Business Entities and their Income Tax Differences C corporations incur income tax expense (federal and state) at the business-entity level; a second level of income taxes are incurred at the C corporation owner level when after-tax net income is distributed in the form of dividends.
This article was published by Fischer Barr & Wissinger LLC (FBW), now part of CBIZ Marks Paneth LLP.
C corporations incur income tax expense (federal and state) at the business-entity level; a second level of income taxes are incurred at the C corporation owner level when after-tax net income is distributed in the form of dividends. Pass-through entities (PTEs), such as S corporations, limited liability companies (LLC), partnerships and sole proprietorships, do not incur any business-entity level income taxes. Income taxes on PTE income are only incurred one time, at the owner level. The avoidance of a second level of income taxes provides a strong incentive for business owners to form their companies as a PTE. As a result of this and other incentives, approximately 78% of all businesses filed income taxes as a PTE during 2012, with approximately 22% of businesses filing as C corporations.
PTEs typically provide their owners with the funding necessary to pay their individual income taxes on the taxable income passed-through to them from the business. Such funding may be classified as dividends, compensation and/or loans. Accordingly, C corporation financial statements may contain current and deferred income tax expenses, and assets and liabilities not found on PTE financial statements; PTE financial statements may contain dividends, higher shareholder compensation and loans not found on C corporation financial statements. These factors complicate the comparability of a PTE’s financial statements with C corporation financial statements. Moreover, if owner income taxes are funded by dividends in one year, owner compensation in another year and loans in another year, the subject company’s year-to-year financial position and results of operations may not be entirely comparable.
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