Contents

§ 2.8 TAXABLE AND NONTAXABLE ENTITIESqualifying corporations are known as S corporations and are treated in much thesame way as partnerships. Limited liability companies are also generally taxedin the same manner as partnerships.Business entities such as partnerships and limited liability companies,though separate legal entities, are not taxable entities. Income received by partnershipsis reported on the partnership level, but the income tax is imposed oneach individual partner on the partner’s share of partnership income. The sameis true with respect to members of limited liability companies. Income receivedby sole proprietorships is taxed to the individual proprietor generating theincome.One category of taxpaying entity is the individual. Individuals are living, naturalpersons (human beings), not fictional creatures.A corporation is a creature of law, existing as an entity generally created pursuantto state law. The hallmark of a corporation is that it usually shields andinsulates persons (individuals) from legal liability that may arise during thecourse of its existence and operation.As noted above, corporations are generally owned by individual taxpayingshareholders, and are themselves taxpaying entities. This results in two layers ofincome taxation.Another category of taxpaying entity is the estate. An estate is recognized asa legally separate person, separate from the individual who, by death, created it.An estate is the legal creation that encompasses all the property and rightsbelonging to a deceased individual, or decedent.Trusts are also creatures of law. A trust is a legal entity created by state lawand encompasses property transferred to it (known as the trust res) by the trust’screator/donor (known as the grantor of the trust) for the benefit of some one orsome thing (known as the trust beneficiary). A trust may be created during thelife of a grantor (an inter vivos trust), or upon the death of a grantor (a testamentarytrust).Other business entities or organizations that do not meet the definition orcriteria of a corporation may not be separately taxed. Instead, the taxable incomethey receive may be taxable to the individuals that form or compose the organization.These types of organizations that are not corporations are genericallyreferred to as associations.Even though an organization is not considered to be a corporation for purposesof state law, it may be deemed a corporation for purposes of federal incometax law. 29 Typically, organizations would like to be deemed associations to avoidtaxation, whereas the government would like them to be considered separate taxableentities. The IRS has promulgated criteria used to determine entity classification;these are in the check-the-box regulations. 30This demonstrates an important aspect of federal income tax law: substance,not form, usually governs and controls federal income tax questions.29 IRC § 7701 defines a corporation to include an association.30 Reg. §§ 301.7701-2 to -4. See Tax-Exempt Organizations § 4.1(b). 35