Formation & Termination
Rules for Business Entities
Master the legal requirements for creating and dissolving partnerships, corporations, and LLCs: the essential CPA REG skill.
CPA Regulation (REG)
Why Formation Rules Matter
Every business entity: whether a sole proprietorship, partnership, corporation, or LLC: must follow specific legal steps to come into existence. These rules determine liability protection, tax treatment, and ownership rights.
The Four Entity Types
General Partnership
Formed by agreement (oral or written). No state filing required. Partners share profits equally by default.
Limited Partnership
Requires a certificate of limited partnership filed with the state. Must have at least one general partner.
Corporation
Formed by filing articles of incorporation with the state. Creates a separate legal entity with limited liability.
LLC
Formed by filing articles of organization. Combines limited liability with pass-through tax flexibility.
Formation Pathway Overview
Partnership Formation Rules
1
Sharing of profits creates a presumption of partnership (strongest indicator).
2
No formalities required: can be oral, written, or implied by conduct.
3
Co-ownership of property alone does not establish a partnership.
4
Receipt of debt payments or wages does not create a partnership presumption.
Corporation Formation Rules
1
Required in Articles: corporate name, number of authorized shares, registered agent and office, incorporator name(s).
2
One incorporator is sufficient: may be a person or an entity.
3
Bylaws govern internal operations but are NOT filed with the state.
4
Organizational meeting must be held to adopt bylaws and appoint initial directors (if not named in articles).
LLC Formation Rules
Members
Can be one or more persons or entities. No minimum member requirement in most states.
Management
Member-managed (default) or manager-managed (if specified in operating agreement).
Tax Election
Default: disregarded entity (1 member) or partnership (2+ members). Can elect corporate tax treatment.
Agreement vs. State Filing
| By Agreement | By State Filing | |
|---|---|---|
| Entity Types | General Partnership | LP, Corporation, LLC |
| Document Name | Partnership Agreement | Articles / Certificate |
| Filing Needed? | No | Yes |
| Liability | Unlimited | Limited |
| When Formed | When co-owners carry on business for profit | When state accepts filing |
How Entities Terminate
Termination (also called dissolution) is the legal process of winding up a business entity's affairs and ending its existence. The rules differ significantly depending on the entity type.
Dissolution
The triggering event that begins the winding-up process: the entity stops conducting ordinary business.
Winding Up
Collecting assets, paying debts, and distributing remaining assets to owners in the required order.
Termination
The final step: the entity ceases to exist. For corporations and LLCs, articles of dissolution are filed.
Partnership Dissolution Rules
1
Dissociation: A partner's withdrawal, expulsion, death, or bankruptcy triggers dissociation (not always dissolution).
2
At-will partnerships: Any partner may dissolve at any time by express will.
3
Term partnerships: Dissolution occurs when the term expires or purpose is achieved.
4
Winding-up order: Pay outside creditors first, then inside creditors (partner loans), then return capital contributions, then distribute remaining profits.
Corporation Dissolution Rules
Voluntary
Board of directors recommends dissolution, then shareholders must approve by majority vote. Articles of dissolution are filed with the state.
Involuntary
State may dissolve for failure to pay taxes or file annual reports. Courts may dissolve on shareholder petition for deadlock or fraud.
How to Apply These Rules
1
Identify the entity type. Look for keywords: "partners," "shareholders," "members," "articles," "certificate."
2
Determine formation method. Was a state filing made? If not, it is either a sole proprietorship or general partnership.
3
Check for proper formation. Missing required elements (e.g., no registered agent in articles) means the entity was not properly formed.
4
For termination: Identify the triggering event, then trace through the winding-up order: creditors → owners.
5
Watch for exceptions: Dissociation vs. dissolution in partnerships; voluntary vs. involuntary dissolution in corporations.
Example 1: Partnership Formation
1
Two or more persons? ✓ Alice and Bob.
2
Carrying on a business? ✓ Operating a bakery.
3
Co-owners for profit? ✓ Sharing profits 50/50.
Example 2: Corporate Formation Defect
De Jure Corporation?
No. Articles were not properly filed (rejected by the state). The corporation does not legally exist.
De Facto Corporation?
Possibly. If Carter made a good-faith attempt to incorporate, a court may recognize limited protection under this doctrine (abolished in most RMBCA states).
Example 3: Winding Up Priority
Common Mistakes
✕ Partnership Requires a Written Agreement
Wrong. A general partnership can form orally or even by implied conduct. Only limited partnerships require a state filing.
✕ Dissociation Equals Dissolution
Wrong. A partner leaving (dissociation) does not automatically end the partnership. The remaining partners may continue.
✕ Shareholders Are Paid Before Creditors
Wrong. Upon dissolution, all creditors must be fully paid before any distribution to shareholders or partners.
Summary Comparison
| Feature | GP | LP | Corp | LLC |
|---|---|---|---|---|
| State Filing | No | Yes | Yes | Yes |
| Document | Agreement | Certificate | Articles of Inc. | Articles of Org. |
| Liability | Unlimited | Mixed | Limited | Limited |
| Dissolution Trigger | Partner will / event | Certificate cancel | Board + shareholder vote | Member vote / event |
| Winding-Up Order | Creditors → Partner Loans → Capital | Creditors → Partner Loans → Capital | Creditors → Pfd. Stock → Common Stock | Creditors → Members (per agreement) |
Question 1 of 5
Adams and Baker share profits equally from a consulting business they operate together. They have no written agreement and have not filed any documents with the state. What entity have they most likely formed?
Under RUPA, two or more persons sharing profits from a co-owned business creates a general partnership by operation of law, even without a written agreement or state filing. A joint venture is for a single transaction, not an ongoing business. LPs and LLCs require state filings.
Question 2 of 5
Which of the following is required in articles of incorporation under the Revised Model Business Corporation Act (RMBCA)?
The RMBCA requires four items: (1) corporate name, (2) number of authorized shares, (3) registered agent and office, and (4) incorporator name(s). Directors' names, par value, and corporate purpose are optional.
Question 3 of 5
In a general partnership dissolution, what is the correct priority for distributing assets?
The correct winding-up priority is: outside creditors (third parties) first, then inside creditors (partner loans), then capital contributions, and finally any remaining profits are split among partners.
Question 4 of 5
Garcia incorporates a business but the Secretary of State rejects the filing due to a defect. Garcia proceeds to do business as though incorporated. Under the RMBCA, Garcia is:
Under the RMBCA, the de facto corporation doctrine and corporation by estoppel are abolished. Any person who acts on behalf of a corporation knowing it was not properly formed is personally liable for all obligations incurred.
Question 5 of 5
Which of the following events will not automatically dissolve a general partnership under RUPA?
Under RUPA, the death of a partner in a term partnership causes dissociation, not automatic dissolution. The remaining partners may choose to continue the business. In contrast, a withdrawal notice in an at-will partnership, unanimous agreement, and a judicial decree all trigger dissolution.