Federal Taxation of Partnerships and S-Corporations
As the title of the 2014 article “Why Use a Partnership Instead Of An S-Corp?” suggests, one of the primary criteria in selecting one particular entity type over another is the question of tax liability. In contrast to a C-corporation, in the case of a partnership or S-corporation, the income of the entity is not taxed; rather the partners and shareholders are taxed at standard rates. Income is not taxed at the entity level. It passes through to partners and shareholders and is taxed though them at their individual, personal tax rates. Of course, this raises the question of why become a C-corporation in the first place. But for very large entities, the benefits of legal fictional personhood are great, given that means that shareholders are not responsible for any debts or other legal liabilities generated by the C-corporation. In contrast, an S-corporation exists as an entity for federal tax purposes (“Why Use a Partnership Instead Of An S-Corp,” 2014).
Although they share some similar features, partnerships and S-corporations also share some critical differences. Partnerships function very much like sole proprietorships. They are very simple to set up, legally speaking. For a small business...
Yet the partners are also legally liable for the debts of the partnership, because there is no separation between the entity and the joint proprietors. On the other hand there is no risk of double taxation of the partners’ incomes and profits derived from the corporation.
Another advantage of a partnership is that any individual can be a partner and there are no limits upon the number of partners. In contrast, given that an S-corporation is designed to limit the scope and size of an incorporated entity, to make it distinct from the large, publically-traded C-corporation, there is a limit of 100 shareholders for S-corporations. S-corporations, unlike C-corporations, are also only permitted to issue one class of stock (“Why Use a Partnership Instead Of An S-Corp,” 2014). The ability of an S-corporation to generate revenue is thus more limited than that of a C-corporation. A partnership is likewise prohibited from selling shares to raise stock, although it is permitted to have different types of partners with different percentages of interest in the partnership (“Why Use a Partnership Instead Of An S-Corp,” 2014). This can, to…
