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Federal Income Tax law will classify each Florida entity as one or more of the following: (1) Sole Proprietorship; (2) C Corporation; (3) S Corporation; (4) Partnership; and (5) Disregarded as an entity separate from its owner (a “Disregarded Entity”). The following chart displays the possible classifications for federal income tax purposes of each structure under which a Florida business entity may operate:
Sole Proprietorship. The Sole Proprietor is taxed on income earned and is liable for self-employment taxes. If the sole proprietorship has employees, it requires an Employer Identification Number (“EIN”). In addition, the sole proprietor annually assumes all income tax liabilities from his or her sole proprietorship. This done by (1) reporting profit or loss on Schedule C (Profit or Loss from Business) or Schedule C-EZ (Net Profit from Business); (2) attaching the schedule to Form 1040 (U.S. Individual Income Tax Return); (3) reporting the profit or loss on Form 1040; and (4) paying any resulting tax. The sole proprietor is liable for 100 percent of the self-employment tax on the income from his or her sole proprietorship. A sole proprietor may deduct 50 percent of the self-employment tax liability. Self-employment tax is composed of (1) the social security tax; and (2) the Medicare tax.
C Corporation: A C Corporation requires an EIN. Income from a C Corporation may be taxed twice: (1) on profits at the corporate level; and (2) the shareholder is taxed when they receive a dividend from the Corporation. The shareholder also is taxed when he receives wages from the C Corporation, but the C Corporation receives a deduction for paying the wages. Corporation shareholders, more often than S Corporation shareholders, can exclude from their gross income the amount paid for fringe benefits. Each taxable year, the Corporation must file Form 1120 (U.S. Corporate Income Tax Return), and individual shareholders of the Corporation report any dividends on Form 1040 and possibly Schedule B (Interest and Ordinary Dividends). In addition, each taxable year, to the extent the shareholder receives a Corporation dividends or wages, the shareholder reports the dividends or wages on Form 1040 and pays income tax on the dividends or wages. In the context of wages to shareholders in a Corporations, social security and Medicare taxes are collectively known as “FICA” taxes and the Corporation shareholder's will pay one half of the FICA obligation and the Corporation pays the other half of the FICA obligation.
S Corporation: A Florida Corporation will only be classified as an S Corporation if (1) if it meets statutory qualifications; and (2) if it makes a timely and valid election to become an S Corporation - IRS Form 2553 (Election by a Small Business Corporation). Statutory qualifications to become an S Corporation: 1. An S Corporation election is in effect for the year; 2. The entity is deemed to be a domestic corporation; 3. The entity’s shareholders are allowable shareholders, which include individuals, certain trusts, and estates, but do not include partnerships, corporations or non-resident aliens; 4. The entity has no more than 100 shareholders; and 5. The entity has one class of stock. Each year, the S Corporation files Form 1120S (U.S. Income Tax Return for an S Corporation), but the S Corporation is not liable for federal income taxes. Only the S Corporation’s shareholders are liable for federal income taxes. The S Corporation’s shareholders report their pro-rata amounts of the S Corporation’s annual profit or loss on Schedules K-1 (Form 1120S) (Shareholder’s Share of Income, Deductions, Credits, etc.) and on Forms 1040, and pay any resulting tax. The social security and Medicare tax consequences of an S Corporation are similar to those of a C Corporation. Wages, but not dividends, to the S Corporation shareholder are subject to FICA taxes. They are taxed at the same rate as wages to a C Corporation shareholder.
Partnership: A business taxed as a partnership requires an EIN. Each year the partnership files Form 1065 (U.S. Return of Partnership Income), but is not liable for federal income taxes on income earned in by the partnership. Instead, only the partners are liable for federal income taxes. They report their pro-rata amounts of the annual profit or loss on Schedule K-1 (Form 1065) (Partner’s Share of Income, Deductions, Credits, etc.) and on Forms 1040, and pay any resulting tax. All income to a partner that is taxed as a partnership is subject to self-employment taxes. A partner is liable for 100 percent of the self-employment tax on his or her income. A partner may deduct 50 percent of the self-employment tax liability.
Marc J. Soss, Esquire
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