Entity and Trust Taxation

How a business entity or trust is taxed determines how income, losses, and deductions reach the investor's tax return. Understanding these structures helps you make suitable recommendations.

C-Corporations

• Taxed as a separate entity at the corporate tax rate (flat 21%)
• Subject to double taxation - corporation pays tax on earnings, then shareholders pay tax on dividends received
• Dividends paid to shareholders are not deductible by the corporation

Exam Tip: Gotchas

• The defining feature of C-corporations is double taxation. The corporation pays 21% on earnings, then shareholders pay dividend tax on distributions.

S-Corporations

• Pass-through entity - income, losses, deductions, and credits flow through to shareholders' individual tax returns
• The entity itself generally pays no federal income tax
• Avoids double taxation
• Limited to 100 shareholders, must be U.S. residents, one class of stock only

Exam Tip: Gotchas

• S-corp limitations are frequently tested. 100 shareholders max, one class of stock, U.S. citizens/residents only.

Partnerships and LLCs

• Pass-through entities - income and losses flow to partners/members on Schedule K-1
• Partners are taxed at their individual rates on their allocable share of income
• Limited partnerships - limited partners receive passive income (relevant for passive loss rules)

Trusts and Estates

• Trusts and estates are separate taxable entities with their own compressed tax brackets
• Trust income distributed to beneficiaries is taxed on the beneficiary's return (passed through on K-1)
• Trust income retained by the trust is taxed at the trust's rates
• Trust tax brackets are highly compressed - the top rate (37%) applies at just ~$15,450 of income (vs. ~$609,350 for individuals)
• Grantor trusts - the grantor (creator) is treated as the owner for tax purposes; income is taxed on the grantor's return

Exam Tip: Gotchas

• Trust tax brackets are severely compressed. A trust hits the 37% rate at a very low income level (~$15,450). This makes it tax-inefficient to accumulate income inside a trust; advisers should generally recommend distributing income to beneficiaries in lower brackets.

REITs (Real Estate Investment Trusts)

• Must distribute at least 90% of taxable income to shareholders
• The entity avoids corporate-level taxation if distribution requirements are met
• Distributions generally taxed as ordinary income (not qualified dividends)

Exam Tip: Gotchas

• REIT dividends are ordinary income, not qualified dividends. This is a common exam trap.

MLPs (Master Limited Partnerships)

• Publicly traded partnerships (typically energy/natural resources)
• Pass-through taxation with K-1 reporting
• Distributions are often return of capital (reduce basis, not immediately taxable)

Entity Taxation Comparison