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    Tax Topic 407

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    Topic 407 – Business Income
    Business income may include income received from the sale of products or services. For example, fees received by a person from the regular practice of a profession are business income. Rents received by a person in the real estate business are business income. A business must include in income payments received in the form of property or services at the fair market value of the property or services.

    A business may be organized as a sole proprietorship, partnership, or corporation. A sole proprietorship is an unincorporated business owned by an individual. A sole proprietorship has no existence apart from its owner. Business debts are personal debts of the owner. A limited liability company (LLC) owned by one individual is treated as a sole proprietorship for federal income tax purposes unless the owner elects to treat the LLC as a corporation. A sole proprietor files Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship), or Form 1040, Schedule C-EZ (PDF), Net Profit From Business (Sole Proprietorship), to report the income and expenses of the business and reports the net business earnings on Form 1040 (PDF), U.S. Individual Income Tax Return. A sole proprietor who has net earnings from Schedule C or C-EZ of $400 or more, must file Form 1040, Schedule SE (PDF), Self-Employment Tax. A taxpayer uses Schedule SE to figure self-employment tax, which is the sum of the social security and Medicare taxes on self-employment income. For more information on sole proprietorships, refer to Publication 334, Tax Guide for Small Business.

    A partnership is an unincorporated business organization that’s the result of two or more persons joining to carry on a trade or business, a financial operation or venture. Each person contributes money, property or services in return for a right to share in the profits and losses of the partnership. An LLC with more than one owner is treated as a partnership for federal tax purposes unless the LLC elects to be treated as a corporation. A partnership reports its income and expenses on Form 1065 (PDF), U.S. Return of Partnership Income. The partnership itself doesn’t pay income tax. Each partner receives a Form 1065, Schedule K-1 (PDF), Partner’s Share of Income, Deductions, Credits, etc., that indicates the partner’s distributive share of partnership income, expenses, and other items, determined in accordance with the terms of the partnership agreement. Partners report on their income tax returns the amounts reported on the Schedule K-1. For more information, refer to the Form 1065 Instructions. For more information on partnerships, in general, refer to Publication 541, Partnerships.

    The term corporation, for federal income tax purposes, generally includes a legal entity separate from the persons who formed it under federal or state law or the shareholders who own it. It also includes certain businesses that elect to be taxed as a corporation by filing Form 8832 (PDF), Entity Classification Election. Corporations report their income and expenses and calculate their tax on Form 1120 (PDF), U.S. Corporation Income Tax Return. For more information on corporations, refer to Publication 542, Corporations. Corporations that meet certain requirements may elect to be taxed under subchapter S of the tax code by filing Form 2553 (PDF), Election by a Small Business Corporation. These rules generally treat S corporations in a manner similar to partnerships. S corporations file Form 1120S (PDF), U.S. Income Tax Return for an S Corporation, and are generally not subject to regular income tax. Most income and expenses of an S corporation are passed through to the shareholders on Form 1120S, Schedule K-1 (PDF), Shareholder’s Share of Income, Deductions, Credits, etc. The shareholder’s report on their income tax returns the amounts indicated on the Schedules K-1. For more information on S corporations, refer to the Form 1120S Instructions.

    A Limited Liability Company (LLC) is a business structure allowed by state statute. Depending on elections made by the LLC and the number of members, for federal tax purposes, the IRS will treat an LLC as either a corporation, partnership, or as part of the LLC owner’s tax return (a disregarded entity). For more information, see Limited Liability Company (LLC).

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