When a business generates income or loss, the tax ramifications for the business and the business owner will depend on the type of business entity selected. Some businesses pay taxes themselves on business income, while others act as conduit or pass-through entities, making their owners responsible for paying taxes on the business income. The concept of tax basis is also important when considering a business’s income or loss. Although myriad business entities exist, the following types will be covered here: C corporations, S corporations, partnerships, sole proprietorships, limited liability companies (LLCs), limited liability partnerships (LLPs), limited partnerships (LPs), and professional corporations (PCs).
Impact on Specific Business Entities
Tax treatment will vary, depending on the type of business entity selected.
C corporations
For federal tax purposes, a C corporation is recognized as a separate taxpaying entity. Double taxation is involved, with corporate income being taxed once to the corporation when earned and again to the shareholders when distributed to them as dividends. You need to be aware of how income is taxed, of how losses are treated, and of any additional taxes that may apply.
Tip: Several pieces of legislation relieve some of the double taxation burden of C corporations by providing that dividends received by an individual shareholder from domestic corporations (and qualified foreign corporations) are taxed at long-term capital gains tax rates for taxable years beginning in 2003 through 2012. For tax years prior to 2003, dividends were taxed as ordinary income. Absent further legislative action, dividends will again be taxed as ordinary income beginning in 2013.
S corporations
In effect, an S corporation conducts business as a regular corporation but is taxed similar to a partnership. The S corporation passes items of income, loss, deduction, and credit through to its shareholders, who report the items and calculate the applicable tax on their individual returns. You should be aware of how income and losses are treated and how basis will be affected.
Partnerships
Like an S corporation, a partnership is a conduit or pass-through entity. It is important to understand how items are allocated to partners and how a partner’s basis is affected by pass-through items.
Sole proprietorships
Business profits and losses are reported on the owner’s personal tax return each year. The business does not file its own tax return. You need to understand how losses can be used to offset income and how to report income.
Limited liability company (LLC)
For federal tax purposes, an LLC with multiple owners can choose to be treated as a partnership or as a corporation. In general, LLCs choose to be taxed according to partnership rules to avoid the double taxation imposed on C corporations. You need to understand how income and losses are treated and reported. An LLC with a single owner will be treated like a sole proprietorship for federal income tax purposes if it does not elect to be taxed as a corporation. However, you should be aware that some states do not recognize or permit LLCs with a single owner.
Limited liability partnership (LLP)
Most states allow certain professionals (like doctors, lawyers, and accountants) to form an entity similar to the LLC. This entity is called a limited liability partnership (LLP). You need to understand how income and losses are treated and reported.
Limited partnerships (LP)
Basically, limited partnerships (LPs) are taxed as partnerships for federal tax purposes. Income and losses pass through to partners, but recognition of losses is limited by certain factors.
Professional corporations (PC)
Professional corporations (PCs) are a special type of corporation composed of professionals. PCs often follow regular C corporation tax rules. However, PCs can sometimes choose to be treated as S corporations for federal tax purposes. Tax treatment of PCs varies, depending on a number of factors.
If you have questions, contact the Business Tax Experts at Henssler Financial: experts@henssler.com or 770-429-9166.
Disclosures
The following information is reprinted with permission from Forefield, a division of Broadridge Financial Solutions, Inc. This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
