Accounting for partnerships and corporations involves the same basic steps. Both
must track revenue and expenses, file payroll reports if they have employees,
account for inventory, pay property taxes and comply with any safety or
environmental regulations that apply. The two critical differences between
partnership and corporate accounting involve income taxes and equity accounts.
Taxes Corporations
One key difference between partnerships and corporations is how taxes are
handled. The Internal Revenue Service considers a corporation as an independent
tax entity. Corporations must compute federal income tax on earnings, file the
appropriate reports and remit payment. When a corporation distributes funds, the
individuals receiving these distributions are liable for personal income tax. This can
result in double-taxation, or the concept that the same money is being taxed
twice. From an accounting point of view, corporations must track income tax
liabilities, make periodic deposits, if required, and at year-end, issue 1099s to
stockholders receiving dividends and W-2s to officers or employees receiving
salaries.
Taxes Partnerships
The IRS considers partnerships as pass-through entities. A partnership itself is not
subject to federal income tax on earnings. Instead, partners report their
distributions on their personal income tax returns. This avoids dual taxation.
However, partners are taxed on what was earned during the year, not what was
distributed. Potentially, partners may pay taxes on funds they have yet to receive.
Accounting for partnerships involves maintaining a separate account for each
partner to record earnings as well as any loans or draws the partner might take
against earnings. The partnership agreement specifies the stake each partner has in
the business. For example, in a partnership with four equal partners, each has a 25
percent stake and is liable for taxes on one-fourth of the partnerships earnings. At
year-end, each partner receives a Schedule K-1 detailing, among other things, the
portion of earnings related to his stake. Partners use the K-1 to prepare their
personal tax return. Partners are typically liable for self-employment taxes, meaning
that they pay both the employee and employer portions of Medicare and Social
Security taxes.
Equity Accounts Corporations
Corporations are owned by stockholders, individuals who own at least one share of
the companys stock. Corporations do not create a separate equity account for each
stockholder. Instead, equity is typically recorded as a bulk amount in the capital
stock account under stockholders equity. When a corporation declares a dividend,
the total dividends are placed in a temporary account, normally called a dividend
account, which is debited when dividends are declared and credited when they are
paid. At year-end, any remaining balance is cleared, with the offset to retained
earnings