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There are different kinds of businesses we can start, but of course, they have their pros and
cons. z The best way to select the type of business is by following the kind of business activities
we will have and how many people we are going to be involved in our business.
Sole Proprietor: This is a business owned by one individual. Usually selected by individuals
who start a new business with a modest amount of investment. They are allowed to contribute
cash to or withdraw profit from the business without tax consequences. A disadvantage is that
profits are taxed to the individual owner, whether retained or withdrawn for personal use.
Partnership: It only reports the taxes of everyone, but it does not pay the taxes of each one.
They must do it separately for their tax return. The tax rate for partners may be lower than a
corporation’s tax rate on the same level of taxable income, its income is not subject to double
taxation because it only taxes to the partners level. A disadvantage could be that all
partnership profits are taxed to their partners when they are earned, even if they are not
distributed. A partners rate could be even higher than a corporation’s rate for the same level
of taxable income.
Corporations: z There are two categories: C-Corporations and S-Corporations. C-corporations
are subject to double taxation, first at the corporation and second at the shareholder. By
contrast, S-Corporation is subject to single-level taxation. Earnings are counted for at the
corporation.
C-corporations the shareholders who are employed by the corporation are employees for tax
purposes. So, they are responsible only for have of their Social Security taxes, and the
corporation will be responsible for the other half.
Also, the tax rate for the C-corporation may be lower than its owners margin tax rates. It can
use a fiscal instead of a calendar year as its reporting period. The earnings may be used for
reinvestment and the retirement of debt.
S-corporations generally pay no tax, instead, S-corporate income passes through and is taxed
to the shareholders. Pass-through income may qualify for the 20% qualified business income
deduction. The self-employment tax does not apply to S-corporation pass-through income.
Shareholders are taxed on all an S-corporation’s current year profits whether the corporation
distributes these profits and whether the shareholders have the wherewithal to pay the tax on
these profits.
Among all these taxable entities account, only corporations may deduct compensation paid to
owner-employees, because a sole proprietor who works at the business may not deduct
compensation paid to owner-employee. Also, for partnerships, a partner is not considered to
be an employee.
The best way to assist a new business owner in identifying the correct form a business should
take, mainly for tax purposes, is knowing the kind of business activity, future goals, and how
far the client would like to succeed with the business. In this case, it is an individual who
would like to open a Restoration Furniture Shop. I have recommended an S corporation, just
for the fact it is a pass-through entity because the business income is treated as the personal
income of the owner and avoids double taxation. Also, the client will be using some of her
money and projecting to expand her business in the future by opening other stores. z Also, in an
S corporation, the shareholders are limited, and they can enjoy limited liability.
There are different entities a new business owner can choose from when beginning their
business. However, how they choose to run their business will and can determine which one is
a better option for them, their business, and any partners they choose to go into business with
if they choose that route.
Sole Proprietorship:
"A sole proprietorship is easy to form and gives you complete control of your business. You're
automatically considered to be a sole proprietorship if you do business activities but don't
register as any other kind of business" (SBA p4). This option is best for an owner that plans on
going into business with no one else and just themself. This option does not allow the liability
and assets be separate from the personal assets and liabilities therefore, the owner can be held
responsible for any debts and obligations that come from the business. z It can be hard to obtain
business loans from a bank or raise money on behalf of the business due to the inability of
creating and selling stock. However, this is a great option for business owners that are "testing
the waters" in running a business. The taxes are paid as self-employment tax or personal tax.
Partnership:
"Partnerships are the simplest structure for two or more people to own a business together.
There are two common kinds of partnerships: limited partnerships (LP) and limited liability
partnerships (LLP)" (SBA p 7). This means a business owner may go in on the business with
additional individuals. Each business partner may have unlimited personal liability unless it is
structured as a limited partnership. Alike the sole proprietorship the taxes are paid as self-
employment tax (except for limited partners) or personal tax.
