GRASSHOPPER

ACADEMY

Tax Implications of Business Legal Structures

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

business structure.

The following factors we'll be looking at include:

Business Entity

Taxation

Tax Forms

What to assess

Business Entity

Business Entity

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

determined. Business Entity Type Business separate from owners

Sole Proprietorship No

Partnership No

Limited Liability Corporation (LLC) Yes

S Corporation Yes

C Corporation Yes

Taxation

Taxation

Before comparing how federal taxes are determined, there’s a few tax terms you need to understand:

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.

Taxation

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.

Taxation

Getting into more detail….

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.

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

rate.

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

income taxes.

Tax Forms

Tax Forms

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 (LLC)

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.

S CorporationForm 1120S, Income Tax Return for S Corporation (info only) and Form 1040, Individual Income Tax Return

C CorporationForm 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.

Tax Forms

Still a little confused? Don’t worry, our Business

Tax Tool can help!

Small Business Tax Filing

Don’t forget…

Just like federal taxes, the legal structure of your

business influences your state tax

requirements; however, each state has its own

tax laws.

So make sure you research yours carefully:

Determine Your State Tax Obligations

Next…

Legal Items: DIY or Hire