Study guide
2.1 Business Structures & Liability: Sole Proprietorship, Partnership, LLC, and Corporation
EA Part 2 — Businesses: Free Study Guide 2026 Exam
Track your progress as you read
Finished sections get a check mark.
1 Chapter 1: Exam Cycle & Preparation
1.1 Current Exam Cycle, Blueprint & Study Decisions
2 Chapter 2: Business Entity Choices & Classification
2.1 Business Structures & Liability: Sole Proprietorship, Partnership, LLC, and Corporation 2.2 Entity Classification & Check-the-Box Rules (Form 8832) 2.3 Classification Elections, Default Rules & the 60-Month Limitation 2.4 EINs, Entity Changes & Closing a Business
3 Chapter 3: Sole Proprietorships
3.1 Schedule C Gross Income & Allowable Business Expenses 3.2 Self-Employment Tax (Schedule SE) & Statutory Employees 3.3 Business Use of Home (Simplified vs. Actual Method)
4 Chapter 4: Partnership Formation & Basis
4.1 Formation & Property Contributions under Section 721 4.2 Partner Liabilities under Section 752 (Recourse vs. Nonrecourse) 4.3 Partnership Tax Year, Accounting Periods & Form 1065 Filing 4.4 Family Partnerships, Gifted Interests & Income Allocations
5 Chapter 5: Partnership Basis & Loss Limitations
5.1 Outside Basis Calculations & Ordering Rules 5.2 Basis, At-Risk (§465) & Passive Loss (§469) Limitations 5.3 Excess Business Losses (§461(l)) & Related-Party Transactions (§707) 5.4 Debt Discharge: Partnership vs. S Corporation
6 Chapter 6: Partnership Operations & Distributions
6.1 Form 1065, Schedule K & Schedule K-1 Separately Stated Items 6.2 Guaranteed Payments vs. Distributive Shares 6.3 Nonliquidating & Liquidating Distributions & Section 751 Hot Assets 6.4 Centralized Partnership Audits, Notices & Opting Out
7 Chapter 7: Partnership Dispositions & Basis Adjustments
7.1 Sale or Exchange of a Partnership Interest 7.2 Optional Basis Adjustments (Section 754, 743(b) & 734(b)) 7.3 Partnership Terminations, Mergers & Divisions
8 Chapter 8: C Corporation Formation & Structure
8.1 Corporate Formation & Section 351 Transfer Requirements 8.2 Boot, Section 357 Liabilities in Excess of Basis & Section 1244 Stock 8.3 Capital Structure: Debt vs. Equity & Section 385 Principles 8.4 Controlled Groups & Closely Held Corporations
9 Chapter 9: C Corporation Operations & E&P
9.1 Form 1120 Gross Income, Corporate Deductions & 21% Flat Tax Rate 9.2 Book-Tax Differences (Schedule M-1 vs. Schedule M-3) 9.3 Current vs. Accumulated Earnings & Profits (E&P) 9.4 Accumulated Earnings & Personal Holding Company Taxes 9.5 Corporate Minimum Tax & Foreign Tax Credits
10 Chapter 10: C Corporation Distributions & Liquidations
10.1 Property Distributions, Dividends & Constructive Distributions 10.2 Stock Redemptions (§302) & Corporate Liquidations (§331/§336)
11 Chapter 11: S Corporation Eligibility & Operations
11.1 S Corporation Requirements & Form 2553 Election Rules 11.2 Election Deadlines, Late Election Relief (Rev. Proc. 2013-30) 11.3 Form 1120-S Operations, Reasonable Compensation & 2% Shareholder Fringes
12 Chapter 12: S Corporation Basis, Distributions & Taxes
12.1 Stock & Debt Basis Calculations, Ordering Rules & Form 7203 12.2 S Corp Distributions, Accumulated Adjustments Account (AAA) & E&P Tiers 12.3 Entity-Level Taxes (BIG §1374 & Passive Income §1375) & Termination
13 Chapter 13: Accounting Periods & Methods
