Contractor License Practice Exam

In what type of business structure does the owner pay income taxes on the net profit at the owner's individual tax rate?

1. Partnership

2. Sole proprietorship

3. Corporation

4. LLC

The correct answer is: Sole proprietorship

A sole proprietorship is a business structure where the owner and the business are legally the same entity. This structure allows the owner to report business income and losses on their personal tax return, meaning that the net profit is taxed at the individual tax rate of the owner. This system is straightforward, as it simplifies tax filing and avoids double taxation, which can occur in other business structures, such as corporations. In contrast, a partnership involves multiple owners but still allows the income to pass through to the partners' individual tax returns. Although the income is reported similarly to a sole proprietorship, the question specifically refers to "the owner," indicating a single entity. A corporation, on the other hand, is a separate legal entity that pays its own taxes, and any distributions to shareholders can incur additional taxation. An LLC (Limited Liability Company) offers flexibility in taxation; it can be treated like a sole proprietorship or a corporation depending on the number of owners, but it doesn't specifically refer to an individual owner's tax situation. Thus, the sole proprietorship is the structure where the owner pays income taxes on net profit directly at their individual rate.