Client Types

The whole unit on one sheet: individuals, business entities, trusts and estates, and foundations and charities, with the liability and tax distinctions the exam loves.

The One-Liners That Win Points

• A sole proprietorship is not a separate legal entity: the owner is the business, with unlimited personal liability and Schedule C pass-through taxation.
• Only the C-corporation has double taxation; every other entity here is pass-through.
• A limited partner who participates in management can lose limited liability and be treated as a general partner.
• An LLC (Limited Liability Company) member can actively manage without losing liability protection (the key contrast with a limited partnership).
• Revocable trust: grantor keeps control, assets stay in the taxable estate, no creditor protection, avoids probate.
• Irrevocable trust: grantor gives up control, assets leave the estate, gains creditor protection, files its own return.
• Executor manages the estate if named in a will; a court-appointed manager is a personal representative.
• The 5% minimum distribution rule applies only to private foundations, not public charities.

Numbers to Lock In

Individuals and Sole Proprietorships

• A natural person is a human being, as opposed to an artificial legal entity like a corporation or trust.
• Individual account assets pass through probate at death (a reason clients prefer trusts).
• A sole proprietorship has no legal separation, unlimited personal liability, and reports income on Schedule C of the personal return (Form 1040).
• Pass-through taxation avoids double taxation; the owner also pays self-employment tax on net business income.

Business Entities

• General partnership: all partners have unlimited liability, any partner can bind the business, pass-through on Form K-1, no formal filing required.
• Limited partnership (LP): general partner has unlimited liability, limited partner is capped at the investment amount, pass-through on Form K-1, state filing required.
• LLC (Limited Liability Company): limited liability for members, flexible management, and flexible taxation (may elect partnership, S-corporation, or C-corporation treatment).
• C-corporation: limited liability, double taxation, multiple stock classes, unlimited life, freely transferable ownership.
• S-corporation: limited liability with pass-through taxation; capped at 100 U.S. citizen or resident-alien shareholders (no partnerships or corporations), one class of stock, though voting vs. nonvoting shares are permitted.

Trusts and Estates

• Three parties: the grantor (also settlor or trustor) creates and funds it, the trustee manages it under a fiduciary duty, and the beneficiary receives the benefits.
• Revocable (living) trust: grantor can modify or dissolve, assets stay in the taxable estate, income reported on the grantor's Form 1040, avoids probate, no creditor protection.
• Irrevocable trust: grantor cannot modify (changes need beneficiary consent), assets leave the taxable estate, files its own Form 1041 under its own Employer Identification Number (EIN), gains creditor protection; funding it is a completed gift and may trigger gift tax.
• Trust tax brackets are compressed, hitting the top rate at low income, so distributing income to lower-bracket beneficiaries is a planning strategy.
• A testamentary trust is created by a will and takes effect after death (goes through probate); an inter vivos trust is created during life and can be revocable or irrevocable.
• An estate is temporary: it holds assets only until debts, taxes, and distributions are complete. Files Form 1041 for income during administration and Form 706 if the gross estate exceeds the exemption. Strategy favors capital preservation and liquidity, not growth.

Foundations and Charities

• A private foundation is funded by a single source, must distribute at least 5% of net investment assets annually, and cannot make investments that jeopardize its charitable purpose.
• Missing the 5% minimum triggers a 30% excise tax on the undistributed amount; net investment income carries a 1.39% excise tax.
• Charitable organizations aim to preserve purchasing power against inflation, generate income, and meet spending needs while maintaining the endowment.
• The Uniform Prudent Management of Institutional Funds Act (UPMIFA) governs charitable institutions holding endowments: it requires written investment policies and allows a total-return spending approach when prudent.
• Foundations follow Internal Revenue Code (IRC) rules (including the jeopardizing investment rule); charities follow UPMIFA. Match the framework to the entity.

Top Gotchas

• A sole proprietorship and a general partnership both carry unlimited liability, but a general partner is also liable for the actions of the other partners.
• The S-corporation one class of stock rule bars economic differences, not voting differences: voting vs. nonvoting shares are fine because they share identical distribution and liquidation rights.
• Revocable trusts give flexibility but no estate-tax or creditor benefit; irrevocable trusts give tax and creditor benefits but the grantor gives up control permanently.
• Estate accounts are temporary, not long-term. If a scenario describes an estate, the answer favors capital preservation and liquidity over growth.
• The 5% distribution rule belongs to private foundations only; watch for it being wrongly applied to a public charity.
• UPMIFA governs charitable institutions, while private foundations are governed by IRC rules; do not swap the two frameworks.

One-Breath Recap

Start with the two great dividers: liability (limited vs. unlimited) and taxation (pass-through vs. double). Individuals and sole proprietorships carry unlimited liability with pass-through Schedule C taxation, general and limited partnerships and LLCs and S-corporations stay pass-through, and only the C-corporation is double-taxed, with the limited partner losing protection if they manage while an LLC member never does. Trusts hinge on revocable (grantor keeps control, assets stay in the estate, no creditor shield) versus irrevocable (control surrendered, assets leave the estate, creditor protection, files its own Form 1041), while estates are temporary preservation-and-liquidity accounts. Finally, private foundations must distribute at least 5% of net investment assets annually under Internal Revenue Code rules, while charities follow the Uniform Prudent Management of Institutional Funds Act, and matching each framework to the right entity closes out the unit.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Client Types unit for the complete lesson.