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Rev. date: 12/10/2013

Business Income

Tax Topic 407
Business income may include income received from the sale of products or services. For example, fees received by a person from the regular practice of a profession are business income. Rents received by a person in the real estate business are business income. Payments received by a business in the form of property or services must be included in income at the fair market value of the property or services.
A business may be organized as a sole proprietorship, partnership, or corporation. A sole proprietorship is an unincorporated business owned by an individual. A sole proprietorship has no existence apart from its owner. Business debts are personal debts of the owner. A limited liability company (LLC) owned by one individual is treated as a sole proprietorship for federal income tax purposes, unless the owner elects to treat the LLC as a corporation. A sole proprietor files Form 1040 (Schedule C), or Form 1040 (Schedule C-EZ), (with Form 1040), to report the income and expenses of the business. A sole proprietor who has net earnings from Schedule C or C-EZ excluding church employee income of $400 or more or has church employee income of $108.28 or more, must file Form 1040 (Schedule SE). A taxpayer uses Schedule SE to figure self-employment tax, which is the sum of the social security and Medicare taxes on self-employment income. For more information on sole proprietorships, refer to Publication 334, Tax Guide for Small Business.
A partnership is an unincorporated business organization that is the result of two or more persons joining together to carry on a trade or business, a financial operation, or venture. Each person contributes money, property, or services, in return for a right to share in the profits and losses of the partnership. An LLC with more than one owner is treated as a partnership for tax purposes, unless the LLC elects to be treated as a corporation. A partnership's income and expenses are reported on Form 1065, U.S. Return of Partnership Income. No income tax is paid by the partnership itself. Each partner receives a Form 1065 (Schedule K-1), Partner's Share of Income, Deductions, Credits, etc., which indicates the partner's distributive share of partnership income, expenses, and other items, determined in accordance with the terms of the partnership agreement. Partners report on their income tax returns the amounts reported on the Schedule K-1. For more information, refer to the Instructions 1065. For more information on partnerships, in general, refer to Publication 541, Partnerships.
The term "corporation," for federal income tax purposes, generally includes legal entities separate from the persons who formed them under federal or state law or the shareholders who own them. It also includes certain businesses that elect to be taxed as a corporation by filing Form 8832, Entity Classification Election. The tax on a corporation's income is figured on Form 1120, U.S. Corporation Income Tax Return. For more information on corporations, in general, refer to Publication 542, Corporations. Corporations that meet certain requirements may elect to be taxed under subchapter S of the tax code by filing Form 2553, Election by a Small Business Corporation. These rules generally treat S corporations in a manner similar to partnerships. S corporations fileForm 1120-S, U.S. Income Tax Return for an S Corporation, and are generally not subject to regular income tax. Most income and expenses of an S corporation are "passed through" to the shareholders on Form 1120-S (Schedule K-1), Shareholder's Share of Income, Deductions, Credits, etc. The shareholders report on their income tax returns the amounts indicated on the Schedules K-1. For more information on S corporations, refer to the Instructions 1120-S (PDF).