Single vs. Double Taxation

Single vs. Double Taxation

Transcript:

There are 2 main types of taxation for businesses. Flowthrough/ Passthrough, single taxation on one hand and double taxation on the other. Partnerships, sole proprietorships, limited liability companies, and subchapter S corporations are passed through, while C corporations are subject to double taxation. Flow-through taxation means that at the entity level there is no income tax.

Instead, profits and losses flow through to the owners, when the business pays dividends to the owners. Those owners will have to pay taxes on the distribution, but the business does not pay taxes on those profits before their due date.

Double taxation means that the profits are taxed twice. The entity pays taxes on profits and the shareholder pays taxes on their distributions of those profits. Even after the corporation has already paid taxes on those very same profits.

Tax classifications and designations are elections not necessarily entity types. A limited liability company can be taxed as a Partnership, disregarded entity, or S-corp and corporations can be taxed as C-corps or S-corps as long as they meet eligibility requirements. It may seem like an easy call to make between being taxed once or twice, but there are some factors that weigh more than the weight of the other like S-corp eligibility, the complications presented by a partnership accounting and the tax burden of proportionate profits, weather the company actually pays distributions or not.

This is why a well-drafted operating agreement will require managers to make taxed distributions to the members each year to cover tax obligations of phantom income that is earned and allocated but not distributed.

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