While there are many factors to consider when forming your business, how the business’s income will be taxed is among the most important. Pass-through entities, such as partnerships, tax a business by dividing the income among the owners and having them include that amount on their personal returns. C Corporations tax business income twice; the federal government taxes the corporation when it earns the income, then taxes the shareholders when it receives dividends from the corporation. Therefore, the C Corporation has a tax disadvantage in comparison to pass-through entities. How great that disadvantage is depends on the corporate tax rate, the owners’ individual tax rates and the overall plan for the business.

Evaluate your plan for the business. A large part of the actual disadvantage depends upon how much of the business’s income is distributed to the owners. Dividends can be taxed only when they are issued. If the owners do not plan to take any distributions, much of the corporate tax disadvantage might be mitigated.

Estimate the business’s annual gross income, tax deductions and planned distributions. Gross income is all revenue that a business earns during the year from all sources. Tax deductions are expenses that the business incurs during the year and are used to determine taxable income. Distributions are transfers from the business to the owners, based on their degrees of ownership.

Compute your tax liability as if the business were a flow-through entity by multiplying the owners’ share of taxable income by the owners’ personal marginal tax rate. Taxable income equals the gross income minus the relevant tax deductions. For a pass-through, the amount of tax an individual owner must pay is based on his share of the business’s income. His share is determined based on what percentage of the business he owns. The marginal tax rate is the rate applied to additional income earned by the individual beyond his current earnings for the year. The marginal rate for the individual owner in the case of a flow-through entity is the tax rate he pays on the last dollar of income generated from the owner’s wages and other fiscal activity.

Compute the tax liability as if the business were a corporation by applying the appropriate tax rates to the business’s taxable income. Corporate tax rates as of October 2011 range from 15 to 38 percent. Divide the total liability by the number of business owners to estimate each owner’s share of the tax.

Compute the tax on distributions as if it were a corporate dividend. Qualified dividends are those that are issued by a U.S. corporation whose underlying stock was held by the recipient for more than 60 days during the 121 days that began 60 days before the ex-dividend date. The ex-dividend date is the last day you can purchase a stock and still be able to claim the dividend. As of October 2011, qualified dividends are taxed at either 0 or 15 percent, depending on the taxpayer’s income. All other ordinary dividends are taxed at the taxpayer’s marginal ordinary tax rate.

Add the taxes assessed on your share of the corporate income and on the dividends to determine the total corporate tax liability.

Subtract the flow-through tax amount from the total corporate tax liability to determine the tax disadvantage to each owner.


Estimates are not predictors of future performance and provide only a general idea of financial conditions. When preparing your business’s tax returns or to estimate tax disadvantages, consult with a certified public accountant.