13.1 Tax Years: Calendar, Fiscal, and 52-53 Week Years 13.2 Cash vs. Accrual Method & Section 448 Gross Receipts Test 13.3 Changes in Accounting Method (Form 3115) & Section 481(a) Adjustments 13.4 2025 Domestic Research Expensing & Foreign Research
14 Chapter 14: Business Gross Income & Inventory
14.1 Gross Receipts & Inclusions in Business Gross Income 14.2 Cost of Goods Sold (COGS) & Inventory Valuation (Cost, LCM, FIFO, LIFO) 14.3 Section 263A Uniform Capitalization (UNICAP) & Small Business Exemption
15 Chapter 15: General Business Deductions & Limits
15.1 Ordinary & Necessary Business Expenses (§162) & Disallowances 15.2 Business Meals, Gifts & Travel 15.3 Vehicle Expenses, Mileage & Substantiation 15.4 Business Interest Expense Limitation (§163(j)) & Business Taxes
16 Chapter 16: Business Losses & Net Operating Losses
16.1 Net Operating Losses (NOLs) 80% Taxable Income Cap & Carryforward Rules 16.2 Business Casualty, Theft & Disaster Losses 16.3 Business vs. Nonbusiness Bad Debts (Direct Write-Off Method §166)
17 Chapter 17: Section 199A Qualified Business Income Deduction
17.1 Section 199A Overview: 20% Deduction & Qualified Trades or Businesses 17.2 Specified Service Trades or Businesses (SSTBs) & Threshold Phase-Outs 17.3 W-2 Wage & UBIA Limitations Calculation & Aggregation Rules
18 Chapter 18: Depreciation Principles & MACRS
18.1 Depreciable Property, Cost Basis & Capitalization vs. Repair Regulations 18.2 MACRS Property Classes (3, 5, 7, 15, 27.5, 39-Year) & Depreciation Methods 18.3 Depreciation Conventions: Half-Year, Mid-Quarter (40% Rule) & Mid-Month
19 Chapter 19: Section 179 Expensing & Bonus Depreciation
19.1 Section 179 Expensing: $2.5M Limit, $4M Phase-Out & Taxable Income Limitation 19.2 2025 Bifurcated Bonus Depreciation: Pre-Jan 20 (40%) vs. Post-Jan 19 (100% OBBBA) 19.3 Listed Property Rules, >50% Business Use & Section 280F Luxury Auto Limits
20 Chapter 20: Amortization & Intangible Assets
20.1 Section 197 Intangibles & 15-Year Straight-Line Amortization 20.2 Start-Up (§195) & Organizational (§248/§709) Expenditures: $5,000 Rule & 180-Month Amortization 20.3 Depletion: Cost Depletion vs. Percentage Depletion for Natural Resources
21 Chapter 21: Business Property Dispositions & Recapture
21.1 Sale of Business Property & Reporting on Form 4797 21.2 Section 1231 Netting Process & 5-Year Lookback Recapture Rule 21.3 Section 1245 (Full Personal Property Recapture) & Section 1250 / Unrecaptured §1250 Gain
22 Chapter 22: Like-Kind Exchanges & Involuntary Conversions
22.1 Section 1031 Like-Kind Exchanges (Real Property Only, 45-Day/180-Day Deadlines) 22.2 Boot Recognition & Basis Calculation for Replacement Property 22.3 Section 1033 Involuntary Conversions & Replacement Periods
23 Chapter 23: Business Tax Credits
23.1 General Business Credit (Form 3800), Net Income Tax Limit & Carryback/Carryforward 23.2 Key Business Tax Credits: Research Credit (§41), WOTC (§51), Small Employer Health (§45R)
24 Chapter 24: Worker Classification & Information Reporting
24.1 Employee vs. Independent Contractor: Common Law Control & Form SS-8 24.2 Section 530 Relief Requirements & Consequences of Misclassification 24.3 Information Returns: Form 1099-NEC vs. 1099-MISC, Form W-2/W-3 & Backup Withholding
25 Chapter 25: Employment Taxes & Compliance
