This section discusses the major tax considerations for the sole proprietorship, partnership, and corporation.
For limited liability companies, the Internal Revenue Service has adopted rules (which appear in 26 C.F.R. 301.7701-1 et. seq.) that allow the organizer(s) to select the federal tax treatment for the LLC: either as a sole proprietorship or a corporation, in the case of LLCs with only one member; or as a partnership or a corporation, in the case of LLCs with at least two members. (The Minnesota Department of Revenue, in Revenue Notice 98-08, has stated that except for entities organized outside the United States and which have only one owner, which is a C corporation, the Department of Revenue will for Minnesota tax purposes respect the choice made under the Federal Regulations).
Thus because LLCs are treated as sole proprietorships, corporations, or partnerships, they are not specifically described in the following text. However a business is treated for federal tax purposes, it also will be so treated for state tax purposes. Detailed advice on specific situations should be obtained from a competent tax advisor.
Tax considerations addressed in this section include:
- Who is the Taxpayer?
- What Tax Forms Are Used?
- Tax Rates
- Tax Impact
- Selection of the Tax Year
- Compensation for Services
- Employment Taxes and Workers’ Compensation Insurance
- Employee Retirement Benefit Plans
- Fringe Benefits
- Capital Gains and Losses
- Net Operating Loss
- Estimated Tax Payments
- Disposition of Ownership Interest
Disclaimer: Both the Internal Revenue Code and Minnesota tax laws are periodically revised. Every effort has been made to incorporate these changes into this section. However, because of the complexity and potential impact of the changes, consultation with a professional advisor on any tax matter is highly recommended.
In a sole proprietorship, the taxpayer is the individual business owner. The proprietor is taxed on the entire net income from the business, regardless of whether the income is withdrawn for personal use or retained in the business. This is the case for both federal and Minnesota tax purposes.
The partnership itself is not a taxable entity. The partnership serves as a conduit through which income, deductions and credits are passed through to the individual partners. Each partner is taxed on his or her share as defined in the partnership agreement. All income of the partnership is taxed to the partners, whether or not it is actually distributed. The partnership itself files an information return which reports partnership income and distributions to the partners. This is the case for both federal and Minnesota tax purposes.
A corporation is a separate legal and taxable entity. For tax purposes, the corporation may be a “C corporation” (taxed under Subchapter C of the Internal Revenue Code and corresponding sections of Minnesota Statutes) or it may elect to be treated as an “S corporation” (taxed under Subchapter S of the Internal Revenue Code and corresponding sections of Minnesota Statutes). Both C corporations and S corporations file federal and Minnesota tax returns.
In a C corporation, the corporation itself pays tax on corporate profits. After taxes are paid, remaining corporate profits may be distributed to shareholders in the form of dividends. The shareholders are then taxed on the dividends they receive from the corporation. In general, an S corporation is taxed in a manner similar to a partnership; that is, the income, deductions and credits of the corporation are passed through to shareholders and are taxed to shareholders at their individual tax rates.
Note: It is possible that each of the above-listed entities, other than a sole proprietorship, may be subject to a Minnesota minimum fee. See the discussion of “Tax Rates,” which follows after the discussion of “What Tax Forms are Used?
CREDITS: This is an excerpt from A Guide to Starting a Business in Minnesota, provided by the Minnesota Department of Employment and Economic Development, Small Business Assistance Office, Twenty-eighth Edition, January 2010, written by Charles A. Schaffer, Madeline Harris, and Mark Simmer. Copies are available without charge from the Minnesota Department of Employment and Economic Development, Small Business Assistance Office.
This is also part of a series of articles on How to Pick the Right Business Entity Type. These articles help you select the right business type for your circumstances.