How a business is owned and taxed may help you decide which form of business is right for you.

Business Ownership vs. Self-Employed

All self-employed people are business owners, but not all business owners are self-employed. Here’s why: Business owners don’t get a paycheck or pay taxes as an employee unless they do work as an employee in addition to their business ownership. As a business owner (except for corporate shareholders) you aren’t taxed on the money you take out of the business. You are taxed on the net income (profits) of your business. Shareholders of a corporation are taxed on the dividends they receive. The IRS defines someone as being self-employed if they:

Carry on a trade or business as a sole proprietor or independent contractorAre a member of a partnership that carries on a trade or business, orAre otherwise in business for themselves, including a part-time business. 

This definition of being self-employed also includes owners of a limited liability company (LLC), because they are taxed as sole proprietors (single-member LLC) or partners (multiple-member LLC). Shareholders of corporations are not considered self-employed. Owners of S corporations are not self-employed, because they don’t pay self-employment tax (Social Security and Medicare tax) on their distributions from the business.

How Business Owners Take Money From Their Business

Many business owners believe they take money from their business as a “paycheck” or “salary.” But that’s not how the IRS sees it. Business owners take either a draw or a distributive share. A draw is money owners take from their business, moving that money into their personal account.  A distributive share is the share of income available to partners (and multiple-member LLC owners). This amount is determined by the partnership agreement or LLC operating agreement.  Corporate shareholders take money from their businesses as dividends. Dividends are payments of corporate profits to shareholders. The board of directors determines the timing and amount of dividends. 

The IRS Decides Ownership 

The IRS has spelled out in their regulations the way business owners are taxed based on the type of business and the owner’s position in the firm. Business owners can be taxed through their personal tax returns or they can be taxed on dividends they receive.

Partners in a Partnership

A partnership is a business in which two or more people have agreed to work together to run a company. Partners are regarded as owners of their business. Partners in this type of business are responsible for reporting the amount of taxable income from the business on their personal income tax. Each partner’s tax is determined is calculated and reported on Schedule K-1as part of the owner’s tax return. 

Limited Liability Company Members

A Limited Liability Company (LLC) is a company that is registered with the respective state’s office of the Secretary of State. Since the LLC isn’t recognized by the IRS as a taxing entity, LLC’s pay tax as other business types:

Multiple-member LLC owners pay taxes in the same way as partners in a partnership.A single-member LLC pays taxes in the same way as a sole proprietor.

Corporate Shareholders

A corporation is also registered with the state they operate in. It is regarded as a legal entity, similar to the way in which a person is regarded as a legal entity, and is taxed as an entity. If you own shares in the company, you are a shareholder and you receive your share of profits as dividends. These dividends are taxed in the year they are received.  if you also work in the firm, as an executive, for example, you are an employee and are responsible for reporting income tax on any salaries, wages, and interest on shares.

S Corporation Shareholders and Employees

An S corporation is a special kind of corporation with specific restrictions on ownership. An S corporation is formed by a corporation that elected to be taxed as an S corporation. S corporation owners may receive money in two ways:

As shareholders, owners receive distributions from the profits of the company.Some S corporation owners work in the business, and they are taxed as employees for this work.