Instructor Blog - Credit College - Credit Basics

Q: Just a side note. There is also a self-employment (SE) tax to be paid on taxable income from sole proprietorships as well as partnerships and Subchapter S corporations in certain situations

A: Partners and sole proprietors must pay all FICA and Medicare taxes themselves, i.e., must pay the full amount of the self-employment tax rather than sharing the burden with their employer.  The partnership does not pay its share of these taxes on the pro-rata share of partnership profit belonging to the partners. The same is true for a sole proprietorship. Note, too, that neither partners nor sole proprietors may take a salary, since salary is not allowed as a tax-deductible expense.

Q: Can you give an example of a Subchapter C corporation versus a non-subchapter c corporation please?

A: Business Organizations Terms and Concepts discusses the various types of business organizations. In addition, the primary differences are highlighted on slides 47 – 51. The major distinction between the Subchapter C corporation and the non-subchapter C business organizations is that federal income tax accounts are present on the income statement and balance sheet for a Subchapter C corporation because the Subchapter C corporation is responsible for paying the income taxes on the profit that it generates. Federal income tax accounts are absent on the income statement and balance sheet of all other types of business organizations because these types of business organizations are not responsible for paying federal taxes on the profits that they generate. The individual owners are responsible for paying the taxes.
 
The owners of these non-subchapter C business organizations receive the cash to pay the taxes from distributions, withdrawals, and loans from their companies. This has critical implications for analysis, which we will address in Session 3. We need to adjust reported profit to account for these distributions, withdrawals, and loans because they are provided for taxes, and any amount in excess of that required to pay taxes is compensation. Taxes and compensation are operating expenses.

An example of a Subchapter C corporation is Microsoft – a huge publicly traded company owned by thousands or millions of equity investors that hold stock in the company. The company pays income taxes directly and, at times, issues taxable dividends to its owners.

Total Coverage, Inc. is a Subchapter S corporation, owned by a single individual who is responsible for paying income taxes on the taxable income his company generates. In addition, the owner – Larry Crevin – supplements his income via distributions from his company, which are tax free to him.