Building Your Business Business Taxes How Various Types of Businesses Pay Income Tax By Jean Murray Jean Murray Facebook Twitter Jean Murray, MBA, Ph.D., is an experienced business writer and teacher who has been writing for The Balance on U.S. business law and taxes since 2008. She has taught accounting, business law, and business finance at business and professional schools for over 35 years, has authored several books on saving money and simplifying your business, and was the owner of startup-focused company Emence Enterprises, LLC. learn about our editorial policies Updated on August 19, 2022 Share Tweet Pin Email In This Article View All In This Article Pass-Through Businesses and Income Taxes Self-Employment Tax for Business Owners How a Sole Proprietor Pays Income Tax How a Partnership Pays Income Tax How a Limted Liability Company (LLC) Pays Income Tax How a Corporation Pays Income Tax How an S Corporation Pays Income Tax Frequently Asked Questions (FAQs) Photo: Maskot / Getty Images An important consideration when you're deciding what type of business to form is how each one of them pays income taxes. The process is different for each, sometimes markedly so, and types of business taxes can have a significant impact on your personal tax return. Key Takeaways Business are taxed based on their structures. Generally, the business pays taxes if it's a corporation and it doesn't if it's a pass-through entity. Pass-through entities include S-corporations, sole proprietorships, limited-liability corporations (LLC) and partnerships.Traditional corporations pay taxes on their income, while shareholders pay taxes on any dividends or stock sales. Pass-Through Businesses and Income Taxes Some businesses pass their earnings and losses to their owners, who pay income taxes on their share of the business's taxable income. These are called "pass-through" taxes. Businesses that are pass-through tax entities: Sole proprietorshipsLimited liability companiesPartnershipsS corporations Note C-corporations and traditional corporations are not pass-through businesses. Here's an explanation of how pass-through taxes work: The business gathers information about its income, deductions, tax credits, and other information and prepares its tax return.Those calculations produce a net income figure.The income tax on the net income is divided between the owners based on their share of the business. If you are the only owner of the business (sole proprietors and single-member LLCs), you'll pay taxes on the entire net income.The amount of taxable income is included on a special report form. This form is different for each type of pass-through business.This business tax amount from the form is included on the individual owner's tax return, along with other income and expenses. Self-Employment Tax for Business Owners Owners of pass-through businesses also must pay self-employment tax (Social Security/Medicare tax) on their business income. S corporation owners are an exception; they don't have to pay self-employment tax. How a Sole Proprietor Pays Income Tax A sole proprietorship is the simplest form of business in the U.S. You're a sole proprietor if you're self-employed or an independent contractor unless you've registered as another form of business entity. A sole proprietorship is more or less formed by default when you don't take steps to register as another type of enterprise but you're in business for yourself. Sole proprietors complete Schedule C to determine their taxable business income after deductions. The income resulting from Schedule C is transferred to the owner's personal tax return and tax is paid at the owner's personal tax rate. Sole proprietors must also file Schedule SE and pay the self-employment tax—the equivalent of the Medicare and Social Security taxes that would otherwise be shared with their employer if they worked for someone else. You should make quarterly estimated tax payments throughout the tax year if you're a sole proprietor because the IRS prefers that you pay as you earn. This involves filing Form 1040-ES. How a Partnership Pays Income Tax A partnership is a result of two or more individual taxpayers joining together for business purposes, and they share in both the profits and the losses of the business. Partnership businesses don't pay income tax directly to the IRS. Rather, the partners are taxed on their shares of the partnership's income. Partnerships calculate their business income or loss on Form 1065, and the individual partners then receive Schedule K-1's showing their shares of this income. Schedule K-1 is included with the owner's personal tax return and taxes are paid at the owner's personal tax rate, just as they would be if they were sole proprietors. Partners must also pay the self-employment tax and make quarterly estimated tax payments. How a Limted Liability Company (LLC) Pays Income Tax The IRS will recognize LLCs as a corporation, partnership, or a "disregarded entity," which means the LLC's taxes are part of the owner's tax return. This can depend on how many owners the business has (referred to as "members"). Members can be individuals or other business types, such as a corporation. A member in a single-member LLC files taxes as a sole proprietor does, using Schedule C and Schedule SE. As with a sole proprietorship, the income of the business is transferred to the member's personal tax return. LLC members should also pay quarterly estimated taxes. Note A multiple-member LLC files taxes as a partnership, with individual member shares reported on Schedule K-1. It can also file Form 8832 and elect to be treated as a corporation for federal tax purposes. How a Corporation Pays Income Tax A corporation is its own separate tax entity, and it pays income tax at the corporate tax rate. The owners of the corporation are shareholders, and they receive income in the form of dividends. They pay taxes on this income at the dividend rate. This can result in double taxation. The business is paying taxes on its earnings at the corporate level, and shareholders are again paying taxes on the dividends they receive. Capital gains on the sale of shares can also be taxed at the individual level. Some shareholders might also be executive employees of the corporation. These employees receive a salary and this income is taxed just as it would be for any other employee. Note A corporation reports and files its taxes on Form 1120. How an S Corporation Pays Income Tax An S corporation passes income, taxes, credits, and deductions down to its owners. The owners pay taxes at their personal tax rates. The S corporation does not itself pay taxes, unlike a corporation, so there's no double taxation. The tax paid by the owners or shareholders is determined by the total amount of the tax that would be owed by the S corporation were it required to pay taxes. This total is then divided among the shareholders based on their percentages of ownership. The corporation files a tax return using Form 1120-S to report income passed down to shareholders, and individual owner shares are reported on Schedule K-1. Frequently Asked Questions (FAQs) Which type of tax is paid by businesses? In general, businesses pay taxes on their net income. However, who pays those taxes depends on the structure of the business. For example, income tax is passed on to the owners or partners in sole proprietorships, LLCs, S-corporations, and partnerships. How do taxes work for small business owners? If your business is a sole proprietorship and you're an independent contractor, for example, then you'll include on your personal tax return the tax that your business owes (if any). The same rule apply if you're a single-member LLC. If your business is a partnership, S-corporation, or mutli-member LLC, the tax liability is split between the owners or shareholders. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Tax Policy Center. "What Are Pass-Through Businesses?" Cornell Law School Legal Information Institute. "Pass-Through Taxation." IRS Video Portal. "Businesses: Lesson 1—Federal Taxes and Your New Business." Wolters Kluwer. "Overview of Tax Implications of LLCs and Corporations." IRS. "Instructions for Form 1120-S U.S. Income Tax Return for an S Corporation." Page 22. IRS. "Sole Proprietorships." IRS. "Partnerships." IRS. "Limited Liability Company (LLC)." IRS. 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