Two friends shake hands and start selling roasted coffee from a cart. They share profits, share losses, sign no paperwork. Six months later, one signs a $400,000 supply contract and disappears. The other is on the hook for the full amount, and never realized she had already formed a general partnership.
The CPA exam tests entity choice on four axes: formation, liability, taxation, management. These rules exist because legislators decided which kinds of risk-sharing the public will recognize. A handshake gets you full personal liability, the state never agreed to limit your exposure. A state-filed certificate gets you a shield in exchange for disclosure.
HIGH-FREQUENCY: Six entities show up on REG: sole proprietorship, general partnership, limited partnership, LLP, LLC, corporation (C or S). Know each on the four axes above.
One person running a business under their own name or a DBA. No state filing creates the entity (local DBA may be required). The owner has unlimited personal liability; income flows onto Schedule C.
Common mistakes
- Splitting profits by capital contribution under RUPA. A partner contributing $90,000 of $100,000 still gets only 50% when the agreement is silent. Trap answer: 90/10. The opposite trap fires for LLCs under RULLCA, where defaults are per capital.
- Filing nothing means no liability. Wrong: no filing defaults you into the worst exposure: a general partnership with joint and several liability. The shield requires filing the right document: certificate of limited partnership, articles of organization, or articles of incorporation.
- Confusing dissociation with dissolution. A partner withdraws or dies, that partner has dissociated; the partnership may continue. Dissolution requires a separate trigger. Trap answer treats every withdrawal as automatic dissolution.
Bottom line
- GP forms automatically by conduct with no filing, carries joint and several liability, and is governed by RUPA defaults
- LP needs a state-filed certificate of limited partnership plus at least one general partner; limited partners stay shielded only if they stay out of management
- LLP is a GP that has filed a statement of qualification, shielding partners from each other's torts but not their own
- LLC needs articles of organization plus an operating agreement; RULLCA gives all members limited liability and defaults to member-managed
Exam shortcut
When a fact pattern shows people doing business with no filing, jump to general partnership: joint and several liability plus per-partner profit splits under RUPA defaults. When a state filing is named, identify it: certificate of limited partnership = LP, articles of organization = LLC, articles of incorporation = corporation. For S-corp eligibility, run the checklist in order: 100, US individuals, one class outstanding, domestic; the first failure terminates.
The full lesson (about 2,748 words, 18 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.E1
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