Accounting Concepts

Information on the different type of business forms and their taxation

Corporation: Corporations file an annual tax return with the IRS (Federal) and usually with the state they are located. Also, they may have to file in a locality (i.e. New York City). Most corporations operate on a calendar year (ending December 31st). Those calendar year corporations returns are due March 15th. If you operate on a fiscal year (a year ending in a month other than October), your tax returns are due the 15th day of the third month after the fiscal year ends. Corporations pay taxes on the corporate level.

S-Corporation: An S-corporation is tax designation for a corporation. There is no legal difference between a corporation and an S-corporation. An S-corporation is a corporation that elected for S-corporation with the Internal Revenue Service (IRS). Some states also recognize S-corporation status and you have to also file an election with the state to be treated as an S-corporation on the state level. If you are located in a locality that has a corporate tax (i.e. New York City) that does not recognized s-corp status, you can be treated as an S-corporation for federal and state tax purposes and a regular corporation for local purposes. S-corporations differ from regular corporations in that they are not taxed on the corporation level. The income is split up between the owners and is shown on the shareholders form K-1. This income (or loss) is picked up on the shareholder's personal tax returns. This income is not subject to self employment tax (i.e. social security and Medicare taxes) on the shareholder level. Many people think operating as an S-corporation is a way to avoid self employment taxes. In reality, if you work and perform services for a company you own, you must tax a fair salary though payroll (i.e. W-2). This is reported to the shareholder on a W-2 and subject to normal self employment taxes. In the case where a shareholder of an s-corporation is an investor type and does not perform services for the company, their income could be reported to them on a k-1, they will report that amount on their personal returns not subject to self employment taxes and they can take a cash distribution for this amount.

Limited Liability Company (LLC): A limited liability company, commonly called an "LLC," is a business structure that fits somewhere between the partnership or sole proprietorship and the corporation. Like owners of partnerships or sole proprietorships, LLC owners report business profits or losses on their personal income tax returns; the LLC itself is not a separate taxable entity. Like a corporation, however, all LLC owners are protected from personal liability for business debts and claims -- a feature known as "limited liability."

Partnership: Partnerships are "flow-through" entities for federal income taxation purposes. Partners in a partnership split their income (or loss) each year and it is shown on their form K-1. Unlike with s-corporations, the income from a partners K-1 is subject to self employment taxes. So a partner working for the partnership does not have to take a salary like with an s-corp. In the absence of an election to the contrary, multi-member limited liability companies (LLCs), limited liability partnerships (LLPs) and certain multi-member trusts are treated as partnerships for United States federal income tax purposes. Certain non-U.S. entities may also be eligible for treatment as partnerships. Local jurisdictions may also impose their own taxes on entities taxed as partnerships at the federal level (e.g. New York City unincorporated business tax). Flow-through taxation means that the entity does not pay taxes on its income. Instead, the owners of the entity pay tax on their "distributive share" of the entity's taxable income. Federal tax law permits the owners of the entity to agree how the income of the entity will be allocated among them, but requires that this allocation reflect the economic reality of their business arrangement, as tested under complicated rules.

Sole Proprietorship: Sole Proprietors are individuals in business that did not form a separate legal entity. These show their income and deductions each year on a Schedule C attached to their personal tax returns. So sole proprietors file a DBA (doing business as). This allows the person operate (and open a bank account) under a different name (i.e. Harry's Hot Dog Hut). A DBA does not change anything legal or income tax purposes.

Multistate Taxation: Businesses operating in more than one state have to file a state tax return in all states in with they have a nexus. The rules vary from state to state but the main factors are sales, payroll and rent. If you have a sales presence, pay wages, or pay rent in a state , you may have to file there in addition to your home state. If you are subject to multi state taxation, your income is allocated between the states so the income is still taxed once on a state level.

Double Taxation: Many small business owners assume they are subject to "double taxation" if they have a corporation. In reality, no small businesses are subject to double taxation. Corporate double taxation is when a large, mainly publicly traded, company issues a dividend. In that case, the corporation pays tax on their income, then distributes the the after tax profits to their shareholders in the form of a dividend. The dividend then can be taxable to the individual receiving it, which would be double taxation. Small and midsized non-public corporations don't pay double taxation. Mainly the owners take a salary, which is a deduction to the corporation and they pay income tax on the personal level through a W-2..

John N. Vazzana, CPA is Brooklyn's premiere accountant for businesses and Not For Profits Corporations