7.1 Business Entity Overview

Choosing a business entity is a trade-off among three variables: formality (what must be filed and maintained), liability (whose personal assets answer for business debts), and taxation (whether the entity itself pays tax). The NALA CP Knowledge Exam tests these distinctions within the Corporate/Commercial Law subject area, usually by giving you a fact pattern and asking which entity fits, or which statement about an entity is correct.

Sole Proprietorship

A sole proprietorship is a business owned by one person that has no legal existence separate from its owner. It requires no state filing to form — it arises automatically when a person begins doing business. If the owner operates under a name other than their own legal name, most states require a fictitious name or "doing business as" (DBA) registration, but that filing is a consumer-protection measure, not entity creation.

• Liability: The owner has unlimited personal liability. Business creditors can reach the owner's home, savings, and other personal assets. There is no liability shield of any kind.
• Taxation: Pure pass-through. Income and losses are reported on Schedule C of the owner's individual Form 1040. Net earnings are also subject to self-employment tax (Social Security and Medicare) under the Self-Employment Contributions Act.
• Duration: The business ends at the owner's death and cannot be transferred as an entity; only its assets pass.

A paralegal scenario: a client opens a home-based notary-signing service under her own name, hires no one, and never files anything with the state. She is a sole proprietor by default — and if a client sues over a botched loan signing, her personal savings are exposed.

General Partnership

A general partnership (GP) is an association of two or more persons to carry on as co-owners a business for profit. Under the Revised Uniform Partnership Act (RUPA), which most states have adopted, a partnership is created by the parties' conduct and intent to share profits — no written agreement and no state filing is required. Sharing profits creates a presumption of partnership; sharing gross revenues does not.

• Liability: Each partner is jointly and severally liable for all partnership obligations, including contracts and the torts of other partners committed in the ordinary course of business. A creditor can collect the entire judgment from any one partner, who must then seek contribution from the others. Each partner is also an agent of the partnership and can bind it.
• Taxation: Pass-through. The partnership files an informational return (Form 1065) and issues each partner a Schedule K-1; partners report their distributive shares on their own returns. The partnership itself pays no federal income tax.
• Formation trap: Because no filing is needed, parties can become general partners accidentally. The exam also tests partnership by estoppel: a person who holds themselves out as a partner (or knowingly allows another to do so) is liable to third parties who reasonably rely on that representation, even if no partnership actually exists.

Limited Partnership

A limited partnership (LP) is a creature of statute: it exists only when a certificate of limited partnership is filed with the secretary of state. It has at least one general partner and at least one limited partner.

• General partner: Manages the business and has unlimited personal liability, exactly as in a general partnership.
• Limited partner: A passive investor whose liability is capped at their capital contribution. Limited partners may not use their surname in the partnership name (under older statutes) and, under the traditional rule, risk losing their liability shield if they participate in control of the business. The Uniform Limited Partnership Act of 2001 (ULPA 2001) modernized this: a limited partner is not liable merely for participating in management. Know both versions — exam questions often hinge on which rule the fact pattern assumes.
• Taxation: Pass-through, like a general partnership (Form 1065 and K-1s).

LPs are commonly used for real-estate syndications, oil and gas ventures, and family estate planning, where investors want exposure without management duty or personal liability.

Limited Liability Partnership

A limited liability partnership (LLP) is a general partnership that has filed a registration (sometimes called a statement of qualification) with the state to gain liability protection. It is the entity of choice for professional firms — law firms, accounting firms, medical practices.

• Liability: In a full-shield state, no partner is personally liable for partnership obligations, whether arising in contract or tort. In a partial-shield state, partners are protected only from liability arising from the negligence, malpractice, or wrongful acts of other partners, but remain jointly and severally liable for ordinary contract debts. Every partner, in every state, remains personally liable for their own malpractice and for obligations they personally guarantee.
• Taxation: Pass-through, same as a general partnership.

Comparison Table

When Each Entity Is Used

• Sole proprietorship: Lowest cost and zero formality; appropriate for very small, low-risk, single-owner businesses.
• General partnership: Two or more owners who want simplicity and share management; risky because of joint and several liability.
• Limited partnership: Passive investors (limited partners) funding a venture run by an active manager (general partner).
• LLP: Licensed professionals who want partnership taxation without personal liability for a colleague's malpractice.

Common exam traps: (1) Assuming a partnership must be filed to exist — only LPs, LLPs, LLCs, and corporations require filings; general partnerships do not. (2) Confusing a limited partner's liability cap with the general partner's unlimited exposure. (3) Forgetting that pass-through entities still file an informational return — Form 1065 is filed even though no entity-level tax is owed.