Any successful small business will have to pay taxes, but the way your business income is reported and taxed will vary depending on the type of entity you’ve chosen for your business.
A sole proprietorship is the simplest type of business. It’s just you, and your business income and expenses are reported on Schedule C of your personal income tax return.
A single-member LLC is generally treated like a sole proprietorship for income tax purposes. However, you can choose to have an LLC taxed as though it were a corporation.
A partnership files an informational tax return. The income or loss of the partnership is then divided among the partners and reported on their individual tax returns.
A multi-member LLC is taxed in the same way as a partnership, unless it elects to be taxed as a corporation.
All of these are called “flow-through” entities because the income of the business “flows through” to the owners’ personal income tax returns.
A C Corporation files its own tax return and pays tax on its income. If distributions are made to shareholders, the shareholders report that income on their personal returns and pay tax on it. This may mean that a small business is taxed on its profits, and then its owners are taxed again on the portion of the profits that they take home. This double taxation is the reason that many small businesses choose not to be taxed as C corporations — though in some instances a C corporation is the best choice.
A corporation that meets certain criteria can elect to be taxed as an S Corporation. S corporations are not taxed separately from their shareholders; instead, the shareholders are taxed on their share of the S corporation’s taxable income.
So what’s best for your business? It depends on your particular situtation, and there simply isn’t one rule that will work for everyone. For that reason, you should seek advice from a legal or tax professional when planning or reevaluating your business.
