Four Ways Business Are Taxed

Businesses are not all taxed alike. There are four different types of tax treatment available. These are sole proprietorship tax treatment, partnership tax treatment, S corporation tax treatment, and C corporation tax treatment.

Tax Treatment Choices

Whenever a business entity is created or comes into existence, it automatically receives a form of tax treatment by default. However, except for sole proprietorship, business entities have some leeway to change from their default treatment to another type of tax treatment.

A multiowner LLC , LLP , or partnership is automatically taxed as a partnership by default, but may choose to be taxed as a C corporation or S corporation. This is easily accomplished by filing a document called an election with the IRS . Once this is done, as far as the IRS is concerned, the LLC , LLP , or partnership is now the same as a corporation and it files the tax forms for that type of entity. However, the great majority of LLC s, LLP s, and partnerships stick with their default partnership tax treatment.

Corporations are taxed as C corporations by default, but may change to S corporation tax treatment by filing an S corporation election. This is extremely common. A one-owner LLC is taxed as a sole proprietorship by default but can elect to be taxed as a C or S corporation by filing an election. This is not common, however. The sole proprietorship is the only entity that can’t change its tax treatment—it must retain the sole proprietorship taxation treatment that it receives by default.

Sole Proprietorship Taxation

When you’re a sole proprietor (or single-member LLC with sole proprietor tax treatment), you and your business are one and the same for tax purposes. Sole proprietorships don’t pay taxes or file tax returns. Instead,

you must report the income you earn or losses you incur on your own personal tax return (IRS Form 1040). If you earn a profit, the money is added to any other income you have—for example, interest income or your spouse’s income if you’re married and file a joint tax return—and that total is taxed.

Although you are taxed on your total income regardless of its source, the IRS still wants to know about the profitability of your business. To show whether you have a profit or loss from your sole proprietorship, you must file IRS Schedule C, Profit or Loss From Business, with your tax return. On this form, you list all your business income and deductible expenses. If you have more than one business, you must file a separate Schedule C for each one.

Sole proprietors must use the sole proprietor form of taxation. If a sole proprietor wants a different type of tax treatment, he must form a business entity such as a corporation or LLC .

In addition, LLC s with one owner are automatically treated like sole proprietorships for tax purposes. However, they have the option of switching to a C or S corporation taxation.