A photographer earns $8,000 from weekend weddings, deducts $22,000 in equipment, vehicle, and travel, and claims a $14,000 Schedule C loss for the third consecutive year. Without a documented profit motive, §183 reclassifies the activity as a hobby, the deductions vanish for tax years 2018 through 2025, and the $8,000 stays fully taxable.
This lesson covers the five federal entity classifications the IRS recognizes for tax purposes: sole proprietorships, partnerships and qualified joint ventures, C corporations, S corporations, and limited liability companies. Each interacts differently with default classification, the entity election regime under Treas. Reg. §301.7701-3, EIN issuance, tax-year selection, and the §183 hobby-versus-business test.
The simplest form. An individual operates a trade or business in their own name or under a DBA. Not a separate legal entity. The owner files Schedule C with Form 1040. Net profits flow to Schedule 1; net earnings of $400 or more trigger self-employment tax on Schedule SE (15.3% on the first $176,100 of 2025 net earnings, then 2.9% Medicare plus 0.9% additional Medicare on earnings above $200,000 single...
Common mistakes
- Treating LLC as a federal tax classification. LLC is a state-law form. Federal treatment is determined by member count and elections: disregarded, partnership, C corp, or S corp.
- Allowing a spousal LLC to elect QJV. §761(f) QJV is available only to unincorporated joint ventures, not to state-law LLCs. A spouse-owned LLC defaults to partnership classification (or disregarded only in community-property states under Rev. Proc. 2002-69). Trap value: filing two Schedule C forms for a spouse-owned California LLC.
- Confusing the 3-of-5 and 2-of-7 hobby presumptions. General activities use 3 profitable years in the last 5; horses (breeding, training, showing, racing) use 2 profitable years in the last 7. Trap answer: applying 3-of-5 to a horse operation.
Bottom line
- Five entity types: sole proprietorship (Schedule C), partnership/QJV (Form 1065), C corp (Form 1120, flat 21%), S corp (Form 1120-S), LLC (state-law form, default disregarded or partnership)
- Default classification: single-member domestic LLC is disregarded, multi-member is partnership; elect C-corp via Form 8832 or S-corp via Form 2553; 60-month lockout on changes
- EIN obtained free on Form SS-4; required for employees, partnerships, corporations, trusts, or certain retirement plans; sole props use SSN unless they have employees or file excise/employment returns
- Tax year: calendar default for individuals and S corps; C corps may pick fiscal (except personal service corps); partnerships/S corps need required year unless §444 election (≤3-month deferral)
Exam shortcut
Entity due date pattern: "3rd month" = pass-through (1065, 1120-S, 2553 election); "4th month" = C corp (1120); "5th month" = exempt org (990). All on the 15th. All extend 6 months on Form 7004 (Form 8868 for exempt orgs). Hobby presumption shortcut: if the fact pattern mentions horses, racing, breeding, or showing, use 2 of 7; everything else uses 3 of 5.
The full lesson (about 4,032 words, 27 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
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