Corporation:
"Corporations offer the strongest protection to its owners from personal liability, but the cost
to form a corporation is higher than other structures. Corporations also require more extensive
record-keeping, operational processes, and reporting" (SBA p17). There are many different
types of corporations a business owner can choose from, however, again it does depend on
what will be best for the owner(s) and the business itself. This option keeps all financials
separate from personal to business. Therefore, taxes are usually filed as tax exempt, however,
can vary based on the type of corporation the business owner chooses.
Business Example:
I personally have a small crafting business that I sometimes do on the side or whenever friends
and family need anything. I choose to have this business ran as a sole proprietorship as I am
the only business owner and I handle everything myself. The business is registered under my
social, therefore when I file my taxes, I take full responsibility and file the taxes for the
business under my personal taxes. This is because I am the only business owner, and not much
goes into running it or ensuring it stays afloat. I choose to use my personal money, if needed,
to continue running the business when I choose.
Proprietorship, partnerships, and corporate tax entities all provide various advantages and
disadvantages for business owners. Sole proprietorship are used for single business owners are
easier to setup than other tax entities. However, they provide liability insurance for any issues
they may arise. The businesses assets and liabilities are not separate from personal assets and
liabilities and don't provide liability insurance in comparison to some partnerships.
Partnerships are commonly Limited Partnership and Limited Lability Partnerships and are
created for multiple business owners. Limited partnerships offer unlimited liability to one
general partner and limited liability to other partners. Profits flow through to the general
partners tax return with no limited liability and profits flow through the other partners with
limited liability. Unlike sole proprietorships, these taxable entities are used for multiple
business owners and can be beneficial for companies such as accounting firms, law firms and
financial advising businesses.
Corporations are a taxable entity that can provide better protection to the owners by having the
corporation held legal liable. Corporations pay income tax on their profits and owners’ assets
and liabilities are separate. Corporations have shareholders that can hold equity in the
corporation and have an easier time finding investors than other taxable entities. S
Corporations can avoid the double tax that corporations can have and allow profits and losses
to passed through to owners. Corporations provide more protection to owners and provide
similar benefits as partnerships.
Business owners must come the decision of choosing how they want their businesses to be
taxed and held liable. An example of this could be a law office with two owners that want to
setup a business together. They could form a partnership and that has the profits and losses
passed through to the individual returns like a sole proprietorship. "For tax purposes, all of the
income of the partnership must be reported as distributed to the partners, and they will be
taxed on it through their individual returns. This is true whether the partners received their
shares of the income..."(Nelson,2020). Forming the correct business entity helps owners with
tax benefits that they might not see otherwise. Partnerships can avoid the double tax of
corporations while having profits and losses pass through the owners like proprietorships.
There are three types of common business formations; Sole Proprietorship, Partnership, and
Corporation. The type of business structure that is chosen is important because those effects
how much the business pays in taxes, the ability to raise money, the paperwork that the
business will need to file and the owners personal liability.
Sole proprietorship: this type of business is easy to form and gives the owner complete
control. A sole proprietorship does not need to have a separate business entity and are not
subject to taxation as a separate entity. z Profits however are taxed to the owner of the business.
Tax rates for a corporation are typically lower than that of a individual tax rate. This means
that assets and liabilities are not separate from personal assets and liabilities. z This also means
that on the other hand the owner is liable for debts and obligations of the business. You are
still able to get a trade name with this structure. One of the disadvantages is that it could be
hard to raise money as well as borrow money. Banks are hesitant to lend to this type of
structure.
Partnership: Partnerships are good for structures that have two or more people that want to
own a business together. z A limited partnerships (LP) and limited liability partnerships (LLP)
are the two options to choose from with this structure. With an LP, there is one general partner
that has unlimited liability. The remaining partners have limited liability. This also is in line
with the control that the partner has. A partner with limited liability usually has limited
control within the company. The profits of the business are passed through to personal tax
returns. The partner without the limited liability must also pay self-employment taxes. The
tax rate has the potential to be lower with is an advantage and it is not subject to double
taxation which is possible with a corporation.
