Business Entities

Quick Answer

Business entities differ on two axes: who is liable for debts, and how profits are taxed. General partnerships and sole proprietorships give no liability protection. LLCs, S-corporations, and C-corporations protect all owners. Only C-corporations face double taxation; every other entity here defaults to pass-through taxation, though an LLC can elect S- or C-corp treatment instead.

The exam pairs each entity with its liability and tax profile, then asks which entity fits a scenario. Learn the pattern once and most business-entity questions become a lookup rather than a puzzle.

What Is a General Partnership?

Two or more persons carrying on a business for profit.

All partners have unlimited personal liability for partnership debts.

Income and losses pass through to partners' personal tax returns (no entity-level tax).

The partnership files Form 1065, an informational return; the partnership itself pays no income tax. Each partner receives a Schedule K-1 reporting their share of income, losses, deductions, and credits, which they report on their own Form 1040.

Each general partner typically has equal management authority, unless the partnership agreement states otherwise.

Fiduciary duty exists between general partners (duty of loyalty, duty of care).

The partnership dissolves upon the death or withdrawal of a general partner, unless the agreement provides otherwise.

How Does a Limited Partnership Differ From a General 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 the amount invested, no management authority.

Pass-through taxation; income and losses flow to partners' personal returns.

Liquidation priority: creditors first, then LPs, then the GP last.

General Partner compared with Limited Partner:

Liability: General Partner, Unlimited. Limited Partner, Limited to investment.

Management: General Partner, Full control. Limited Partner, No management role.

Fiduciary duty: General Partner, Yes. Limited Partner, No.

Liquidation priority: General Partner, Last. Limited Partner, Before GP.

Exam Tip: Gotchas

Limited partners are generally passive. Exercising control over the business may create personal-liability exposure, but the consequence depends on the governing partnership statute and the conduct involved.

The general partner always has unlimited personal liability in a limited partnership.

How Does an LLC Combine Partnership and Corporate Benefits?

Hybrid entity combining partnership tax benefits with corporate liability protection.

All members have limited liability, so personal assets are protected from business debts.

Default tax treatment is pass-through under the check-the-box Treasury regulations: a single-member LLC is a disregarded entity by default, taxed as a sole proprietorship when the owner is an individual, or folded into the owner's own return when the owner is another entity; a multi-member LLC defaults to partnership taxation.

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 an operating agreement.

No limit on the number of members; members can be individuals, corporations, other LLCs, or foreign entities.

How Is a C-Corporation Taxed and Managed?

Separate legal entity from its owners (shareholders).

Limited liability for all shareholders.

Subject to double taxation:

1. The 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 the death or transfer of shareholders.

Can issue multiple classes of stock (common and preferred).

Can retain earnings for business use, subject to an accumulated earnings tax if excessive.

How Does an S-Corporation Differ From a C-Corporation?

Special tax election under Subchapter S of the Internal Revenue Code.

Pass-through taxation: income and losses flow to shareholders' personal returns, avoiding double taxation.

Limited liability for all shareholders, same as a C-corp.

Restrictions:

Maximum of 100 shareholders under the Internal Revenue Code, though a family (a common ancestor, their lineal descendants, and spouses) counts as ONE shareholder for this cap, so a family-owned S-corp can have far more than 100 individual owners and still qualify.

Individual shareholders must be U.S. citizens or resident aliens (no nonresident alien shareholders); eligible trusts, estates, and qualifying tax-exempt organizations are separate eligible-holder categories.

Only one class of stock permitted, though differences in voting rights among shares of common stock do not create a second class under the Internal Revenue Code.

Shareholders must be individuals, certain trusts, or estates; corporations and partnerships generally cannot be shareholders, though certain tax-exempt organizations such as qualified retirement plans and charities may hold shares.

Exam Tip: Gotchas

Double taxation = C-corporation only. Every other entity here defaults to pass-through taxation, though an LLC can elect S- or C-corp treatment instead.

100 shareholder limit = S-corporation only. Among the multi-owner entities (partnerships, LLCs, corporations), no other type caps owners. A family counts as one shareholder toward that cap, so family ownership can exceed 100 individuals without breaking the limit.

C-Corp vs. S-Corp comparison:

Taxation: C-Corporation, Double taxation (entity + shareholder). S-Corporation, Pass-through (shareholder only).

Shareholders: C-Corporation, Unlimited, any type. S-Corporation, Max 100 (a family counts as one shareholder); U.S. individuals, certain trusts/estates, and qualifying tax-exempt organizations only (no corporations or partnerships).

Stock classes: C-Corporation, Multiple classes allowed. S-Corporation, One class only (voting-rights differences within common stock do not create a second class).

Nonresident alien owners: C-Corporation, Permitted. S-Corporation, Not permitted.

Tax losses: C-Corporation, Trapped at corporate level. S-Corporation, Flow through to shareholders.

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.

What Should You Check on Exam Day?

Match liability first, then taxation. General partnerships and sole proprietorships: no protection. LLC, S-corp, C-corp: protection for all owners.

Only a C-corporation double-taxes. Every other entity here defaults to pass-through taxation, though an LLC can elect S- or C-corp treatment instead.

LLC and S-corp are the entities that give both liability protection and pass-through taxation together.

S-corp restrictions travel as a set: 100 shareholders (a family counts as one shareholder), U.S. individuals/eligible trusts/estates/qualifying tax-exempt organizations only, one stock class (voting-rights differences do not create a second class), no corporate or partnership shareholders.