Question

Partnerships and C-Corporations are both entity choices a taxpayer has when deciding how to form their business. Identify and explain some of the similarities and differences between the entities

a. Identify and explain some of the similarities and differences between the entities in how the net income is taxed at both the entity and the owner level.

b. Identify and explain some of the similarities and differences between the entities in how liquidating distributions are taxed at both the entity and the owner level.

Answer 1

PARTNERSHIP: A partnership is an arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, businesses, interest-based organizations, schools, governments or combinations.

C-CORPORATIONS: A C corporation, under United States federal income tax law, refers to any corporation that is taxed separately from its owners.

DIFFERENCE

Entity level

A corporation is a legal entity that is separate from the owners for tax purposes. According to the IRS, the corporations pay income taxes on profits when they are earned. Unlike the owners of partnerships, shareholders are not responsible for paying taxes on the profits a corporation earns.  A partnership is not a legal entity that is separate from the owners and therefore the partnership itself does not pay taxes.

Partnerships must file a tax return to report losses and profits to the Internal Revenue Service, and general partners include their share of profits and loss in the return. Corporations are required to pay state and national taxes, and shareholders must also pay taxes on their salaries, bonuses and dividends. The corporate tax rate is usually lower than the individual income tax rate, according to the SBA.

Owner level:

The Internal Revenue Service says that under a partnership structure, the profits a business earns flow directly to the personal income tax returns of the owners. For example, if a partnership with two owners makes $500,000 in profit and the owners split profits equally, each would have to report $250,000 in income on their personal tax returns. Partners are responsible for paying self-employment taxes on business income.

C corporation income is also subject to what is called “double taxation,” when the income of the business is distributed to the owners in the form of dividends, because dividends are taxable. Tax is paid first by the corporation on its income and then again by the owners on the dividends received. If the owner draws a salary from the corporation, that salary is also subject to income tax (and FICA).

SIMILARITIES:

In both the partnership and c- corporation the taxes are filed in the form 1040. The similarity between these entities is that they are both owned groups of people instead an of individual.

b. Difference:

entity level:

Upon liquidation of a partnership, the Internal Revenue Service views the distributions as a sale of a partnership interest; as a result, gains are generally taxed as long-term capital gains to partners.

The sale of assets results in taxable gains and losses for the corporation that must be calculated on an asset-by-asset basis. Most gains and losses are then reported on an IRS Form, which is filed with the corporation’s Form 1120, U.S. Corporation Income Tax Return, for the year of sale.If the corporation has loss or tax credit carryovers, they can be used to offset gains and taxes resulting from the asset sale. However, if the corporation’s assets are highly appreciated, there may be substantial corporate-level income taxes to pay.

Owner level:

partners who have held an interest in the partnership for more than one year as of the date of a liquidating distribution will pay lower rates of tax on the gain than they do on a partnership's operating profit.

For federal income tax purposes, each shareholder’s receipt of the liquidating corporate distribution amount is treated as a sale of all the shareholder’s stock in exchange for the distribution.This means each shareholder must recognize a taxable gain (or loss) equal to the difference between the distribution amount and the shareholder’s basis in the stock relinquished in the liquidating transaction.