How Business Income is Taxed
How you pay taxes on your profits will depend on how you have structured your eBay business. As explained in the section Business Entities: What Kind of Business Should Your eBay Business Be?, there are four basic business forms: sole proprietorship, general partnership, limited liability company (LLC), and corporation (both “C” and “S” type). For tax purposes, however, there are only two types: those whose owners pay tax on business income on their individual tax returns (called “pass-through” entities, because income and expenses pass through the business to the owners), and those that must pay their own taxes.
The vast majority of eBay small business owners are running a pass-through entity. Sole proprietorships, partnerships, LLCs, and S corporations (corporations that elect to be taxed like a partnership) are all pass-through entities. A pass-through entity does not pay its own taxes. Instead, its profits or losses are deemed to be the profits and losses of the individual owners, who must report those amounts on their personal tax returns. Keep in mind that owners of a pass-through entity categorizes the entity’s income as their own, whether or not they actually receive any money from the entity. C corporations are separate entities for tax purposes.
The basic rules for reporting income by the various business entities are as follows.
Sole proprietors report business income and expenses on IRS Schedule C, Profit or Loss From Business, which they must file along with their personal tax returns (IRS Form 1040).
Partners report their respective shares of partnership income and expenses on IRS Schedule E, Supplemental Income and Loss, which they must file along with their 1040s. In addition, the partnership itself must file an informational return (IRS Form 1065, U.S. Return of Partnership Income) and provide each partner with an IRS Schedule K-1, which lists each partner’s share of income and expenses.
Shareholders in S corporations report their respective shares of the corporation’s income and expenses on their personal tax returns (IRS Schedule C, Profit or Loss From Business, and IRS Form 1040). In addition, the S corporation must file IRS Form 1120S, U.S. Income Tax Return for an S Corporation. This return gives the IRS information about the S corporation, but you don’t pay any taxes with it. Note that S corporations filing a calendar year income tax return usually have a filing date of approximately March 15, not April 15 as for individual returns. To assist you, here is a tax calendar.
LLC members report their income and expenses just like sole proprietors, if it’s a one-member LLC. In a multimember LLC, members report their income and expenses just like partners. A multimember LLC also has to file IRS Form 1065, U.S. Return of Partnership Income, and issue an IRS Schedule K-1 to each member. (LLCs may, however, choose to be taxed as C corporations by filing IRS Form 8832, Entity Classification Election, in which case the LLC would file its own tax return and pay its own taxes on LLC income.)
Shareholders in C corporations only report the corporation’s income to the extent the corporation pays it out to them. The C corporation, the form most large businesses take, is the only business form listed here that is not a pass-through entity. A C corporation must file its own tax return and pay its own taxes on corporate income. (It does so by filing IRS Form 1120, U.S. Corporation Income Tax Return.) Corporate shareholders have to report personal income tax on their IRS Form 1040 only on the corporation’s business income that is paid out to them as compensation or dividends. This is where the potential tax-saving benefits of incorporating come from — that is, shareholders can decide how much corporate income to distribute and how much to retain in the corporation, thereby timing when they will receive taxable income. Note that corporations filing a calendar year income tax return usually have a filing date of approximately March 15, not April 15 as for individual returns. To assist you, here is a tax calendar.