If you sell a service or a product, the money you make is generally defined as business income. Additionally, business income includes real estate rents and any fees for service that is paid to an individual. Business income must be reported at tax time, regardless of the type of business.
There are three different classifications for the type of businesses one can own.
- Sole Proprietorship is defined as an individual-owned business that has no incorporation. If the owner leaves, the business is no longer active. An important distinction is that all business debts and expenses belong to the individual owner and are considered personal. If your business is registered as a limited liability corporation (LLC), the IRS will consider it a sole proprietorship if you are the only owner. However, you can chose to have your LLC taxed as a Corporation if you chose. Sole Proprietorship businesses will file Form 1040, Schedule C, Profit or Loss from Business (Sole Proprietorship), or Form 1040, Schedule C-EZ when completing a tax return. These types of businesses which make greater than $400 net profit are required to pay Social Security and Medicare taxes, which can be calculated by filing a Schedule SE, Self-Employment Tax.
- Partnership is defined as a business venture with two or more individuals responsible for the operation of the business, trade or finances. This type of business is not incorporated, and each “owner” is responsible for the operation of the business in order to gain shares and the rights to losses. LLCs with multiple owners are treated as a partnership, unless the LLC has opted to be taxed as a corporation. Each partner is responsible for a distribution of the taxes, instead of the entire partnership being taxed as a single business. The partners will report on their individual returns the amount of partnership taxes stated on a Form 1065 Schedule K-1.
- Corporation is defined as its own legal entity that is completely detached from both owners and shareholders. Businesses, such as LLCs, can chose to be taxed under the corporation regulations. In doing so, all businesses taxed as a corporation are required to report their net profits using Form 1120, U.S. Corporation Income Tax Return. Corporations can chose to be taxed as a subchapter S corporation, provided certain regulations are met. S corporations generally are taxed under the guidelines for a partnership, where regular income tax is not applicable. Instead, the shareholders are taxed and need to report the amount individually on their tax returns.