Tax Implications of Business Legal
Before settling on a business legal structure, make sure you understand the tax
implications of each type.
For the purpose of this lesson, we'll be
comparing the federal income taxes of each
The following factors we'll be looking at include:
What to assess
When we talk about “business entity” we mean
how the IRS “sees” the business; whether the
business is separate from the owners or not.
This influences how federal taxes are
Business Entity Type Business separate from owners
Sole Proprietorship No
Limited Liability Corporation (LLC) Yes
S Corporation Yes
C Corporation Yes
Before comparing how federal taxes are
determined, there’s a few tax terms you need to
Not a taxable entity: the business and owner are legally the
same. Sole proprietor pays all taxes.
Pass-through entity: (Also known as “flow-through entities”) Owners
are directly taxed individually.
Separate taxable entity: Corporation pay taxes based on net
income each year.
Double taxation: Tax is paid first by the corporation on its
income and then taxed again as personal income when
distributed to stockholders/shareholders as dividend.
Below, is a brief comparison of how business
structures are federally taxed:
Business Entity Type Taxation
Sole Proprietorship Not a taxable entity.
Partnership Not a taxable entity. Pass-through income taxation for all partners.
Limited Partnership (LP) Pass-through income taxation for all partners.
Limited Liability Partnership (LLP) Pass-through income taxation for all partners.
Limited Liability Corporation (LLC) Pass-through income taxation.
Corporation Double taxation
S Corporation Pass-through income taxation
C Corporation A separate legal entity. Subject to double taxation.
Sole Proprietorship: the sole proprietor pays all taxes which
are reported on his/her personal tax return.
Partnership: A “pass-through business entity”, where profits
and losses flow to each partner. Income is taxed to the
partners on their personal tax rates.
Limited Partnership: Like a partnership, the pass-through taxation
flows to the partners, who report their (agreed upon) shares on their
individual tax returns.
Limited Liability Partnership: Profits pass through to partners
without being taxed at the entity level.
Limited Liability Corporation: Pass-through” taxation.
Corporation: The owner/shareholder is taxed on any
distribution from the company and on dividends paid to the
shareholders; the corporation pays taxes at the corporate
S Corporation: An S corporation does not have to pay taxes like a
corporation. Instead, individual shareholders report their earnings on
their individual tax returns.
C Corporation: Taxed separately from its owners. Subject to double
taxation, where taxed on corporation income before profits are
distributed, and then taxed again when investors pay personal
The business structure you choose will
determine the tax forms you need to file.
Here’s what you can expect:
Business Entity Type Tax Forms
Sole Proprietorship Schedule C and a Standard Form 1040.
Partnership Form 1065, Return of Partnership Income (info only) and Form 1040, Individual Income Tax Return
Limited Liability Corporation
Form 1065, Return of Partnership Income (info only) and Form 1040, Individual Income Tax Return
Corporation Form 1120 or 1120-A: Corporation Income Tax Return.
Form 1120S, Income Tax Return for S Corporation (info only) and Form 1040, Individual Income Tax
Form 1120, Corporation Income Tax Return. Dividend income reported on Form 1040, Individual Income
Tax Return. An accountant is recommended as these forms can be difficult.
Still a little confused? Don’t worry, our Business
Tax Tool can help!
Small Business Tax Filing
Just like federal taxes, the legal structure of your
business influences your state tax
requirements; however, each state has its own
So make sure you research yours carefully:
Determine Your State Tax Obligations