How each entity is taxed
Schedule C, Form 1065, Form 1120-S and Form 1120 — and Northwind's illustrative year taxed twice as a C corporation (32.85%) or once as a partnership.
The entity decides which return the business files, and whether its profit is taxed once or twice. There are four federal returns to know.
Twice, or once
A C corporation pays 21% on its taxable income. When it pays a dividend out of what's left, the shareholders are taxed again, and the corporation gets no deduction. Qualified dividends are taxed at the capital gain rates, 0%, 15% or 20%, and higher-income owners can owe the 3.8% net investment income tax on top (over $250,000 of income on a joint return, $200,000 for most others).
A pass-through skips the first layer. If Northwind were an LLC taxed as a partnership, the same $20,968.80 would land on two K-1s of $10,484.40. No entity tax — but each founder owes income tax on that share at their own rates whether or not the cash is paid out, and, as an active member, self-employment tax of $1,481.40.
Wrong
Pass-through always beats a C corporation because there's only one tax.
Right
C corp: 21% now; the second layer only on what's paid out. Pass-through: owners' rates on all of it, every year, cash or not.
Pass-through isn't automatically cheaper. A C corporation that keeps its profit to grow pays only the first layer, and its owners' second layer may never come — or come at a low rate on a sale of qualified small business stock. A pass-through's owners pay every year, on income they may not have received.
Northwind's dividend, from the founders' side
JE-14 declared a $500 dividend, $250 to each founder. Each is over the $10 threshold, so Northwind sends each founder a Form 1099-DIV for the year they're paid, and each reports it on their own return.
A C corporation's profit is taxed when earned and again when paid out; a pass-through's is taxed once, to the owners, as earned.
In this lesson: self-employment tax worked on Schedule SE, the §199A deduction after the 2025 law, and the taxes states put on the entity itself.
Pages in this lesson
3 pages go deeper, about 10 minutes in all. Read them in order, or open the one you need.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Background reading explains; it is never the authority for a rule. Anything marked as a convention is ours, not the rule-maker's.
- Federal statute
- 26 U.S.C. §1(h)(1), (h)(11)(A) (opens in a new tab)Qualified dividends are taxed at the capital gain rates: 0%, 15% or 20%Free to read
- 26 U.S.C. §1411(a)(1), (b) (opens in a new tab)Net investment income tax: 3.8%, over $250,000 joint or $200,000 for most othersFree to read
- 26 U.S.C. §11(b) (opens in a new tab)Tax imposed on corporationsFree to read
- IRS guidance
- Instructions for Form 1065 (2025), When To File (opens in a new tab)Form 1065 — who files and whenFree to read
- Instructions for Form 1120-S (2025), When To File (opens in a new tab)Form 1120-S — who files and whenFree to read
- IRS, Forming a corporation (opens in a new tab)Corporations — the double taxFree to read
- Instructions for Forms 1099-DIV, Specific Instructions (opens in a new tab)Form 1099-DIV for each shareholder paid $10 or moreFree to read
- Official form
- Form 1065 (2025) (opens in a new tab)Form 1065, U.S. Return of Partnership Income (PDF)PDF · Free to read
- Form 1120-S (2025) (opens in a new tab)Form 1120-S, U.S. Income Tax Return for an S Corporation (PDF)PDF · Free to read
- Form 1120 (opens in a new tab)U.S. Corporation Income Tax Return (PDF)PDF · Free to read
- Background reading — not an authority
- Wikipedia, “Double taxation” (opens in a new tab)Double taxationFree to read
The words this lesson teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- Double taxationA C corporation's profit taxed to the corporation when earned and again to its shareholders when paid out as dividends. The corporation gets no deduction for the dividend, and shareholders cannot deduct its losses
- Pass-through entityAn entity whose income is taxed to its owners instead of itself — a partnership, an S corporation, a disregarded entity. Each owner is taxed on their share of the income, which need not match the cash the entity pays out
- Schedule K-1The statement a partnership (with Form 1065) or an S corporation (with Form 1120-S) gives each owner, reporting that owner's share of income, deductions and credits for their own return
- Self-employment taxSocial Security and Medicare on net earnings from self-employment — 92.35% of net profit, taxed at 12.4% up to the year's wage base and 2.9% on all of it — owed once net earnings reach $400, with half deducted from income. Sole proprietors and general partners pay it on Schedule SE
- C corporationA corporation taxed as a taxpayer in its own right: it files Form 1120 and pays 21% of its taxable income, and its shareholders are taxed again on what it pays them as dividends. Every corporation is a C corporation unless it elects S status
- DividendA distribution of earnings to shareholders, declared by the board — a liability from the declaration date and a reduction of retained earnings, never an expense
In the founder glossary
This lesson’s ideas, explained for the founder running the company. Each has an entry in the founder glossary.
See also
- Journal entry for dividendsWhen dividends are declared, debit Dividends declared (or Retained earnings) and credit Dividends payable. When paid, debit Dividends payable and credit Cash. At year-end, close Dividends declared to Retained earnings.
- Journal entry for an owner's drawFor a sole proprietorship or partnership, debit Owner's drawings and credit Cash when the owner takes money out. At year-end, close drawings to capital: debit Owner's capital, credit Owner's drawings. A contribution is the reverse: debit Cash, credit Owner's capital.
- Journal entry for an income tax provisionAt period-end, debit Income tax expense for the total provision, credit Income taxes payable for current tax, and credit (or debit) the Deferred tax asset for the change in deferred tax, such as a net operating loss carryforward used this year.
- Startup tax deadlines by month for a C-corpFederal tax deadlines for a calendar-year C-corp, month by month: W-2s, 1099s, Form 941, Form 1120, estimated taxes and Delaware franchise tax.
- Form 1120: what to give your tax preparer, and whenWhat a startup hands its tax preparer for Form 1120: closed books, a balance sheet that ties to Schedule L, book-to-tax items, ownership and 1099s.
- Qualified small business stockStock in a US C corporation, issued directly by the company while its gross assets were under a limit, can let holders exclude some or all of the gain on sale from federal income tax.