Business Entities

Business entities come in several forms, each with different liability, taxation, and management structures. The exam heavily tests the distinctions between these entity types.

General Partnership

• Two or more persons carrying on a business for profit
• All partners have unlimited personal liability for partnership debts
• Income/losses pass through to partners' personal tax returns (no entity-level tax)
• Each general partner typically has equal management authority (unless partnership agreement states otherwise)
• Fiduciary duty exists between general partners (duty of loyalty, duty of care)
• Partnership dissolves upon the death or withdrawal of a general partner (unless the agreement provides otherwise)

Limited Partnership

• Requires at least one general partner (GP) and one limited partner (LP)
• GP: unlimited liability, manages the business, owes fiduciary duties
• LP: liability limited to amount invested, no management authority
• If an LP participates in management, they risk losing limited liability protection
• Pass-through taxation; income/losses flow to partners' personal returns
• Liquidation priority: creditors first, then LPs, then GP last

Exam Tip: Gotchas

• Limited partners who participate in day-to-day management may lose their limited liability protection and be treated as general partners.
• The general partner always has unlimited personal liability in a limited partnership.

Limited Liability Company (LLC)

• Hybrid entity combining partnership tax benefits with corporate liability protection
• All members have limited liability (personal assets protected from business debts)
• Default tax treatment: pass-through (single-member LLC taxed as sole proprietorship; multi-member as partnership)
• Can elect to be taxed as an S-corp or C-corp
• Members can participate in management without losing liability protection (unlike LPs)
• More flexible management structure than corporations (governed by operating agreement)
• No limit on number of members; members can be individuals, corporations, other LLCs, or foreign entities

C-Corporation

• Separate legal entity from its owners (shareholders)
• Limited liability for all shareholders
• Subject to double taxation:
  1. Corporation pays corporate income tax on profits
  2. Shareholders pay personal income tax on dividends received
• Can have unlimited shareholders of any type
• Managed by a board of directors elected by shareholders
• Perpetual existence - not affected by death or transfer of shareholders
• Can issue multiple classes of stock (common and preferred)
• Can retain earnings for business use (subject to accumulated earnings tax if excessive)

S-Corporation

• Special tax election under Subchapter S of the Internal Revenue Code
• Pass-through taxation - income/losses flow to shareholders' personal returns (avoids double taxation)
• Limited liability for all shareholders (same as C-corp)
• Restrictions:
  • Maximum 100 shareholders
  • Shareholders must be U.S. citizens or resident aliens (no foreign shareholders)
  • Only one class of stock permitted
  • Shareholders must be individuals, certain trusts, or estates (no corporations or partnerships as shareholders)

Exam Tip: Gotchas

• Double taxation = C-corporation only. All other entities in this unit use pass-through taxation.
• 100 shareholder limit = S-corporation only. No other entity type has a cap on owners.

C-Corp vs. S-Corp comparison:

Exam Tip: Gotchas

• When a question asks which entity provides BOTH liability protection AND pass-through taxation, the answers are LLC and S-corporation. General partnerships have pass-through taxation but no liability protection. C-corporations have liability protection but double taxation.