Regardless of whether you have to pay taxes or not, the IRS requires all entities to file documentation showing their financial activity for the year. Non-exempt entities have to record their activity on a return and either the entity itself or the organization’s owners have to pay tax on earned income. Exempt entities need to report their financial activity to demonstrate they qualify for exempt status and comply with tax-exemption rules. However, both entities have the same filing requirements if they employ individuals for a wage.
Non-exempt tax entities include businesses, estates and trusts. Some entities, such as estates and C-corporations, are taxable entities. This means that the entity itself must pay some form of tax on its assets or income. The related filings reflect this responsibility, and are structured with the purpose of calculating the tax liability. Other businesses, such as partnerships and S-corporations, are flow-through entities. This means that these entities’ income and losses are divided among the owners or beneficiaries and the individuals pay tax on their share of the income. In addition to filing the appropriate report summarizing their annual activity for submission to the IRS, a flow-through entity is also required to provide a detailed report to its beneficiaries or owners detailing their share of the income, its type and how it should be treated for tax purposes. This report is generally provided on a K-1.
Tax-exempt status is reserved for entities that have a purpose outside of making money. Generally, these entities' purpose is to educate, provide charitable gifts or organize social groups. To achieve this designation, the entity has to apply with the IRS, which will then formally grant the designation. Once the exemption is granted, the entity is still required to file annual reports, or Form 990s, summarizing its financial activity with the IRS. This is done to ensure that income is recorded appropriately and is not against tax-exempt regulations.
Despite the difference in reporting requirements between exempt and non-exempt entities, there are some commonalities between the two types. Both are required to apply for and receive employer identification numbers (EINs). These are the IRS equivalent of Social Security numbers for entities and are used to identify these entities for tax purposes. Also, if these entities have any employees, both types of entities are required to file paperwork regarding their employees’ wages and pay employment taxes. The relevant form is the W-2, the Wage and Tax Statement issued to employees at the end of the year; Form 941, the employer’s Quarterly Federal Tax Return detailing what employee and employer taxes are owed; and Form 944, the Employer’s Annual Federal Tax Return detailing what employee and employer taxes are owed.
When preparing any annual report for the IRS, consult with a certified public accountant to ensure that filings are accurate and in compliance with federal law. Keep copies of the completed filing as well as all documents supporting the underlying facts for at least seven years, in case of an audit. While every effort has been taken to ensure this article’s completeness and accuracy, it is not intended to be legal advice.
- IRS.gov; Estate Tax; March 2011
- IRS.gov; Publication 542 – Corporations; February 2006
- IRS.gov; S Corporations; December 2011
- IRS.gov; Partnerships; September 2010
- USLegal.com: Non Profit Law & Legal Definition
- IRS.gov: Form 1023 – Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code
John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.