Decoding Business Equity
Your choice of business structure profoundly impacts liability, accounting, and taxes. This guide breaks down the essential differences.
Side-by-Side Comparison
Explore the core attributes of each business entity, from terminology to tax treatment.
Sole Proprietorship
Terminology: Owner’s Capital, Owner’s Equity.
Accounting: A single capital account tracks all owner transactions. Profits increase it, while losses and owner drawings decrease it.
Tax Form: Income is reported on the owner’s personal Form 1040, Schedule C.
Liability: Unlimited personal liability.
Partnership
Terminology: Partner’s Capital, Drawing Account.
Accounting: Each partner has a separate capital account reflecting their share of profits, losses, contributions, and drawings.
Tax Form: A pass-through entity. Partners report their share of income via Form 1065, K-1.
Liability: Unlimited for general partners.
S Corporation
Terminology: Shareholder’s Equity, Retained Earnings.
Accounting: Capital from stock issuance is tracked separately from accumulated profits (retained earnings).
Tax Form: A pass-through entity. Shareholders report their share of income via Form 1120S, K-1.
Liability: Limited liability for shareholders.
C Corporation
Terminology: Stockholder’s Equity, Common Stock, Retained Earnings.
Accounting: The most complex structure, tracking various stock types and retained earnings.
Tax Form: Corporation files Form 1120 and pays corporate tax. Dividends are reported on shareholders’ personal returns.
Liability: Limited liability for shareholders.
The Flow of Profit & Taxes
The tax journey from business profit to owner’s pocket differs dramatically. This visualization clarifies the two main paths: pass-through and double taxation.
Pass-Through Taxation
Applies to Sole Proprietorships, Partnerships, and S Corps. Profits “pass through” to be taxed once on the owners’ personal returns.
1. Business Generates Profit
2. Profit “Passes Through”
No Corporate Tax Paid
3. Owner Personal Tax Return
Income taxed once at personal rate
Double Taxation
Applies to C Corporations. Profits are taxed first at the corporate level, and again when distributed to shareholders as dividends.
1. Business Generates Profit
2. Tax #1: Corporate Income Tax
Corporation pays tax on profits
3. Remaining Profit Distributed
As dividends to shareholders
4. Tax #2: Personal Income Tax
Shareholders pay tax on dividends
Owner Liability Protection
A primary reason for incorporating is to shield personal assets from business debts. This chart shows the level of protection each structure offers.
Accounting Complexity
The number of distinct equity accounts often reflects the overall accounting complexity. More accounts mean more detailed tracking is required.