Unlike a C corporation, an S corporation is not a separate taxable entity for most federal and state income tax purposes.The S corporation’s owners (shareholders) pay tax on a proportionate share of the income and gain realized by the company (whether or not it is distributed to them) and may, subject to certain limitations, use the entity’s losses to offset other income. Not every corporation, however, is eligible to be an S corporation.

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An individual who operates a business as a sole proprietorship without forming an entity will be directly taxable on the business income and gain, and may, subject to certain limitations, be able to offset other income and gain with the loss and deduction from the business.

The individual reports the sole proprietorship’s income, gain, loss and deduction on his or her federal and state tax returns.

Two or more individuals who operate a business without forming an entity will nevertheless be taxed as a partnership.

For example, for tax purposes, corporations may be classified as C corporations or S corporations.

C corporations are separate taxable entities for federal and state income tax purposes.

A C corporation pays an entity-level tax on its income and gain and only the C corporation may take advantage of any loss and deduction it generates.

A C corporation’s owners (shareholders) pay another tax on the corporation’s distribution of corporate earnings and profits when distributed as a dividend.

Partnerships themselves are not subject to income tax (though they are required to file an income tax return.) Rather, income, gain, deductions and loss generated by the partnership are reported by each partner on his or her federal and state tax returns as allocated by the partners.

Most entrepreneurs, however, choose to operate through a legal entity such as a corporation or a limited liability company (“LLC”) for business reasons, including the limitation of liability.