TAXABLE ENTITIES, TAX FORMULA,
INTRODUCTION TO PROPERTY
SOLUTIONS TO PROBLEM MATERIALS
The three classes of taxable entities under the Federal income tax system are:
Regular corporations; and
Fiduciaries (Estates and Trusts).
In addition to the taxable entities, the partnership files an information return showing its income,
deductions, gains, and losses, and how they are allocated among the partners. An S corporation, or electing
small business corporation, usually pays no Federal income tax and is treated similar to a partnership. (See
The net taxable income of a corporation is subject to Federal income taxation. Any portion of the net profit
remaining that is distributed to its shareholders as dividends is taxed at the shareholder level. The
corporation is not entitled to a deduction for this dividend paid. This is thought by some to be double
taxation because they believe the same income is taxed twice. (See pp. 3-5 and 3-6.)
A fiduciary that makes no current distributions is taxable on its entire net taxable income. When a
fiduciary makes distributions, they are generally taxable to the beneficiaries to the extent of the trust’s or
estate’s taxable income. Any distributions in excess of the entity’s income are considered distributions of
capital, known as corpus, and are tax free.
It is important to note that the trust or estate is entitled to a deduction for the amount of distributions
that are taxable to the beneficiary(ies). Therefore, the income is not taxed twice. (See Example 4 and 5
The annual return of a partnership (Form 1065) merely provides information about the income, deductions,
gains, losses, and credits of the partnership, and information about how they are allocated among the
partners. Since the partnership is never subject to tax on its income, the return can properly be referred to
as an information return. The same is generally true of the S corporation tax return (Form 1120S), but in
some instances penalty taxes must be paid. (See Example 7 and p. 3-10.)
The question is not specific as to whether the income of the partnership is derived from a trade or business
The guaranteed compensation paid to Y is subject to income tax and self-employment taxes.
Y’s share of net income of $22,000 is subject to income tax. It is also subject to self-employment tax
if it was earned in a trade or business. If it was not trade or business income (e.g., rents), the income
would not be subject to self-employment tax.
(See p. 3-10.)