Section 3: 10–20%T9
Choice of Entity and Formation Planning
Exam insight
The entity you pick drives a business's lifetime tax cost, and the AICPA tests whether you can weigh single-layer pass-through taxation against C corporation double taxation, using the permanent 21 percent rate, the section 199A QBI deduction, self-employment and payroll tax exposure, and tax-free formation under sections 351 and 721. The wrong choice can cost owners a second layer of tax or the loss of section 1202 QSBS benefits.
What AICPA wants you to know
- 1Compare the tax cost of C corporations, S corporations, partnerships/LLCs, and sole proprietorships under single versus double taxation.
- 2Determine QBI section 199A eligibility and the 2025 taxable income thresholds for each pass-through entity.
- 3Analyze self-employment and payroll tax exposure across entity types and identify loss-utilization differences.
- 4Apply the section 351 (corporate) and section 721 (partnership) tax-free formation rules, including the 80 percent control requirement.
- 5Evaluate exit and sale planning, including the section 1202 qualified small business stock gain exclusion available only to C corporations.
- 6Explain how partnership liabilities increase a partner's outside basis, a feature unique to partnerships.
Patterns in this topic
The exam re-skins the same archetypes. Recognize these here, then drill them in the Pattern Lab.
The C Corporation PlanRun the C corporation at 21 percent: take the DRD by ownership tier, cap the NOL at 80 percent, and weigh double taxation against 1202 QSBS.The Distribution and Liquidation PlanCharacter follows the exit path: 351 boot caps formation gain, E&P orders a distribution, and the redemption tests decide sale versus dividend.The Partnership AllocationTrack outside basis the partnership way: add the share of liabilities, run distributions for gain, and carve out 751 hot assets and 736 payments.The Compensation and Fringe PlanPay owners by the entity rulebook: reasonable S-corp wages, no excessive C-corp pay, guaranteed payments deducted, and 2-percent-shareholder fringes taxed.
Exam tip
Study smarter: before you expand each card, cover the screen and try to recall what the concept means from its title alone. Retrieving it from memory builds the recall the exam actually tests, and it beats re-reading.