Sole Proprietorships, Partnerships & Corporations

Why this matters

📌 The exam is likely to ask about specific business forms. Understand the basics for two main reasons:

• If you provide services to business clients (for example, securities advice to a small business), you need to know how the entity works.
• If you advise investors, entity structure affects taxes, liability, and how investments are bought and sold.

Entrepreneurs also often need guidance on which entity to form. 📌 The exam typically stays at the fundamentals: key characteristics, ease of formation, tax status, liability, and basic suitability.

🔑 The specific business entities discussed in this chapter:

• Sole proprietorships
• General partnerships
• Limited partnerships
• Limited liability companies (LLCs)
• S corporations
• C corporations

🔑 Master comparison table — all six entity types

🔑 Definitions

Sole proprietorships

• Usually the simplest business form to create. In most states, you can establish it with a simple form and a small fee.
• There’s one owner, and the owner’s personal finances are often intertwined with the business’s finances.
• Many businesses start as sole proprietorships and later convert to another form, often because of liability concerns.
• ⚠️ Unlimited liability — the owner’s personal assets can be reached by creditors. A business with meaningful liability exposure is usually not a good fit for a sole proprietorship.
• Taxes: all gains and losses flow through to the owner’s personal tax return. As discussed in the limited partnerships chapter, flow-through losses can be valuable: if the business has a loss, the owner may be able to deduct that loss on their personal return.

Summary:

• One business owner
• Easiest business entity to form
• Unlimited liability
• Flow through of gain and loss

General partnerships

• Similar to a limited partnership, but it has no limited partners. All owners are general partners who manage and (sometimes) fund the business.
• Like any partnership, it requires at least two partners.
• More involved than forming a sole proprietorship, but still relatively straightforward.
• General partners have unlimited liability.
• The partnership’s gains and losses flow through to the partners’ personal tax returns.

Summary:

• At least two general partners
• Forming the business is not significantly difficult
• Unlimited liability
• Flow through of gain and loss

Limited partnerships

A limited partnership has at least one general partner and at least one limited partner:

• 🔑 Limited partnerships are often better at raising capital than general partnerships because investors can participate as limited partners. That structure lets an investor seek returns, potentially use flow-through losses to offset other income, and avoid unlimited liability.
• ⚠️ In a general partnership, an investor generally must become a general partner to receive flow-through losses — meaning they would take on unlimited liability. As a result, investors often prefer limited partnerships.

Summary:

• At least one general partner
  • Manages and sometimes funds the business
  • Unlimited liability
• At least one limited partner
  • Only funds the business
  • Limited liability
• Forming the business is not significantly difficult
• All partners obtain flow through of gain and loss

Limited liability companies (LLCs)

• As the name suggests, LLCs limit the owners’ liability — typically to the amount invested (similar to limited partners).
• LLC owners are called members.
• Members receive flow-through gains and losses.
• Forming an LLC often requires legal assistance and can be more complex, especially as the business grows.

Summary:

• Business owners referred to as members
• Forming the business can be difficult
• Limited liability
• Flow through of gain and loss

S corporations

• There are two general types of corporations: S and C corporations. S corporations are typically used by smaller businesses.
• Owners are called shareholders, and there can be no more than 100.

🔑 Key restrictions:

• ⚠️ Shareholders may not be non-resident aliens (shareholders must be U.S. residents or citizens).

• ⚠️ The corporation may issue only one class of stock (unlike C corporations, which may issue multiple classes).

• Forming an S corporation generally takes about the same effort as forming a partnership or LLC.

• Shareholders have limited liability — generally doesn’t exceed their basis (the amount invested).

• Shareholders also receive flow-through gains and losses.

Summary:

• Business owners referred to as shareholders
• No more than 100 shareholders
• Shareholders may not be non-resident aliens
• Forming the business is not significantly difficult
• Limited liability
• Flow through of gain and loss

C corporations

• Typically the most complex business form to create and operate. They often rely on teams of lawyers and accountants to maintain compliance with corporate and IRS requirements.
• 🔑 C corporations are also the best structure for raising significant capital:
  • They may issue stock and bonds in multiple forms and classes.
  • They may sell to unlimited investors.
  • There are no residency or citizenship requirements for investors.
  • Securities can be registered for public trading, which makes it easier for investors to liquidate* their investments.
• Because they can raise capital efficiently, virtually all publicly traded companies are C corporations.

*All other business forms typically avoid registration of their securities, meaning interest (ownership) in those entities is obtained in private transactions. The more private the transaction, the more liquidity risk the investor is subject to.

• Owners are called shareholders. Shareholders have limited liability, so losses generally won’t exceed the amount invested.
• ⚠️ Unlike the other business forms in this chapter, C corporations do not allow flow-through of losses. A shareholder generally can’t claim a tax-deductible loss unless they sell (liquidate) their investment for less than their basis (for example, buying at $50 and selling at $30). If the corporation has operating losses, those losses stay at the corporate level.

⚠️ Double taxation

• C corporations can distribute gains to shareholders, but those gains may be subject to double taxation.
• Example as stated: a C corporation earns $100,000 in gross profits. After expenses, it pays corporate income tax on its taxable income. The corporation can then retain the remaining earnings and/or distribute some or all of them as a dividend. If dividends are paid, shareholders pay tax on the dividends received.
• In other words: the corporation pays tax on earnings, and shareholders may pay tax again when those earnings are distributed.

Summary:

• Business owners referred to as shareholders
• Unlimited shareholders
• No residency or citizenship requirements
• Forming the business can be significantly difficult
• Limited liability
• Flow through of gain only (double taxation)

Suitability

Financial professionals generally provide two types of guidance related to these business forms.

First — recommending an entity type to a client who is deciding what to form. 🔑 Key factors include:

• Ease of formation
• Ability to raise capital
• Liability exposure
• Pass-through status

Second — making recommendations to an existing business entity. For example, general partners in a limited partnership might hire an investment adviser to advise the partnership’s investments. ⚠️ Suitability standards vary by business form.

🔑 Whose suitability profile is considered, by entity

Key points

Sole proprietorships

• One business owner
• Easiest business entity to form
• Unlimited liability
• Flow through of gain and loss

General partnerships

• At least two general partners
• Forming the business is not significantly difficult
• Unlimited liability
• Flow through of gain and loss

Limited partnerships

• At least one general partner
  • Manages and sometimes funds the business
  • Unlimited liability
• At least one limited partner
  • Only funds the business
  • Limited liability
• Forming the business is not significantly difficult
• All partners obtain flow through of gain and loss

Limited liability companies (LLCs)

• Business owners referred to as members
• Forming the business can be difficult
• Limited liability
• Flow through of gain and loss

S corporations

• Business owners referred to as shareholders
• No more than 100 shareholders
• Shareholders may not be non-resident aliens
• Forming the business is not significantly difficult
• Limited liability
• Flow through of gain and loss

C corporations

• Business owners referred to as shareholders
• Unlimited shareholders
• No residency or citizenship requirements
• Forming the business can be significantly difficult
• Limited liability
• Flow through of gain only (double taxation)

Sources

Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.