How Different Business Entities Are Taxed

Under federal and state tax rules, there are two different types of business income tax treatment: pass-through taxation and corporate tax treatment. With pass-through taxation, the business’s profits and losses “pass through” to the owners of the business, who include the profits or losses on their individual tax returns. With corporate taxation, the business is taxed as a separate entity from the owners, who pay taxes on any salary or dividends they receive from the corporation. 

There are advantages and disadvantages to the two different tax classifications. Which business form you choose will decide the tax treatment for your business. Each business entity--sole proprietorship, partnership, limited liability company, and corporation--has a default tax treatment (although in some cases this can be changed). It is important to understand the differences so you select the business form that provides the most favorable tax treatment for your business and situation.