California Real Estate Practice Exam

Which business structure does not avoid double taxation?

1. Sole Proprietorship

2. Partnership

3. Limited Liability Company (LLC)

4. Corporation

The correct answer is: Corporation

The reason that the corporation is identified as the business structure that does not avoid double taxation lies in its tax treatment under federal law. Corporations are considered separate legal entities from their owners (the shareholders). As a result, when a corporation generates profits, it must pay corporate income tax on those earnings. If the corporation then distributes its profits to shareholders in the form of dividends, those dividends are taxed again at the individual level, leading to double taxation. In contrast, other business entities such as sole proprietorships, partnerships, and limited liability companies (LLCs) typically allow profits to "pass through" to the owners without being taxed at the entity level. This means that the income earned by these entities is taxed only once—at the individual level for the owners—thus avoiding the scenario of double taxation. Understanding the distinct tax implications of these various business structures is crucial for business owners when choosing how to organize their enterprises.