25.1 Form 941 (Quarterly Payroll Tax Return) & Federal Income Tax / FICA Withholding 25.2 Federal Unemployment Tax (Form 940) & State Unemployment Credit 25.3 Payroll Tax Deposit Schedules (Monthly vs. Semi-Weekly, $100K Rule) & Trust Fund Penalty (§6672)
26 Chapter 26: Fiduciary Income Taxation (Trusts & Estates)
26.1 Principles of Fiduciary Income Taxation & Form 1041 Filing Requirements 26.2 Fiduciary Tax Years, Exemptions & Estimated Payments 26.3 Simple and Complex Trusts, Tiers & Distribution Timing 26.4 DNI Computation & Fiduciary Expense Allocation 26.5 Income Distribution Deduction & Schedule K-1 (Form 1041) Flow-Through 26.6 Foreign Trusts, Grantor Control & Abusive Schemes
27 Chapter 27: Tax-Exempt Organizations & Farm Taxation
27.1 Recognition of Tax Exemption (Form 1023/1024) & §501(c)(3) Standards 27.2 Maintaining Exemption, Political Activity & Excess Benefits 27.3 Form 990 Series Annual Returns & Unrelated Business Taxable Income (UBTI / Form 990-T) 27.4 Unrelated Business Income & Debt-Financed Property 27.5 Farm Income, Schedule F & Conservation Costs 27.6 Farm Income Averaging & Conservation Deductions 27.7 Farm Disaster Elections & Livestock Replacement 27.8 Farm Rentals, Estimated Tax & Farm Depreciation
28 Chapter 28: Business Records, Reporting & ACA
28.1 Financial Statements, Records & Owner Transactions 28.2 Filing Extensions, International Forms & Cash Reporting 28.3 ACA Employer Size, Coverage & Reporting
29 Chapter 29: Employer & Self-Employed Retirement Plans
29.1 Qualified Plans, 401(k) Limits & Nondiscrimination 29.2 SEPs, Self-Employed Contributions & Owner Compensation 29.3 SIMPLE IRAs & Small-Employer Contribution Choices 29.4 Plan Reporting, Loans & Prohibited Transactions
30 Chapter 30: Rental Property & Passive Activities
30.1 Rental Income, Expenses & Conversion Basis 30.2 Rental Losses, Active Participation & Real Estate Professionals 30.3 Vacation Homes, Personal Days & Rental Allocations
2.1 Business Structures & Liability: Sole Proprietorship, Partnership, LLC, and Corporation
Key Takeaways Explain This Topic AI
A sole proprietorship has no separate legal existence from its owner, exposing the owner to unlimited personal liability for all commercial debts, torts, and obligations.
General partners in a general partnership (GP) or limited partnership (LP) face joint and several personal liability for entity debts, whereas limited partners, LLC members, and corporate shareholders enjoy a statutory liability shield.
Under federal tax law, state-chartered corporations are per se corporations subject to double taxation under Subchapter C (unless electing Subchapter S), whereas unincorporated entities follow default pass-through classification rules.
A C corporation is taxed at a flat 21% entity rate (IRC §11) with subsequent shareholder taxation on dividends, whereas S corporations and partnerships pass income directly to owners on Schedule K-1 generally without regular entity-level income tax; special S corporation taxes and partnership audit liabilities can apply.
S corporations must satisfy strict statutory constraints under IRC §1361 (maximum 100 allowable shareholders, one class of stock, and eligible individual/estate/trust owners), unlike LLCs and C corporations which permit unlimited and foreign ownership.
