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Business entities and taxes: Four examples

Each business entity has its own rules regarding tax obligations.

Business owners need to take various considerations into account when determining which business entity is best for their needs. Business owners should discuss the benefits of protection from liability and the potential tax implications of each business entity option. This piece will focus specifically on the tax implications of the chosen entity. It will provide the basics on the role of the Internal Revenue Service (IRS) on four of the more common business structures.

Before diving into this discussion, it is important to know exactly what the IRS considers subject to taxation. In most cases, the IRS will tax a business’ net profit or loss. Business owners generally calculate this amount by subtracting any applicable deductions from the business’ sales and revenues.

Entity #1: The sole proprietorship

In most cases, the IRS does not consider a sole proprietorship a separate entity from the business owner. As a result, the IRS generally expects the business owner to include tax obligations on their personal tax filings.

Entity #2: The partnership

A partnership is a business that involves two or more owners. The IRS requires these owners to file an annual information return to report income, deductions, gains and losses from business operations. The agency then expects each owner to include their share of the partnership’s income or loss on their own, personal tax returns.

Entity #3: The limited liability corporation (LLC)

The taxes for this business entity are also taken from the owner’s individual tax return. Similar to the partnership structure noted above, the exact amount due will vary depending on the taxpayer’s percentage of business ownership.

Entity #4: The corporation

There are many different types of corporations. Two of the more common options include the S corporation and the C corporation. With the S corp., the IRS will expect the owner to include their salary along with any remaining business profit or loss on their personal tax returns. Again, the amount of business profit or loss will depend on the owner’s percentage of ownership in the business. In contrast, the IRS recognizes a C corp. as its own taxable entity, separate from the owners.

It is important to note that these figures focus on federal tax obligations. Additional state taxes may be due. Business owners are wise to carefully consider all tax implications of each business structure before moving forward with incorporation. An attorney experienced in this area of business law can review your options and help better ensure you choose the best structure for your needs.

This article is intended for basic information and should not be relied on as a legal opinion of the Firm. Before deciding on which business entity is correct for your situation, you should consult an attorney and tax specialist who can better address specific concerns.