Business entity types compared for US tax
For federal income tax, a business is taxed in one of two ways: it is either a pass-through, where the income lands on the owners’ own returns, or a separate taxpayer, as a C corporation. Sole proprietorships, partnerships and S corporations are pass-throughs; a C corporation pays its own tax. An LLC has no tax identity of its own, because it takes the treatment of whichever type it defaults to or elects. The decision rule: identify the legal form, apply the default classification, then check whether an election (Form 8832 or Form 2553) changed it. This guide describes the rules as published by the IRS for 2025 returns; the sources are linked where each rule appears.
Comparison grid
| Entity | Taxed as | Return filed | Owner-level reporting |
|---|---|---|---|
| Sole proprietorship | The owner (not separate) | Form 1040 with Schedule C | Net profit is taxed to the owner, who also pays self-employment tax on Schedule SE |
| Partnership | Pass-through | Form 1065 | Each partner gets a Schedule K-1 and reports a share |
| C corporation | Separate taxpayer | Form 1120 | Shareholders are taxed again on dividends |
| S corporation | Pass-through | Form 1120-S | Shareholders report income, losses, deductions and credits on their own returns |
| Single-member LLC | Disregarded entity by default | Owner’s return, e.g. Schedule C | Same as a sole proprietor unless it elects corporate treatment |
| Multi-member LLC | Partnership by default | Form 1065 | Same as a partnership unless it elects |
Sources: Sole proprietorships, Publication 541 (12/2025), Partnerships, Publication 542 (01/2024), Corporations, S corporations, Limited liability company.
Rules that separate the entities
Sole proprietorship. An unincorporated business with one owner. The owner reports profit on Schedule C and pays self-employment tax on it. A sole member of an LLC that elects corporate treatment is not a sole proprietor.
Partnership. The partnership generally pays no income tax. It passes profits and losses to partners. Guaranteed payments, made to a partner regardless of partnership income, are generally deducted by the partnership and reported as ordinary income by the partner. An unincorporated organisation of two or more members running a business and dividing profit is generally a partnership; one that only shares expenses is not.
C corporation. The corporation figures tax on taxable income at a flat 21%, per Publication 542, on Form 1120. When it pays dividends, shareholders report them on their own returns, which is the double tax.
S corporation. A domestic corporation with no more than 100 shareholders and one class of stock that is not an ineligible corporation (such as certain financial institutions and insurance companies). Shareholders must be individuals, certain trusts or estates; partnerships, corporations and nonresident aliens are not allowed. The corporation elects on Form 2553, signed by all shareholders. It can still owe tax on certain built-in gains and passive income.
LLC. An LLC is a state-law form. A single-member LLC is disregarded for income tax unless it elects to be taxed as a corporation on Form 8832, though for employment tax and certain excise taxes it is still treated as a separate entity. An LLC with two or more members is a partnership by default. An eligible entity that timely files Form 2553 is treated as having elected to be classified as a corporation (Treas. Reg. §301.7701-3(c)(1)(v)(C)), so no separate Form 8832 is needed to become an S corporation. The effective date of a Form 8832 election generally cannot be more than 75 days before the filing date or more than 12 months after it.
One business, four ways to be taxed
Mia earns 120,000 of net profit from a design business she owns alone. As an unincorporated sole proprietor she reports the whole profit on Schedule C and pays self-employment tax on it. Forming a single-member LLC changes nothing for income tax, because the LLC is disregarded. If the LLC elects S status, the business files Form 1120-S, and the profit flows to Mia on a Schedule K-1; as a shareholder-employee she must also receive reasonable compensation as wages before taking non-wage distributions, and the IRS can reclassify distributions as wages when the salary is too low. If the LLC instead elects C corporation treatment on Form 8832, the company files Form 1120, pays tax at 21% on its profit, and Mia is taxed again on any dividend. The legal form stayed an LLC in every case; only the tax classification moved. For the individual side of the same facts, see filing status.
Which exams test this
| Exam | How the topic appears | Covered on this site |
|---|---|---|
| SEE Part 2 | Domain 1, Business Entities and Considerations (30 of 85 scored questions): sole proprietorships, partnerships, corporations, S corporations and LLCs, default classifications and elections, S corporation eligibility and election. Domain 2, Business Tax Preparation, adds choosing an entity (benefits and drawbacks) when advising a business client | Business entities explained and business tax preparation |
| SEE Part 1 | Minor, indirect: Income and Assets lists pass-through income from Schedule K-1 (income, deductions, basis, QBI items), so the entity type matters only from the owner’s side of an individual return | Income and assets |
How exam questions are built
The question gives a legal form and a hidden election. Typical traps:
- Default versus elected. Read for “has never filed an election” or “filed Form 8832”; the answer changes with it.
- Form number to entity. 1065 partnership, 1120 C corporation, 1120-S S corporation, Schedule C sole proprietor or disregarded entity.
- S corporation eligibility. One disqualifier is enough: a partnership shareholder, a nonresident alien, a second class of stock, more than 100 shareholders.
- “Separate entity” for employment tax. A disregarded LLC still has its own employment tax obligations.
- Pass-through does not mean untaxed. The owners are taxed; the entity usually is not.
Practice questions
Question 1. Jonas is the only member of a domestic LLC. The LLC has never filed Form 8832 or Form 2553. How is it treated for 2025 federal income tax, and how does Jonas report its profit?
- A. As a partnership, on Form 1065
- B. As a disregarded entity, on Schedule C of his Form 1040
- C. As an S corporation, on Form 1120-S
- D. As a C corporation, on Form 1120
Show answer
Answer: B
A single-member LLC is disregarded as separate from its owner for income tax unless it elects corporate treatment, so the profit goes on Jonas’s Form 1040, typically on Schedule C. The LLC does not file Form 1065, which needs two or more members. It is not an S or C corporation without an election.
Question 2. A corporation with 40 individual shareholders wants to make an S election, but one shareholder is a partnership that owns 10 percent of the stock. What is the effect?
- A. The corporation is ineligible while a partnership holds shares
- B. The election is valid because 40 is under 100 shareholders
- C. The election is valid if the partnership holds under 20 percent
- D. The election is valid if all shareholders sign Form 8832
Show answer
Answer: A
S corporation shareholders must be individuals, certain trusts or estates. A partnership shareholder makes the corporation ineligible until it is removed, even though the corporation is under 100 shareholders and the election is filed on Form 2553. Reasonable compensation and the size of the stake are not the issue.