Last updated: October 2026
Foundations of Business Entity Selection
Selecting an appropriate business entity is one of the most critical structural decisions an entrepreneur and their tax advisor face. On the Special Enrollment Examination (SEE) Part 2, candidates must demonstrate a comprehensive command of how state legal forms intersect with federal tax rules. Entity choice dictates the extent of an owner's personal liability shield, the operational and management structure, the legal transferability of equity interests, the ease of raising equity or debt capital, and the foundational default federal income tax treatment.
- Primary Business Structures: Formation and Liability Profiles
- 1. Sole Proprietorships
A sole proprietorship is an unincorporated business owned and operated by a single individual. It is not a separate legal entity under state law. No formal state organizational filing is required to establish a sole proprietorship, although the owner must obtain local commercial licenses, permits, and register any fictitious business name (DBA). The owner bears unlimited personal liability for all commercial debts, contractual obligations, and tort liabilities incurred in the business; commercial creditors can attach the owner's personal bank accounts, investments, and non-exempt real property. For federal tax purposes, it is a disregarded entity reported directly on Schedule C (Form 1040), with net profit subject to self-employment tax (Schedule SE) under IRC §1401 on 92.35% of net profit: 12.4% Social Security up to the remaining $176,100 wage base in 2025 and 2.9% Medicare without a wage cap. The 0.9% Additional Medicare Tax can also apply above the filing-status threshold.
2. General Partnerships (GPs)
Under the Uniform Partnership Act (UPA/RUPA), a general partnership is an association of two or more persons carrying on as co-owners of a business for profit. A GP arises by formal written agreement, oral contract, or conduct without filing organizational documents with the state. Every partner acts as an agent under mutual agency, legally binding the firm in ordinary course operations. Crucially, general partners bear joint and several personal liability for all partnership debts, commercial contracts, and tort liabilities caused by any partner or employee. For federal tax purposes, a GP is a pass-through entity under Subchapter K, filing an information return on Form 1065 and issuing Schedules K-1.
3. Limited Partnerships (LPs)
Governed by the Revised Uniform Limited Partnership Act (RULPA), an LP requires filing a Certificate of Limited Partnership with the state. An LP requires at least one general partner (who exercises operational management and bears unlimited personal liability) and at least one limited partner (who contributes capital, shares in profits, and enjoys limited liability capped at their capital contribution). Under traditional RULPA rules, a limited partner who participates in the management or control of the business risks losing their liability shield to third parties. LPs file Form 1065.
4. Limited Liability Partnerships (LLPs)
An LLP is a general partnership that files a Statement of Qualification with the state, primarily used by licensed professional service firms (accountants, attorneys, physicians). The LLP provides a statutory liability shield protecting innocent partners from personal liability for the malpractice, negligence, or wrongful acts of co-partners and employees, though partners remain liable for their own acts and, in some states, general contract debts. LLPs file Form 1065.
5. Limited Liability Companies (LLCs)
An LLC is a flexible statutory entity created under state law by filing Articles of Organization. Owners are "members" whose personal assets are generally shielded from entity obligations, subject to personal guarantees, their own wrongful acts, and applicable state-law exceptions. Governance is established by an Operating Agreement. LLCs may be member-managed (all members possess agency authority to direct daily business) or manager-managed (management authority is centralized in appointed managers, leaving non-managing members as passive investors). Equity transfers are restricted: assignees receive economic rights (profit distributions) but cannot become full voting members without member consent. Tax defaults are pass-through: single-member LLCs default to disregarded entities (Schedule C), and multi-member LLCs default to partnerships (Form 1065).
6. C Corporations
A C corporation is an independent legal entity formed by filing Articles of Incorporation with the state. It possesses perpetual existence, centralized management (Board of Directors and executive officers), and a full liability shield for shareholders, directors, and officers. Shares are freely transferable, and the entity can issue multiple classes of common and preferred stock, providing optimal access to institutional capital. A C corporation is subject to double taxation under Subchapter C: the corporation pays a flat 21% tax on taxable income (IRC §11) on Form 1120, and shareholders pay tax on dividend distributions on Form 1040 (at 0%, 15%, or 20% qualified dividend rates, plus the 3.8% Net Investment Income Tax under IRC §1411).
