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 is automatically double-taxed; every other entity here is pass-through by default (though an LLC may elect C-corporation taxation).
• A limited partner who participates in management may 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 generally leave the estate, may gain 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 generally pass through probate at death unless a TOD/POD beneficiary designation is on file (a reason clients prefer trusts or TOD/POD registration).
• 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 generally bind the business for ordinary transactions, 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 shareholders, generally individuals who are U.S. citizens or resident aliens (certain trusts and estates may also qualify; 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 generally cannot unilaterally modify (any change depends on trust terms and state law), assets generally leave the taxable estate, files its own Form 1041 under its own Employer Identification Number (EIN), may gain 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. Must file Form 1041 if it has $600 or more of gross income during administration, and Form 706 if the gross estate plus adjusted taxable gifts exceeds the exemption (or to elect portability even if not otherwise required). Strategy favors capital preservation and liquidity, not growth.

Foundations and Charities

• A private foundation typically has a single major funding source, must distribute at least 5% of non-charitable-use 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) generally governs charitable institutions holding endowments, including private foundations: it requires prudent management and allows a total-return spending approach when prudent.
• Private foundations carry additional federal rules charities don't (the 5% distribution requirement, excise taxes, the jeopardizing investment rule); the exam tests which rules are additional, not which entity UPMIFA applies to.

Top Gotchas

• A sole proprietorship and a general partnership both carry unlimited liability, but a general partner is also liable for the other partners' actions taken in the ordinary course of business.
• 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 benefits and may provide creditor protection, 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 generally governs charitable institutions' endowments, including private foundations; private foundations layer ADDITIONAL federal IRC rules (5% distribution, excise taxes, jeopardizing investment) on top, they don't swap out UPMIFA.

One-Breath Recap

Start with the two great dividers: liability (limited vs. unlimited) and taxation (pass-through vs. double). Sole proprietorships carry unlimited liability with pass-through Schedule C taxation, general and limited partnerships and S-corporations stay pass-through, and only the C-corporation is automatically double-taxed.

The limited partner risks losing liability protection if they manage while an LLC member never does, and an LLC may itself elect C-corporation taxation.

Trusts hinge on revocable (grantor keeps control, assets stay in the estate, no creditor shield) versus irrevocable (control surrendered, assets generally leave the estate, may gain creditor protection, files its own Form 1041), while estates are temporary preservation-and-liquidity accounts.

Finally, private foundations must additionally distribute at least 5% of non-charitable-use assets annually under Internal Revenue Code rules, while both foundations and charities generally follow the Uniform Prudent Management of Institutional Funds Act, and knowing which rules are additional for foundations 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.