000Thus, AFTER TAX PROFITS = $650,000ASSUME RETAINED EARNINGS = $100,000Then, DIVIDENDS = $550,000At 15%, stockholders’ tax on dividends = $550,000 x .15 = $82,500After tax income for stockholders = $550,000 - $82,500 = $467,500DOUBLE TAXATION OF CORPORATE PROFITS IS A BIG DISADVANTAGE FOR


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