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Differences Between a Corporation & Partnership for Taxes

Differences Between a Corporation & Partnership for Taxes

When starting a business, one of the first decisions you'll face is what type of business to register for. The type of business you choose will affect your taxes, obligations, and the way your business is run. If you're unsure of which business structure to choose, reviewing five critical differences between a business and a partnership can help you choose the best option for your business.


The structure of partnerships and corporations

Partnerships and corporations differ in their structures, with corporations being more complex and involving more people in the decision-making process. A corporation is an independent legal entity owned by shareholders, where the shareholders decide how the company is managed and by whom. A partnership is an activity in which two or more people share the property.

In general, all management functions, expenses, responsibilities, and profits are divided between two or more owners. In limited partnerships, general partners share ownership responsibilities, and limited partnerships only act as investors.


Business creation costs

Corporations are more expensive and more complicated to form than partnerships. Starting a business involves a large number of administrative costs and complex legal and tax requirements. Businesses must file articles of incorporation and obtain state and local licenses and permits. Corporations often hire lawyers to help them with this process.

The US Small Business Administration advises only large, well-established corporations with multiple employees to form a corporation. Partnerships are cheaper and easier to form. Partners must register the business in the state and obtain local and state licenses and business permits.


Liability of partnerships and corporations 

Within partnerships, the general partners are responsible for all the legal obligations and obligations of the company. The assets of the general partners can be used to pay the debts of the company. Partnerships often include partnership agreements that define exactly the percentage of business for which each general partner is responsible, and the percentage may vary from partner to partner.

On the other hand, corporations are not liable to individuals for the company's debts or legal obligations. The company is considered a separate entity, and therefore the company itself is responsible for meeting all legal debts and fees, and shareholders do not risk losing personal property.


Taxation of partnerships and corporations

According to the United States Small Business Administration, partnerships do not have to pay corporate tax, but profits and losses are "passed on" to individual general partners. Partnerships must file an income tax return to report profits and losses to the Internal Revenue Service, and general partners include their share of the profit and loss of the return. On the other hand, a corporation must pay national and state taxes, and shareholders must also pay taxes on salaries, bonuses, and dividends. The income tax rate is generally lower than the personal income tax rate, according to the SBA.

  • Corporation Tax Rules: A corporation is a business that belongs to a group of shareholders who buy shares of the corporation. A corporation is a legal person separate from its owners for tax purposes. According to the IRS, businesses pay income tax when they are earned. Unlike business owners, shareholders are not responsible for paying taxes on a company's profits. The shareholders of the company are not subject to tax on their own account.

  • Partnership Tax Rules: A partnership is a business structure in which a business's ownership and administrative responsibility are split between two or more people. A partnership is not a separate legal entity from the owners, and therefore the corporation itself does not pay taxes. The IRS says that a company's profits flow directly into the owners' tax returns in a partnership structure. For example, if a partnership with two owners generates $700,000 in profits and the owners share the profits equally, each would have to report an income of $350,000 on their personal tax return. Partners are responsible for paying their taxes on business income.

 

Management of partnerships and Corporations

Corporations have complex management structures than Partnerships. In a partnership, all the general partners decide how the business is run. General partners typically take on leadership responsibilities or share the decision to hire and supervise managers.

Corporations are governed by shareholders, who hold regular meetings to determine the company's direction and policies. Shareholders do not generally participate in the company's day-to-day management but supervise the directors who manage it.


Liability of owners

Another important difference between a corporation and a partnership is the owners' liability for the business's debts. In businesses, owners are legally responsible for the debts of the business. If a partnership fails, partners may have to pay creditors with their resources. The shareholders of the company are not responsible for the debts of the company. In other words, if a corporation closes, shareholders will not be liable for any debts or taxes owed by the company.


Conclusion 

A dividend is a payment in cash or in shares that a company pays to shareholders. Although corporate shareholders do not pay corporate income tax, they pay taxes on the profits that the company distributes in the form of cash dividends. Additionally, if a shareholder sells shares of a company that has increased in value over time, they must pay capital gains tax on profits from the sale of shares.


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