Taxable and Nontaxable Income

In accordance with the Internal revenue guidelines, the following are some pertinent information that must be considered in determining taxable and nontaxable income for individuals. Also, a description of business entities is provided for guidance.

Individuals

Most types of income are taxable, but some are not. Income can include money, property or services that you receive. Examples of income that are usually not taxable:

1. Child support payments;
2. Gifts, bequests and inheritances;
3. Welfare benefits;
4. Damage awards for physical injury or sickness;
5. Cash rebates from a dealer or manufacturer for an item you buy; and
6. Reimbursements for qualified adoption expenses.

Some income is not taxable except under certain conditions. Examples include:

1. Life insurance proceeds paid to you because of an insured person’s death are usually not taxable. However, if you redeem a life insurance policy for cash, any amount that is more than the cost of the policy is taxable.
2. Income you get from a qualified scholarship is normally not taxable. Amounts you use for certain costs, such as tuition and required course books, are not taxable. However, amounts used for room and board are taxable.

All income, such as wages and tips, is taxable unless the law specifically excludes it. This includes non-cash income from bartering – the exchange of property or services. Both parties must include the fair market value of goods or services received as income on their tax return.

If you received a refund, credit or offset of state or local income taxes, you may be required to report this amount. If you did not receive a Form 1099-G, check with the government agency that made the payments to you. Report any taxable refund you received even if you did not receive Form 1099-G.

Corporations

A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.

The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.

S corporations are corporations that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income.

To qualify for S corporation status, the corporation must meet the following requirements:

1. Be a domestic corporation
2. Have only allowable shareholders
   1. including individuals, certain trust, and estates and
   2. may not include partnerships, corporations or non-resident alien shareholders
3. Have no more than 100 shareholders
4. Have one class of stock
5. Not be an ineligible corporation i.e. certain financial institutions, insurance companies, and domestic international sales corporations.

Form 2553 is required to be signed by all shareholders in order to become an S corporation

Partnerships

An unincorporated organization with two or more members is generally classified as a partnership for federal tax purposes if its members carry on a trade, business, financial operation, or venture and divide its profits. However, a joint undertaking merely to share expenses is not a partnership. For example, co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants.

An organization formed after 1996 is classified as a partnership for federal tax purposes if it has two or more members and it is none of the following.

1. An organization formed under a federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic.
2. An organization formed under a state law that refers to it as a joint-stock company or joint-stock association.
3. An insurance company.
4. Certain banks.
5. An organization wholly owned by a state or local government.
6. An organization specifically required to be taxed as a corporation by the Internal Revenue Code (for example, certain publicly traded partnerships).
7. Certain foreign organizations identified in section 301.7701-2(b)(8) of the regulations.
8. A tax-exempt organization.
9. A real estate investment trust.
10. Any other organization that elects to be classified as a corporation by filing Form 8832.

Every partnership that engages in a trade or business or has gross income must file information showing its income, deductions, and other required information. The partnership return must show the names and addresses of each partner and each partner’s distributive share of taxable income. The return must be signed by a general partner. If a limited liability company is treated as a partnership, it must file Form 1065 and one of its members must sign the return.

If a partnership is terminated before the end of what would otherwise be its tax year, Form 1065 must be filed for the short period, which is the period from the beginning of the tax year through the date of termination. The return is due the 15th day of the fourth month following the date of termination.

Limited liability company

A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC. Unlike a partnership, none of the members of an LLC are personally liable for its debts. An LLC may be classified for federal income tax purposes as either a partnership, a corporation, or an entity disregarded as an entity separate from its owner .

A domestic LLC with at least two members that does not file Form 8832 is classified as a partnership for federal income tax purposes.