Business Entity Types and Their Tax Implications

Business Entity Types and Tax Implications

Sole Proprietorship

• Income reported on Schedule C of personal return
• Subject to self-employment tax (15.3%)
• Simplest to set up, least protection

Partnership

• Income flows through to partners' personal returns
• Partners pay self-employment tax on their share
• File Form 1065 informational return

Limited Liability Company (LLC)

• Default: Single-member treated as sole proprietorship; multi-member as partnership
• Can elect to be taxed as S-Corp or C-Corp
• Combines flexibility with liability protection

S-Corporation

• Income flows through to shareholders' personal returns
• Shareholders who work in the business must take a reasonable salary
• Distributions above salary not subject to self-employment tax
• File Form 1120-S

C-Corporation

• Separate tax entity with flat 21% corporate tax rate
• Subject to double taxation (corporate tax + dividend tax)
• Better for retaining earnings in the business
• More attractive for outside investors

Nonprofit (501(c)(3))

• Exempt from federal income tax
• Donations are tax-deductible for contributors
• Complex compliance requirements

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Starting a business? Get the entity structure right from day one to maximize tax savings.