SEE Part 2 business entities explained
Business Entities and Considerations is 30 of the 85 scored questions on SEE Part 2, about 35%. It tests how each type of entity is classified, formed and taxed, and how money and property move between the entity and its owners. The common thread is basis: an owner’s basis decides what is taxable when cash comes out and which losses can be deducted.
Entity types and classification
| Entity | Default treatment | Return |
|---|---|---|
| Sole proprietorship | Not separate from the owner | Schedule C with Form 1040 |
| Single-member LLC | Disregarded entity | Owner’s return (e.g. Schedule C) |
| Multi-member LLC | Partnership | Form 1065 |
| General or limited partnership | Partnership | Form 1065 |
| Corporation | C corporation | Form 1120 |
| Corporation or LLC with an S election | S corporation | Form 1120-S |
An eligible LLC can elect to be taxed as a corporation on Form 8832; an eligible corporation, or an LLC treated as one, elects S status on Form 2553. A qualified joint venture lets a married couple who jointly own and operate an unincorporated business, both materially participate and file jointly, skip Form 1065 and each report their share on their own Schedule C.
The outline also names EINs, tax years, information reporting and hobby versus business: hobby income is reportable, but the expenses produce no deductible loss.
Partnerships
Formation. Contributing property for a partnership interest is generally tax-free. The partner’s basis in the interest starts at the adjusted basis of what was contributed, and the partnership takes the same carryover basis in the property. Contributing services for an interest is different — the value received is compensation.
Partner’s basis — the calculation to master:
| Increases basis | Decreases basis |
|---|---|
| Cash and adjusted basis of property contributed | Cash and basis of property distributed |
| Share of taxable and tax-exempt income | Share of losses and nondeductible expenses |
| Increase in share of partnership liabilities | Decrease in share of partnership liabilities |
Basis never goes below zero. A decrease in a partner’s share of liabilities is treated as a cash distribution, and cash distributed in excess of basis produces gain.
Guaranteed payments for services or the use of capital are deductible in figuring the partnership’s ordinary income and taxable to the partner as ordinary income, generally subject to self-employment tax, whatever the partnership’s profit.
Filing. Form 1065 is due by the 15th day of the 3rd month after year-end — March 16, 2026 for 2025 calendar-year partnerships, as March 15 fell on a Sunday. Late filing is penalised per partner per month. A partnership with 100 or fewer eligible partners may elect out of the centralized audit regime; a partnership or trust among the partners blocks the election.
C corporations
Formation under section 351. No gain or loss is recognised when property is transferred for stock and the transferors control the corporation immediately afterwards — at least 80%. If the transferor also receives cash or other property (boot), gain is recognised up to the boot. Liabilities assumed in excess of the basis of the property transferred also trigger gain. Services exchanged for stock are not property: the stock is compensation.
Earnings and profits and distributions. A distribution is a dividend to the extent of current and accumulated E&P, then a tax-free return of the shareholder’s stock basis, then capital gain.
Other corporate items: a flat 21% rate; a dividends-received deduction of 50% (less than 20% owned) or 65% (20% or more owned); charitable contributions generally limited to 10% of modified taxable income; estimated tax when expected tax is $500 or more; Form 1120 due by the 15th day of the 4th month. Also accumulated earnings tax, controlled groups, liquidations and redemptions.
S corporations
Eligibility. A domestic corporation with no more than 100 shareholders (a married couple counts as one), only one class of stock, and only eligible shareholders — individuals, estates, certain trusts and certain exempt organisations. A nonresident alien, partnership or C corporation shareholder is disqualifying.
Election. Form 2553, with every shareholder’s consent, no more than 2 months and 15 days after the start of the tax year it is to take effect, or during the preceding year.
Flow-through. Income, deductions and separately stated items pass to shareholders on Schedule K-1. Shareholders deduct losses only to the extent of their stock basis plus debt basis — debt basis coming from loans the shareholder personally made to the corporation. Excess losses carry forward. Distributions are generally tax-free up to stock basis; the accumulated adjustments account matters when the corporation has E&P from C corporation years.
Ending S status. Revocation needs consent from holders of more than half of the shares; termination is automatic when the corporation stops qualifying.
Sample questions
Question 1. Dana transfers equipment with an adjusted basis of $50,000 and a fair market value of $100,000 to a newly formed corporation. In exchange she receives 100% of the stock, worth $90,000, plus $10,000 cash. How much gain must Dana recognise?
- A. $0
- B. $10,000
- C. $40,000
- D. $50,000
Show answer
Answer: B
The transfer qualifies under section 351 because Dana controls the corporation immediately afterwards. Her realised gain is $50,000 ($100,000 received minus $50,000 basis), but she recognises gain only up to the boot received, the $10,000 cash. Recognising nothing ignores the boot, and $50,000 treats the exchange as fully taxable.
Question 2. An LLC with two individual members has never filed an entity classification election. How is it treated for federal tax purposes, and which return does it file?
- A. Partnership, filing Form 1065
- B. Disregarded entity, reported on each member’s Schedule C
- C. C corporation, filing Form 1120
- D. S corporation, filing Form 1120-S
Show answer
Answer: A
An eligible domestic LLC with two or more members is classified as a partnership by default and files Form 1065. It becomes a corporation only by electing on Form 8832, or an S corporation by also filing Form 2553. Disregarded entity status applies by default only to a single-member LLC.
Question 3. A C corporation has no current earnings and profits and $30,000 of accumulated earnings and profits. It distributes $50,000 cash to its sole shareholder, whose stock basis is $15,000. How is the distribution treated by the shareholder?
- A. $50,000 dividend
- B. $30,000 dividend and $20,000 nontaxable return of capital
- C. $15,000 nontaxable return of basis and $35,000 capital gain
- D. $30,000 dividend, $15,000 nontaxable return of basis and $5,000 capital gain
Show answer
Answer: D
A distribution is a dividend to the extent of E&P, here $30,000. The remaining $20,000 is first a tax-free return of the $15,000 stock basis, reducing it to zero, and the last $5,000 is capital gain. Treating the full $50,000 as a dividend ignores the E&P limit, and treating the whole $20,000 as return of capital ignores that basis cannot go below zero.
What to practise
Build three basis schedules from invented numbers: a partner through formation, income, a liability increase and a distribution; an S shareholder with a loss above stock basis and a shareholder loan; and a C corporation distribution running through E&P into gain. Then try the practice test.