An LLP is very similar; however, the limited liability is for every owner. The LLP protects
each partner from debts and will not be responsible for the actions of the other partners.
Corporations: z This is the structure that has the legal entity sperate from its owners. They can
make a profit, be taxed, and can be held legally liable. This structure has the strongest
protection to its owners. There is also a higher cost in forming this type of business and will
have more extensive record-keeping, operational processes, and reporting. Corporations pay
income taxes on their profits, which is often taxed on the profit and then when the dividends
are paid to shareholders. Shareholders will not be able to withdraw the profits without
recognizing it as income.
The business I choose is a Maple tree farm. The potential owner of this business just bought
50 acres of land that is all wooded and a great potential for being successful in making and
selling maple syrup. I choose this company to be a sole proprietor because it is the first time
that they owner has even been in business and will be starting from the ground up. This will
give the owner the opportunity to build the business and figure out if it will be a thriving
business. The tax forms will be simple while the owner is figuring things out. The owner
knows that all profits and losses will be on the personal tax return. z Profits will be taxed as the
owners tax rate.
Sole Proprietorship
The advantages of selecting a sole proprietorship include simplicity of tax forms, lower tax
rates than corporate rates, and ability to offset non-passive income of owner with business
loss. Some disadvantages include unlimited liability, higher income brackets are subject to tax
rates higher than corporate rates, and calendar year has to be used as the tax year. Owners may
withdraw cash without treating it as a dividend.
Partnerships
The advantages of partnerships is that it is not subject to double taxation. When business
owner receives contributions and distributions, normally they are not taxed. Furthermore,
similar to sole proprietorship, partners income can be offset by pass-through income/losses.
Disadvantages of partnerships is that depending on the marginal rate of income, tax rates can
be higher than that for corporations. Furthermore, partners’ fringe benefits are taxed as they
are not considered as employees.
C-Corporation
Compared to highest income bracket tax rates, corporate tax rates may have lower marginal
rates. Another huge advantage of forming a corporation is that owners are subject to limited
liability. Furthermore, certain fringe benefits are tax-exempt for shareholder-employees. Some
disadvantages include that corporations are subject to double taxation (business-entity level
and individual level). Unlike partnerships, net operating losses does not offset individual
shareholder income. Furthermore 20% QBI (qualified business income) deduction may not be
taken. Finally, when corporations distribute property in form of dividends to shareholders,
these are also taxable.
Example of business entity selection:
For companies in the airline industry or entering it, there is expected to be great risk. So, one
should choose to form a C-corporation that is subject to limited liability. Airline industries can
also be highly profitable, and C-corporations are subject to top corporate marginal rate of 21%
which is lower than the highest bracket income tax rate of individuals. Thus, forming a C-
corporation deems appropriate in forming a company in the airlines industry.
References:
Rupert, T. J., & Anderson, K. E. (2023). Prentice Hall’s Federal Taxation 2023 Corporations,
Partnerships, Estates & Trusts. Pearson Custom.
SBA. (2023). Choose a Business Structure. Retrieved from https://www.sba.gov/business-
guide/launch-your-business/choose-business-structure
Sole proprietorships, partnerships and llcs are commonly used entities. Back to top. (n.d.).
Retrieved February 2, 2023, from https://www.wolterskluwer.com/en/expert-insights/sole-
proprietorships-partnerships-and-llcs-are-commonly-used-entities
Choose a business structure. sba.gov. (n.d.). Retrieved February 5, 2023, from
https://www.sba.gov/business-guide/launch-your-business/choose-business-structure
Anderson, K., Hulse, D., Rupert T., Person’s Federal Taxation 2023 Corporations,
Partnerships, Estates, and Trust. z Pages 2-7
Pass Through Entity | Definition & Meaning | Investing Answers
Understanding S Corporations (investopedia.com)
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