![]() Sole-Proprietorships and Single-Member LLCs: Schedule CĪs covered above, the income and expenses of sole proprietorships and SMLLCs are reported on Schedule C of IRS Form 1040. It's helpful to be familiar with the tax forms that are used by pass-through entities to business income to their owners. (For more information on LLCs choosing S Corporation status, see Why You Might Choose S Corp Taxation for Your LLC.) Why would an LLC, which is already a pass-through entity, elect S corporation status? As we'll explain below, S corporation status can result in savings on self-employment (Social Security and Medicare) taxes. LLCs can also elect to be taxed as S Corporations. S Corporation is a special tax status that corporations and LLCs can elect.Ī corporation that would be taxed as C corporation by default and subject to double-taxation can elect to be taxed as an S Corporation, which is a pass-through entity. S Corporations aren't actually a separate type of business entity. For more information on LLC taxation, read about how LLC members are taxed. As explained below, an LLC can elect to be taxed as an S corporation, but most multi-member LLCs are taxed as partnerships. The IRS treats LLCs with more than one owner ("multi-member LLCs") as partnerships by default. (LLCs owned by two spouses are considered SMLLCs.) LLCs with only one owner ("single-member LLCs" or " SMLLCs") are sole-proprietorships for tax purposes, with income and expenses flowing through to Schedule C of the member's personal tax return. All partnerships are pass-through entities. ![]() But partnership taxation remains a cornerstone of business taxation because LLCs with more than one owner are taxed as partnerships. Partnerships as business entities are not as popular as LLCs or corporations. Schedule C serves as the profit and loss statement for the business's tax purposes. The IRS treats sole-proprietorships as "disregarded entities," which means that the owner reports business income and expenses directly on Schedule C of their personal tax return. (More on LLCs below.) Sole Proprietorships as Pass-Through Entities LLCs afford limited liability protection to owners while being taxed at only the individual level. Jane would be responsible for taxes owed on income that she didn’t actually receive.With sole proprietorships, LLCs, partnerships, and S corporations, business income flows through to the business owners and is taxed only at the individual level.Īvoiding double taxation is a major reason for the explosion in popularity of LLCs in recent decades. There’s also a possibility that it won’t make a distribution next year. Jane owes the IRS $40,000, but XYZ did not make a distribution during the previous year. Occasionally, pass-through income isn’t actually distributed to shareholders, leaving the owners with a tax burden (but no cash with which to pay it).įor example, assume that Jane's tax burden ends up being 20% of $200,000 for the previous tax year. Why Is Pass-Through Income Important?ĭepending on a company’s operations, pass through income can make for a complicated tax situation. Note: Losses are also passed through to owners, but the total available deductible is limited to the original investment amount. It is important to note that Company XYZ allocates the income to Jane and Bill regardless of whether the $400,000 of net income is actually distributed. Jane and Bill each file their own tax return with $200,000 reported as income. XYZ sends both Jane and Bill an IRS Schedule K-1 that reports their portions of XYZ's pass-through income. XYZ has two owners, Jane and Bill, who each own 50% of the company. It files a tax return that looks like this: ![]() ![]() Pass-Through Income ExampleĬompany XYZ is a pass-through entity. These special business structures help to reduce the effects of double taxation.īecause income isn’t taxed at the corporate level, tax liability is passed on to the owners. Pass through income is sent from a pass-through entity to its owners.
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