Business Entities Overview (2025)

Entity Types

Sole Proprietorship

• Owner reports income/expenses on Schedule C (or Schedule F for farming)
• Net earnings ≥$400 → pays SE tax (15.3%) on Schedule SE
• Unlimited personal liability
• Can hire spouse (special FICA rules apply)
• OBBBA (2025): Self-employed individuals may qualify for qualified tip deduction up to $25,000/year, limited by net profit and SSTB restrictions, reported on new Schedule 1-A

Partnerships (General)

• Form 1065 filed annually (due March 15, or 3rd month after FYE)
• Schedule K-1 to each partner for their share of income/deductions/credits
• No entity-level tax; income flows through
• General partners: pay SE tax on share. Limited partners: SE tax only on services rendered to partnership (guaranteed payments for services)
• Husband-wife: can elect Qualified Joint Venture (file two Schedule C's instead of 1065) — only for MFJ couples, both must materially participate, must be only owners
• OBBBA (2025): Transactions where partner provides services or transfers property to partnership in non-partner capacity are treated as with a third party (§707(a) clarification)

C Corporations

• Taxed at 21% flat rate (TCJA permanently repealed graduated rates and corporate AMT)
• CAMT (IRA 2022): 15% minimum tax on adjusted financial statement income (AFSI) — only applies to corporations with average annual financial statement income >$1 billion over prior 3 years
• Dividends taxed to shareholders → "double taxation"
• Retained earnings: not taxed to shareholders until distributed
• Form 1120 due April 15 (can use fiscal year)
• Must pay quarterly estimated taxes (April 15, June 15, Sept 15, Dec 15)
• C corp shareholder-employees eligible for tax-free fringe benefits (health insurance, etc.)

S Corporations

• Pass-through taxation (like partnerships)
• Max 100 shareholders (family members + estates can elect to count as ONE; all US citizens/residents)
• One class of stock only (voting rights can differ)
• Form 1120-S due March 15
• Shareholder basis tracked for losses/distributions (Form 7203)
• Must pay reasonable compensation to shareholder-employees before distributions
• 2025 late filing penalty: $255/month per shareholder, max 12 months

LLCs

• State-law entity, not federal tax classification
• Single-member LLC: disregarded (Schedule C) by default
• Multi-member LLC: partnership (Form 1065) by default
• Can elect C-corp (Form 8832) or S-corp (Form 2553) treatment
• PLLC: Professional LLC for licensed professionals, state-specific restrictions

Entity Classification Election

• Form 8832: Entity can elect tax classification (e.g., LLC electing C-corp status)
• Form 2553: Elect S-corp status
• Election effective date: no earlier than 75 days before filing date, no later than 12 months after filing date
• After changing classification, generally cannot change again for 60 months (5 years) — exception for initial election of newly formed entity effective on formation date
• New EIN required when: sole prop/partnership converts to corporation, sole prop becomes partnership, bankruptcy (Ch. 7/11), old partnership terminated and new one created, pension plan established, owner dies and estate takes over business
• New EIN NOT required for: name/address change, adding locations, sole proprietor operating multiple businesses

Tax-Exempt Organizations

• §501(c)(3): Charitable, religious, educational — donors get deductible contributions
• Must apply for recognition (Form 1023/1024), churches exempt from filing
• Cannot be organized as partnership or sole proprietorship
• Form 990 series for annual reporting
• Unrelated Business Income Tax (UBIT) on non-exempt activities
• 21% excise tax on excess executive compensation >$1,000,000 per covered employee (one of top 5 paid; once covered, always covered)
• Form 990-T required if unrelated business gross income ≥$1,000

Key Reporting Forms

Employer Identification Number (EIN)

Required when: paying employees wages, operating as corporation/partnership/exempt org/trust/estate, filing employment/excise tax returns, withholding nonresident alien tax, establishing pension plan. Sole proprietors with no employees may voluntarily obtain EIN to protect SSN. Apply online (immediate) or Form SS-4.

Worker Classification

IRS uses three-factor test (Form SS-8 for IRS determination):

• Behavioral control: Does business have right to direct HOW work is done? (instructions, training)
• Financial control: Does business control financial/business aspects? (unreimbursed expenses, investment, profit/loss opportunity)
• Relationship type: How do parties view relationship? (written contract, benefits, permanency)

Employing Family Members

Employment Taxes

FICA (2025)

• OASDI (Social Security): 6.2% employer + 6.2% employee on first $176,100 (max $10,918.20 each)
• Medicare: 1.45% employer + 1.45% employee — no wage base limit
• Self-employed: 12.4% SS + 2.9% Medicare = 15.3% (deduct half on Schedule 1)
• Additional Medicare Tax: 0.9% on earned income exceeding thresholds (no employer match):
  • MFJ: $250,000 | MFS: $125,000 | Single/HOH/QSS: $200,000
  • Employer must withhold 0.9% on wages >$200,000 (regardless of filing status)
  • Self-employed cannot deduct the additional 0.9% portion

FUTA (2025)

• 6.0% on first $7,000 per employee (max $420/employee)
• Credit up to 5.4% for state unemployment taxes paid → effective rate 0.6%
• Employer-only tax (not withheld from employee)
• Reported on Form 940 (annual, due Jan 31; Feb 10 if timely deposits made)

Filing Forms

• Form 941: Quarterly wage/tax reporting (Apr 30, Jul 31, Oct 31, Jan 31)
• Form 944: Annual return for small employers (annual liability ≤$1,000)
• EFTPS: Electronic deposit required for all federal tax deposits (2025: Direct Pay for Businesses also available)

Trust Fund Recovery Penalty (TFRP)

100% penalty on responsible persons who willfully fail to remit withheld employee taxes (SS, Medicare, income tax withholding).

• Responsible person: signs checks, has authority over business funds (officers, directors, owners, payroll managers)
• Willful: knew taxes weren't being paid but used funds for other purposes (paying other creditors instead of taxes)
• Penalty equals total unpaid withholding taxes