Of the types of business organization, income earned in a C corporation is generally subject to the toughest tax bite, as the earnings are taxed twice. First, a corporate income tax is imposed on the corporation’s net earnings. Then, after the earnings are distributed to shareholders as dividends, each shareholder must pay taxes separately on its share of the dividends. A corporation can reduce, or even eliminate, its federal income tax liability by distributing its income as salary to shareholder-employees who actually perform valuable services for the corporation. Although this can reduce taxation at the corporate level, employees who receive payments from a corporation in exchange for services must still pay tax on the amount received, which is treated as salary.
This scheme of taxation differs radically from that applied to partnerships, limited liability companies, S corporations, and sole proprietorship. These entities do not pay an entity-level tax on their earnings. There is no income tax on partnerships, or on limited liability companies treated as partnerships for federal tax purposes. Nor is there an S corporation income tax or sole proprietorship income tax. Rather, the owners or members of these entities are taxed n their share of the entity’s earnings.