ABA Family Legal Guide

Forming and Operating a Small Business

Types of Business Organizations

Corporations

How are corporations taxed?

Anyone thinking of setting up a corporation--or any other form of business--ought to be concerned with how their choice of business form affects the taxes they'll have to pay. For partnerships and sole proprietors, the company isn't taxed per se, but rather tax obligations are simply passed through to the owners. This results in income being taxed only once.

A corporation is a separate taxable person and faces double taxation: a tax on the earnings of the corporation as an entity and a tax paid by the shareholder on dividends paid by the corporation.

Fortunately, there's a way around this for most small corporations--if they meet the requirements of Subchapter S of the Internal Revenue Code and choose to be taxed under this section. There are two subchapters in the Internal Revenue Code that govern corporations. One is Subchapter S, which small corporations meeting certain criteria can choose; corporations that meet the requirements of this subchapter are known as S corporations. The other is Subchapter C, under which many corporations, including large corporations, operate; corporations meeting its criteria are known as C corporations.