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How a Business is Taxed

by admin on August 16, 2012

in Administrative

The way your business is taxed is dependent on the type of  entity you have. By entity I am referring to your business structure, be it a sole proprietorship, partnership, corporation or limited liability company.  We are only going to be covering basic fundamentals here and it is by no means meant to be a guideline  as to how you file your taxes. We would suggest that you employ the assistance of a professional, such as an attorney, accountant or enrolled agent, to answer the more in-depth questions you may have and how the tax code pertains to your particular enterprise.

1. Sole Proprietors – A sole proprietorship is the most  basic requiring the self-employed person to file what is known as a Schedule C,  Profit or Loss from a business, which is attached to your personal tax return.  With the Schedule C you will transfer your income and expenses from your records into the appropriate categories on the Schedule C. A sole proprietor  will also need to file a Schedule SE, Self-Employment Tax, to calculate the social security tax and medicare that is owed.

2. Partnership – Partnerships are what is known  as pass-through entities. A partnership has two or more owners and is required to file a Form 1065, Return of Partnership Income. A partnership return is considered an information return as it doesn’t pay any  taxes itself. Income and losses are then passed to owners on a Schedule K-1,  Partner’s  Share of Income, Deductions,  Credits, etc., which is then reported on their personal return.

3. Corporation – Corporations are taxed as a separate entity using Form 1120, Corporation Tax Return. A Corporation, as a separate entity, pays taxes itself. Most people are familiar with the S Corporation which is a pass-through entity and files a Form 1120S, Income Tax Return for an S Corporation. Like a partnership, the shareholder will receive a Schedule K-1, Shareholder’s Share of Income, Deductions, Credits, etc., which is then reported on their personal tax return. Unlike a partnership, the S-Corporation may be liable for taxes itself.

4. Limited Liability Companies – LLC’s can be taxed in a  number of ways depending on the type of entity classification you choose. The IRS default is, when the LLC has only one member, is taxed as a sole proprietorship. Two or more members, it will be taxed as a partnership. Members of an LLC may file Form 8832, Entity Classification Election, opting for the LLC to be taxed as a corporation.

Keep in mind that each entity is different and there are many factors which need to be considered. Again, I will suggest that if you are unsure, seek the help of a qualified professional.


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