Tax Basics: Types of Entities

There are two main types of business entities for taxes, we discuss them in this video:

The two main types are flow through entities and corporations. Flow through entities include sole proprietorships, partnerships, and LLCS. These entities don't pay taxes directly to the IRS, instead the income generated in these companies goes onto the owner's personal tax return (typically the 1040) and gets rolled up with everything else. The owner then pays taxes on the earnings regardless of the amount of those earnings they pull out of the business.

On the other hand corporations pay taxes directly to the IRS. And when we talk about corporations in this sense we are talking about c-corporations, s-corporations have flexibility on how they are treated. So a c-corporation will file their own returns, submit it to the IRS, and then pay taxes. Remember a corporation is completely separate from the owners. One drawback to this is that corporate income is considered to be "double taxed." Essentially the corporation pays taxes on the income, they also may distribute income in the form of dividends to their shareholders. If their shareholders receive dividends they must claim those on their personal tax returns and pay taxes on them. The income is taxed once at the corporate level and again at the personal level when paid in dividends.

So from a tax perspective it may initially seem that there are no benefits to having a corporation over a flow through entity, but that is not the case. Not only are there other tax differences we will not discuss today, but there are also legal differences such as liability that come into play here. It is always best to discuss the most advantageous business formation for your particular needs with a lawyer and an accountant.

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