7. S Corporations
An S corporation is a domestic corporation (or electing LLC) that files Form 2553 to elect pass-through taxation under Subchapter S (IRC §§1361–1379), reporting on Form 1120-S. It combines the corporate liability shield with single-tier pass-through taxation. Strict eligibility rules apply under IRC §1361(b): maximum 100 shareholders (family members treated as one under §1361(c)(1)); eligible shareholders generally include U.S. citizens, resident aliens, estates, qualifying trusts, and certain exempt entities (no nonresident aliens, C corporations, or partnerships); and strictly one class of stock (voting differences permitted under Treas. Reg. §1.1361-1(l), but distribution and liquidation rights must be identical).
Comprehensive Entity Comparison Table
Entity Form Formation Requirement Owner Liability Shield Management Structure Transferability of Ownership Capital Access & Investors Default Federal Tax Return
Sole Proprietorship None (informal; local licenses/DBA only) None (unlimited personal liability) Sole owner has exclusive operational control Cannot transfer entity; sells individual assets Highly limited (owner capital and personal debt) Form 1040, Schedule C / SE (Disregarded)
General Partnership (GP) None (oral or written agreement; conduct-based) None (joint and several personal liability) Mutual agency; equal management by all partners Requires consent of all partners to admit new member Limited to partner contributions and loans Form 1065 / Schedule K-1 (Partnership)
Limited Partnership (LP) State filing (Certificate of Limited Partnership) Split: GP has unlimited liability; LPs have limited liability General partner manages; limited partners are passive Assignee gets economic rights; admission requires consent Moderate (can attract passive investor limited partners) Form 1065 / Schedule K-1 (Partnership)
Limited Liability Partnership (LLP) State filing (Statement of Qualification) Shield against co-partner malpractice/negligence All partners can participate in management Transfer of full partner status requires consent Limited to professional partners (CPAs, attorneys) Form 1065 / Schedule K-1 (Partnership)
Limited Liability Company (LLC) State filing (Articles of Organization) Full liability shield for all members Member-managed or Manager-managed Economic rights transferable; membership requires consent Flexible (can issue multiple membership classes/units) Single-member: Schedule C/E/F; Multi-member: Form 1065
C Corporation State filing (Articles of Incorporation) Full liability shield for all shareholders Centralized: Board of Directors and executive officers Free transferability of shares (unless restricted) Highest (public offerings, venture capital, multiple classes) Form 1120 (Flat 21% corporate tax rate)
S Corporation State filing (Articles) + Federal Form 2553 Full liability shield for all shareholders Centralized: Board of Directors and executive officers Transferable, but restricted to eligible shareholders Restricted (max 100 shareholders; single class of stock) Form 1120-S / Schedule K-1 (Pass-through)
Practical Exam Scenario: Analyzing Entity Selection & Liability Exposure
Scenario : Three software consultants—Elena, Marcus, and Dave—form a consulting firm generating $450,000 in gross revenue and $150,000 in operating expenses in 2025, leaving $300,000 in net profit. They distribute $60,000 to each founder and retain $120,000 for business expansion.
General Partnership : All three face joint and several personal liability for commercial contracts and potential client malpractice claims. Each partner is allocated $100,000 of ordinary business income on Schedule K-1, paying income and self-employment tax on their entire $100,000 share regardless of distributions.
Multi-Member LLC : The owners enjoy limited liability for entity obligations, subject to personal guarantees and their own wrongful acts. By default, it is taxed as a partnership on Form 1065, yielding identical pass-through tax results to the GP but with a statutory liability shield.
C Corporation : The entity pays an entity-level corporate tax of 21% on $300,000 ($63,000 corporate tax under IRC §11), leaving $237,000 in after-tax earnings. The $180,000 total distributed to the three founders is taxed a second time as qualified dividends on their individual Form 1040 returns.