If a business wants to avoid double taxation, which form is preferable?

• A. Sole proprietorship
• B. S corporation
• C. C corporation
• D. General partnership

Answer: (B)

Double taxation happens when earnings are taxed once at the entity level and again when distributed to owners as dividends. An S corporation avoids this by using pass-through taxation: the business itself isn’t taxed on its profits; instead, those profits and losses pass through to the owners and are reported on their personal tax returns. This means profits are taxed only once, at the owners’ individual rates, rather than at both the corporate and personal levels. At the same time, an S corporation provides limited liability protection, which sole proprietorships and general partnerships do not offer. C corporations, by contrast, face double taxation because profits can be taxed at the corporate level before dividends are taxed again at the shareholder level. So, the form that best minimizes tax layering while preserving liability protection is the S corporation, within its eligibility rules (such as limits on the number and type of shareholders).