Tax Consequences if Business Generates Income or Loss

What are the tax consequences if a business generates income or loss?

When a business generates income or loss, the tax ramifications for the business and the business owner will depend on the type of business entity selected. Some businesses pay taxes themselves on business income, while others act as conduit or pass-through entities, making their owners responsible for paying taxes on the business income. The concept of tax basis is also important when considering a business’s income or loss. Although myriad business entities exist, the following types will be covered here: C corporations, S corporations, partnerships, sole proprietorships, limited liability companies (LLCs), limited liability partnerships (LLPs), limited partnerships (LPs), and professional corporations (PCs).

Impact on specific business entities

Tax treatment will vary, depending on the type of business entity selected.

C corporations

For federal tax purposes, a C corporation is recognized as a separate taxpaying entity. Double taxation is involved, with corporate income being taxed once to the corporation when earned and again to the shareholders when distributed to them as dividends.

You need to be aware of how income is taxed, of how losses are treated, and of any additional taxes that may apply.

In general, the American Taxpayer Relief Act of 2012 permanently extended the preferential income tax treatment of qualified dividends and capital gains. Capital gains and qualified dividends are generally taxed at 0% for taxpayers in the 10% and 15% tax brackets, and at 15% for taxpayers in the 25% to 35% tax brackets. However, dividends and capital gains are generally taxed at 20% for taxpayers in the 39.6% tax bracket. Also, as a result of the Affordable Care Act of 2010, an additional 3.8% Medicare tax applies to some or all of the net investment income for married filers whose modified adjusted gross income exceeds $250,000 and single filers whose modified adjusted gross income is above $200,000..

S corporations

In effect, an S corporation conducts business as a regular corporation but is taxed similar to a partnership. The S corporation passes items of income, loss, deduction, and credit through to its shareholders, who report the items and calculate the applicable tax on their individual returns.

You should be aware of how income and losses are treated and how basis will be affected.

Partnerships

Like an S corporation, a partnership is a conduit or pass-through entity. It is important to understand how items are allocated to partners and how a partner’s basis is affected by pass-through items.

Sole proprietorships

Business profits and losses are reported on the owner’s personal tax return each year. The business does not file its own tax return. You need to understand how losses can be used to offset income and how to report income.

Limited liability company (LLC)

For federal tax purposes, an LLC with multiple owners can choose to be treated as a partnership or as a corporation. In general, LLCs choose to be taxed according to partnership rules to avoid the double taxation imposed on C corporations. You need to understand how income and losses are treated and reported.

An LLC with a single owner will be treated like a sole proprietorship for federal income tax purposes if it does not elect to be taxed as a corporation. However, you should be aware that some states do not recognize or permit LLCs with a single owner.

Limited liability partnership (LLP)

Most states allow certain professionals (like doctors, lawyers, and accountants) to form an entity similar to the LLC. This entity is called a limited liability partnership (LLP). You need to understand how income and losses are treated and reported.

Limited partnerships (LP)

Basically, limited partnerships (LPs) are taxed as partnerships for federal tax purposes. Income and losses pass through to partners, but recognition of losses is limited by certain factors.

Professional corporations (PC)

Professional corporations (PCs) are a special type of corporation composed of professionals. PCs often follow regular C corporation tax rules. However, PCs can sometimes choose to be treated as S corporations for federal tax purposes. Tax treatment of PCs varies, depending on a number of factors.

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