Corporations and partnerships are both business entities, or ways of organizing a business structure. A corporation is an independent entity, while a partnership operates under the auspices of its partners. Corporations and partnerships are subject to different taxation schemes, but some types of corporations can reap the advantages of partnership-type taxation while maintaining their status as an independent legal entity.
A corporation is an independent legal entity, separate from its owners. A corporation is considered a legal person for many purposes, including its ability to sue and be sued and assert legal rights. Like other legal persons, a corporation is also a taxpayer. A general corporation -- known as a C corporation -- is required to file a tax return in its own name and pay corporate taxes separate from the personal income taxes paid by its owners.
Although a partnership is considered a business entity for purposes of business organization and operation, the Internal Revenue Service considers a partnership to be a relationship between two or more people - rather than an independent entity - for purposes of taxation. A business formed as a partnership is really the alter ego of its owners and does not exist as a separate legal person. In other words, for taxation purposes, the IRS disregards the existence of the partnership.
A disregarded entity does not pay taxes as a business entity. Instead, it passes its profits and losses through the entity to the owners. Partnerships are pass-through businesses because the partners report their portion of the business profit or loss on their personal income tax forms.
Double taxation describes how C corporation profits are taxed twice, once at the corporate level and once at the personal level. Because corporations are independent entities, they must file their own tax returns and pay taxes on profits. Then, those profits are distributed to the corporation's shareholders, who pay income tax on the profits as unearned income. C corporations can minimize their double-taxation burden by paying out salaries and expenses to reduce corporate profit.
Corporations that elect to have S corporation status continue to be independent legal entities, but have taxation advantages similar to those of a partnership. Corporations that opt for S corporation status are pass-through entities, even though they maintain their independent corporate entity status. An S corporation is limited to 100 individual shareholders and one class of stock, so it may not be appropriate for all businesses. However, S-corps have the advantage of avoiding double taxation by passing their income, losses and deductions through to their shareholders.
Limited Liability Companies
Single-member limited liability companies may also be considered disregarded entities for tax purposes. Single-member LLCs are created under state law. The owner of a single-member LLC may elect to have the entity treated as a corporation by the IRS, or can choose to have the IRS tax it as a disregarded entity, attributing all of its income, expenses and profit to the person who owns it. Multiple-member LLCs that choose to be taxed as partnerships also function as pass-through entities, or they may elect to be taxed in the same manner as ordinary C corporations.