You might be surprised to learn that a for-profit business you start might not be a taxable entity, while some nonprofits are required to pay taxes. You can structure a small business or the way you offer contract services in different ways, based on how you want to handle your liability and taxes. Understanding the taxable entity meaning will help you choose the right one for you.
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What's a Taxable Entity?
A taxable entity is a business or person required to pay income taxes. If a business or individual is required to file an income tax return, it's a taxable entity. Businesses that pass their profits directly to the owner or owners, who then pays taxes on the profits, are not taxable entities because they are not taxed – the owner is. This term isn't generally used to describe private citizens.
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Understanding Non-Taxable Entities
If you run a small business, you might want to pass the profits onto yourself, paying personal income tax on your profits. This way, you won't have to file separate tax returns or pay the higher corporate income tax rate. If you choose to set up your business as an S corporation, limited liability company, partnership or sole proprietorship, those are non-taxable entities, explains business consulting firm, Wolters Kluwer.
If you choose to set your business up as a corporation, including a C corporation (common for small businesses), your business would need to file separate tax returns and pay income tax at the corporate rate.
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For-Profit vs. Nonprofit Entities
Nonprofits often pay taxes, based on their tax status and activities. However, they are not taxable entities even if they are required to pay taxes on some of their activities because they aren't required to file income tax returns each year. Instead, they file a Form 990, which lists their income and expenses.
Let's look at a trade association for plumbers. It exists to help its members be better plumbers, make more money and/or lobby legislatures. Those aren't charitable goals. Because the organization's mission isn't to make a profit, however, the IRS would award this type of nonprofit 501(c)(6) tax-exempt status.
A local charity that raises and distributes money for social activities would get 501(c)(3) status. Nonprofits can make profits, but that can't be their main focus, and they can't pile up large profits without spending them on their mission or the IRS might revoke their tax-exempt status.
In addition, they might have to pay income taxes on some activities. For example, if either organization publishes a member magazine that costs $30,000 per issue to print and mail, but generates $60,000 in advertising sales, the organization would probably have to pay tax on the $30,000 of unrelated business income.